A number of unexpected catastrophes and shortages dominated the headlines in the first quarter of 2011. Japan was hit by a magnitude 9.0 earthquake and tsunami that caused a nuclear disaster, persistent power outages, and a host of other major societal and economic challenges. China sharply tightened its limits on exports of rare earth minerals, on which the information technology, automotive, and energy industries rely. The nations of the Middle East and North Africa experienced severe political eruptions, including civil war in Libya and regime-shaking protests in Algeria, Egypt, Iraq, Jordan, Syria, and Tunisia, which pushed oil prices above US$100 per barrel. Portugal and Greece tottered on the edge of insolvency, destabilizing their political leaders. Christchurch, New Zealand, was hit by two major earthquakes in quick succession, and the state of Queensland in Australia suffered the worst floods in recorded history in at least six river systems, resulting in great social and economic disruption.
All these events are examples of the kinds of high-magnitude, low-frequency upheavals that Nassim Nicholas Taleb labeled black swans, after a historical reference to their improbability.
Whether environmental, economic, political, societal, or technological in nature, individual black swan events are impossible to predict, but they regularly occur somewhere and affect someone. Some observers argue that the frequency of these events is increasing; others say global communication networks have simply made us more aware of them than we were in the past.
In any case, with the rise of global business, it is likely that black swans carry increased risks for your company, including negative impacts on your customers, suppliers, partners, assets, operations, employees, and shareholders. Today, not only can a catastrophe in one part of the world affect the sourcing, manufacture, shipping, and sale of products locally, but the interconnections of global financial, economic, and political networks ensure that the effects of such events ripple around the world.
This shows the importance of a currency hedging strategy. External surveys show that fewer than one in three small and medium enterprises are using forward exchange contracts and fewer than 15% employ a hedging strategy. This is generally a result of a lack of education on the subject that has led to some common misconceptions, such as that hedging is too complex and prohibitively expensive for small companies, or that it is “gambling” on the foreign exchange market. Yet small businesses can be the most vulnerable to currency exchange fluctuations.
Meanwhile, businesses also need to better understand how disruptions to the physical supply chain at the root of their currency flows could in turn affect their financial supply chains. Supply shortages in one market forced some businesses to look to other markets for short-term supplies, itself a costly process involving vetting new factories, arranging shipping and the like.
Risk management is not just about managing financial risks, such as risks relating to currency movements or changes in the price of commodities. It’s not just about managing the risk of failing to comply with laws and regulations. It’s not just about the risk of errors in the financial statements. It’s also not just about operational and strategic risks, such as the potential failure of a sole supplier.
It’s about managing the potential effects of uncertainty throughout your business operations. In other words, it’s all of the above. Whenever executives and the boards discuss strategies, they should be considering risk. Whenever managers make decisions, they should be thinking about the risks and doing something about them.
CFOs have the opportunity, if not the responsibility, to recognize where immature risk management limits the ability of the company to manage potential adverse events and seize opportunities. As corporate leaders, CFOs can help the executive management team recognize and realize the value of risk management when it is given executive support, resources, and made a part of how the organization works.
Risk management, in the words of COSO (the Committee of Sponsoring Organizations of the Treadway Commission), “helps an entity get to where it wants to go.” Even CFOs who do not have organizational responsibility for risk management should ask these questions:
- Is our risk management program mature? Is the consideration and management of risk part of how we make decisions at all levels of the organization?
- Are we prepared both to handle potential negative events and seize opportunities?
- How often are we surprised when we shouldn’t be?
- Do the executive leadership team and the board have the risk information they need to set and then modify corporate strategies?
- What actions are we going to take? When?
– How to Manage Risk Management by Norman Marks
– Safeguarding the Financial Supply Chain By Kerry Agiasotis
- CertFocus, Risk Management Compliance Assured (prweb.com)
- Community Banks Team with Centrix to Fight Payments Fraud and Manage Risk — ACH Risk Analytics – ACH Positive Pay – Check Positive Pay – Payee Match (prweb.com)
- Deloitte | A Risk Intelligent View of Reputation | Governance and Risk Management (bjconquest.com)
- Toyota: Rebuilding and Fortifying a Global Supply Chain (Part 3) (spendmatters.com)