A Business Reminder: Actively Manage Your Risk

12 November 2015


Yeah, yeah, yeah, you say. Firstline, tell me something I don’t know!

Ok, grasshoppers. Let’s set the scene with a story first…

About BP

Tony Hayward had experienced a long and successful career at BP. His rise up the ranks was nothing short of meteoric. In September 2000, he was appointed BP’s group treasurer and his responsibilities included global treasury operations, foreign exchange dealing, corporate finance, project finance, and mergers and acquisitions. Hayward became an Executive Vice-President in April 2002, and Chief Executive of Exploration and Production in January 2003.

Looking at this from a slightly different angle and focusing on his early career highlights, we can surmise that Tony Hayward knew all about the concept of risk.

Therefore, in 2007 when BP appointed Tony Hayward as their Chief Executive Officer, it is not surprising to note that he made safety his top priority. Accordingly, he instituted a wide range of requirements, even including that all employees use lids on coffee cups while walking, and refrain from texting while driving. These rules were applicable worldwide to all companies under the BP group umbrella.

All the rules Tony Hayward instituted were sensible ones really.

Three years later on the 20th April 2010, the Deepwater Horizon Oil rig exploded in the Gulf of Mexico causing one of the worst man-made disasters in history. Boom!

A U.S. investigation attributed the disaster to management failures that crippled “the ability of individuals involved to identify the risks they faced and to properly evaluate, communicate, and address them.”

Tony Hayward stepped down on the 1st October 2010. How the mighty had fallen!

Preliminary conclusion?

Sometimes rules aren’t everything. Sometimes they cloud our focus and hinder our ability to act.

Andertoons Cartoon

 

 

 

 

 

 

 

The Three Main Risk Categories

The first step in creating an effective risk management system for your own business is to acknowledge that every single business has risks (no, you have not hit upon some risk-free business model. Continue reading please) and then identify the main types of risks that your business faces.

In most organisations these can usually be grouped as follows:

Preventable risks

Strategy risks

External risks

Preventable risks

Preventable risks are internal risks that arise from inside the organisation. By their nature they are controllable and every effort should be made to eliminate them.

Perhaps the best example of a preventable risk is the “Rogue Trader”. A Rogue Trader may, for example, bribe a politician or spy on and undercut a competitor in order to achieve short term profits for a business in the form of “windfall profits” or a new contract, but over time things have a tendency to come back and “haunt you”, and ultimately will diminish the value of your business.

FIFA is a classic modern day example.

Preventable risks as a whole are best managed through the use of active prevention measures. This involves monitoring processes, behaviours, and decisions towards a desired norm.

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Strategy risks

The reality of business is that all entrepreneurs accept some risk in order to generate what they hope will be a superior level of returns. As an example, a bank or finance house assumes credit risk when it lends money, while a big airplane manufacturer like Boeing or Airbus take on risk through their research and development processes. Modern jets are bigger, lighter, and faster for just that reason.

Strategy risks are of a very different nature to preventable risks primarily because in most cases strategy risks are desirable because they provide the impetus to drive the business forward.

Anyone who has ever owned an investment will know that the risk and return in respect of that investment are intrinsically linked. All things being equal a rational investor anticipates that the higher the risk the greater the return.

Returning to BP’s drilling operations in the Gulf of Mexico, BP accepted the high risks of drilling several miles below the surface of the ocean because they were anticipating the high value of the oil and gas that they expected to extract.

Rules-based controls are inadequate for policing strategy risks. What is needed is a risk management system that is designed to reduce the probability that a possible risk might actually materialise, and to improve the business’s ability to manage or contain those risks should they in fact occur.

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External risks

Some risks arise from events that are external to the business and are therefore beyond its sphere of influence or control. Common examples of such risks would include natural and political disasters, and major macroeconomic events (e.g. the banking crash of 2007).

External risks require yet another approach. Because the events arising from the risk are outside the business’s sphere of influence and control, the managers of the business must focus on identification and mitigation of their impact.

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Wrapping up on risk

All businesses should consider the concept of risk. You should tailor your risk management processes around the three categories noted in this blog entry. This involves using your imagination which is sometimes not the easiest thing to do! Don’t be afraid to seek professional help if needed.

While a compliance-based approach will almost always be effective in containing the effect of preventable risks, in most cases it doesn’t work for both strategy and external risks. These risk categories require a frank, open, and explicit discussion within your organisation.

The question remains: is your business addressing all the risks?

Closing thoughts – a time to chill and a time to invest?

Firstline Securities Limited offers comprehensive coverage of local and international markets with a bias for the energy sector. We offer a number of unique opportunities to put surplus cash to work either as your asset manager or investment advisor. Please contact us for more details at info@nullfirstlinesecurities.com or at 868.628.1175. We can discuss your investment needs in detail and craft a portfolio that makes sense for you. We look forward to hearing from you.

Also, take a look at the indicative prices. Call/email us with your interests. Highlighted are the bonds that Ihsan believes are good investments for this week.
http://firstlinesecurities.com/wp-content/themes/fsl/uploads/2015/11/FSL-MARKET-UPDATE-151112.pdf

 

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