Communicating Risk Strategy: Turning Plans into Action
They say it takes an oil tanker 2 kilometres to turn. That’s the distance between London’s St. Paul’s Cathedral and Tower Bridge or half the length of New York’s Central Park. With that kind of handling well implemented planning is critical to steer a ship. Executing business price risk management strategy has parallels. Fortunately for ships modern electronics do much of the work. Business managers face a complicated manual process however. What makes it worse is the necessary involvement of many people in several layers in numerous places that don’t understand how they matter. Crueler still is that risk means different things to each function and at each level. The peril of the “the broken telephone” ever hangs above like the sword of Damocles To avoid misunderstanding and inevitable disarray, risk planners use a simple communication framework to translate goals into results.
- All businesses face intrinsic risks from their markets, operations, technologies etc., but few are willing to accept them completely uncontrolled. Hence the risks a company is prepared to accept are really a residual. This is called “risk appetite”. Articulating risk appetite is key to strategy. It differentiates the business from competition, defines it for investors who want to participate in gains made from taking risk, and directs employees who must make profitability happen. A statement of risk appetite must be agreed by executive management and the board and is generally high level and qualitative. Its importance cannot be overstated. It will be the chart that is used to set the ship’s course.
- For functional management the deck below, risk appetite needs tighter focus. We’ve said in other blogs that the outcomes of risk programs must be measurable. Measurement does not work without a yardstick and it’s here that its length gets defined. Hence the degree of risk a company is comfortable with must be at least partially quantified. It will likely be an expression of aggregate risk. There may be many exposures to consider along with the practicality and desirability of trying to offset all risk. In risk circles, such guiding statements are known as “risk tolerance”. Measures can appear as percentages or hard numbers, whatever is practical for the situation, but tolerance statements are to be taken seriously. Breaches require immediate adjustment of exposures. As part of planning, developing guidance on such adjustments should also be done to avoid the consequences of knee-jerk reaction.
- Next deck down, the execution level, where actual results happen. Here, line management must translate strategy into hard edged terms, creating risk targets and limits that pertain to specific exposures and positions being attended to. Limits should be quantitative, easily measured and consistent with the hedging policy that will cover mechanics and controls. These can cover timing, the degree and nature of allowed exposure as well as positions to cover them. Breaches of limits must also be taken seriously. They require immediate review. Management endorsed action can range from situation monitoring to risk curtailment.
Through the entire chain, these measures must align. Each business will have its own special circumstances so a business’s mix of appetites, tolerances, targets and limits will be unique. To aid visualisation, the attached table gives examples from the metals industry, although the range of possibilities is by no means exhaustive. Before concluding, note that the communication framework must also change with the evolution of the business and its environment. Regular review and renovation, at least annually, is important. Putting this together can be daunting, whether it be the first time or as a result of a need to reflect change. If you lack experience, time or resources to “reinvent the wheel”, remember experienced guidance is available.
Examples of Risk Appetites, Tolerances, Targets and Limits