LAST September, consulting firm Accenture released a global survey that had a big surprise. Despite a stable global economy, booming markets and solid growth prospects, executives in North America, Europe and Asia now regard risk management as their top priority.
Surprisingly, managing risk was put ahead of achieving growth while increasing profitability. Looking after shareholder value was near
the bottom of the list.
Today’s paradox is that growth, economic stability and solid profits are masking, and in some cases, creating new risks. This problem is captured in a new report from Britain’s corporate regulator, the Financial Services Authority. In its Financial Risk Outlook report, the FSA said things had never been better, growth was steady and there had been no bad shocks to the system.
But it warned the risks had never been greater, and that there could be significant dangers in the next 18 months. “While global economic and financial conditions remained most favourable in 2006, a set of conditions has developed in economies and markets that could become unsustainable. Furthermore, the probability of these conditions unwinding in a disorderly fashion may rise over time.”
There are at least 10 potential flashpoints ahead.
1. Raw material costs: Commodity prices are booming, fuelled by demand from the surging economies of India and China, and this has put pressure on margins. With the downturn in oil prices, the trend now is that raw material costs have been decoupled from fuel and are now driven by tight supply and growing demand. The prices are volatile and vulnerable to any shocks, such as terrorism or bad weather, hitting the supply chain.
2. China and India: Developing a China strategy is now considered an absolute must for companies aspiring to be globally competitive. The same goes for India, the world’s second fastest-growing economy. China is well advanced in turning itself into “the world’s factory” and India already controls more than half the global IT and back-office outsourcing market. The emergence of these two players presents tensions and issues for global trade.
3. Risk appetite: In a low-volatility environment, households and financial institutions have been taking on more risk.
4. Debt: As a result of rising house prices and a good job market, consumers are borrowing more, leaving them vulnerable and ill-prepared for a downturn.
5. Compliance: Regulations are piling on around the world, all designed to reduce risk. But the sheer volume of compliance requirements can stretch resources of smaller companies and result in high opportunity costs.
6. Cyber crime: Experts are predicting more electronic malfeasance and attacks. Greater technological complexity and more cross-border transactions are fertile ground.
7. Capital markets: Regulators around the world are keeping an uneasy eye on the private equity boom, which, they say, has all the signs of a bubble.
8. Geopolitical risks in a stable environment: Growth is robust and volatility remains low. Geopolitical risks, however, are growing with the continuing conflict in the Middle East and issues out of North-East Asia, particularly North Korea. Regulators, like the FSA, are concerned that financial markets are now so complex that their models for pricing risk are not that accurate.
9. Inflation: Rising oil prices have contributed to an inflationary surge and, although those prices have come down, the market remains volatile, vulnerable to potential shocks such as global warming, supply and Iran’s nuclear program. In Australia, meanwhile, inflationary pressures are rising as a result of strong wages growth.
10. US housing: At the moment, there is little sign of the weakness in the US housing market creating any sort of contagion that would hurt the world’s biggest economy. However, some economists are warning that higher interest rates, falling house prices and the credit ethos do not bode well for the US economy.
This list is by no means comprehensive. There are many more risks ahead, and the solutions to these are not clear. These include climate change and the prospect of pollution taxes or a credible system of tradable permits. The proponents say these would promote the development of a wider variety of alternative energy sources and encourage energy conservation but critics fear they would impose costs.
Then there is the changing face of managerial capitalism, where company managers now have to answer to fund managers when the real owners, the retail investors, are often unaware of these relationships.
Not to mention the insatiable demand for energy that has resulted in the doomsayers predicting we will run out of oil.
Globalisation and population ageing are also major flashpoints. Good risk management is about thinking into the future. What’s so unsettling is that the imponderables ahead now seem even more profound.