Risks and Uncertainties - Is there a focus?
A company's Board has overall responsibility to determine the company's approach and develop its culture towards risk, risk identification, oversight of risk management and crisis management. Better risk decision-making should not automatically mean less risk-taking, which is essential to entrepreneurial activity. Companies Act requirements impose a duty on directors to disclose and describe the principal risks and uncertainties facing their company's business. Such disclosures should include explanation of actions taken and processes adopted to mitigate the effects of those risks and uncertainties. Supervisory authorities, including the Irish Accounting and Auditing Supervisory Authority (IAASA) and the UK Financial Reporting Review Panel (FRRP), have commented that there is considerable scope for improvement by many companies in the way they report such information in their Annual Report.
Two areas which are currently receiving significant attention are the sustainability of a company's business model in the light of a substantially changing environment for businesses, and the current economic uncertainties facing many countries and regions.
Challenge to Sustainable Business
Actual and prospective resource scarcity, population growth, environment concerns in a world of increasing globalisation and growing policy activity in response to financial, governance and other global issues have heightened expectations of corporate transparency and accountability. These are the broader considerations to be embraced in the development of corporate strategies for wealth creation and protection. Ensuring that the negative social and environmental impacts of business activities are reduced to be consistent with development in a finite planet is a fundamental principle of sustainability.
For a large and growing number of customers, suppliers, employees, investors and others, sustainability has become a key criterion often determining whether or not they wish to be associated with an organisation. Substantive indications of how the demands and expectations facing the corporate community have moved over time are:
- Approximately $22 billion is invested in socially responsible funds, representing about 10% of global capital markets
- In 1975 83% of market value of global corporates was represented by physical and financial assets, by 2009 this had reduced to 19% with the remainder represented by intangible factors, some of which are explained within financial statements but many of which are not
Such factors highlight the need for boards to ensure that their organisations view corporate sustainability as more than just good corporate citizenship, it must be an integral part of overall business strategy. The Discussion Paper (DP) on Integrated Reporting issued by the International Integrated Reporting Committee in September 2011 is a significant step in the evolution of an integrated report which would bring together material information about an organisations strategy, business model, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates. Will this be the bringing together of the various strands within the current corporate reporting model, or something more than that?
A Deloitte global survey of 200 Chief Financial Officers (CFOs) suggested that key questions to be addressed by organisations include:
- Have you fully worked through the basics of sustainability management?
- Do processes for capital investment and mergers and acquisitions/divestitures anticipate shifts to a sustainable economy?
- Do you understand your company's positions in markets linked to the environment?
- Do you know what sustainability questions stakeholders are asking and the answers?
- Do you have the right team, with the right skills to address the emerging issues?
The Deloitte survey suggests that astute CFOs can help their companies gain competitive advantage by developing strategic insights on costs, benefits, risks and ultimately opportunities arising from the sustainability imperative.
A separate Deloitte publication, 'the Sustainable Board' comments that sustainability is seen by many leading organisations as the next megatrend, which will transform organisations, their markets, and the economy in a way comparable to past megatrends, such as the advent of mass production, the IT revolution, and globalisation. The publication examines some of the important sustainability issues facing boards today, highlighting the need for these matters to be considered in the context of the principle risks and uncertainties presenting challenges to organisations today. The culture of 'short-termism' which many would see as a key contributor to the fundamental issues causing economic and financial difficulties on a global basis is very much exposed when sustainability of the business model becomes the key issue.
The FRC has recently published an 'Update for Directors of Listed Companies: Responding to Increased Country and Current Risks in Financial Reports'. This comments on the need for directors to convey a balanced and understandable assessment of a company's position and prospects in the context of increased country and currency risks. Currency and/or country risks have seen significant change in the past year, of particular note are:
- Funding pressures on certain countries
- Curtailment of capital spending
- The possibility of one or more Euro area countries being forced to exit the Euro area
- Risks arising from regime changes in the Middle East
These conditions may give rise to delays or other defaults on contracts with customers and other trading partners exposed to, or based in, countries experiencing difficulties, and /or may affect expectations of future business volumes and margins.
Areas where directors may need to give additional attention include:
- Potential impairment of non-financial assets - a company may need to impair property, plant and equipment where output is being substantially sold to consumers in countries experiencing significant economic difficulty
- Potential impairment of non-financial assets - are there debts due from corporates or financial institutions that need to be reviewed for impairment - or is there exposure to a particular country in major difficulty
- Risk of change in carrying amount of assets and liabilities - disclosure may be required of particular risk positions or exposures, even where provision for impairment is not required
Valuation and recovery of assets may be the primary focus of attention in the FRC Update, but there may be other matters of concern including, for example, potential disruption of supply lines which may need consideration in the Annual Report.
A view expressed widely amongst investors is that Boards should focus on strategically significant risks in their Annual Reports, and that this might be done best by linking risk reporting to discussion of the business model. Discussing changes to the strategy and business model, and how the company might develop in the future, might enable companies to air some key risks in a way that did not raise commercial sensitivities.
Market participants do not welcome surprises, effective reporting helps to avoid them and support companies in maintaining the trust and loyalty of stakeholders.
First published in Finance Dublin Online.