Bigger shocks demand more spend on risk management

The move towards a connected, smarter world will create more frequent and severe large shocks, suggesting risk management resources will need to increase, according to speakers at this year’s Cambridge Centre for Risk Studies (CRS) annual summit. The so-called smarter world is likely to result in increased complexity and connectivity, as well as greater vulnerability to extreme shocks, according to Christopher Loch, dean of the Cambridge Judge Business School. “The smarter world will make us more vulnerable to bigger and scarier shocks than in the past,” he told delegates at the CRS summit. According to Mr Loch, there is a strong connection between complexity, risk and uncertainty, as can be seen in motor manufacturing and electronic chip design. An engineer by background, Mr Loch used examples of engineering product design, in which interdependencies can create “nightmarish scenarios” where changes in the design of one component can “ripple through” and significantly impact the work of others. In the worst cases, systems can become paralysed by such interdependencies. As systems get larger and more complex, the number of interdependencies increase, according to Mr Loch. For example, on average large projects overrun by 70%, while budgets end up 100% higher than scheduled. “No matter how robust you make a system, at some point the system gets so big you can’t control it anymore and it blows up in your face,” he told delegates. He noted that because of globalisation and digital technology, systems are becoming larger and more interdependent. Supply chains are becoming deeper and financial systems more interlinked, Mr Loch said. “A smarter world will make this all the worse…The global economy is exposed to more instability from increased complexity,” he warned. There are actions companies can take to counter this trend. These include limiting the size of projects, adopting a modular approach and ensuring people understand and coordinate complex systems. He also suggested there needs to be a “systemic approach” to address the systems effect of new technology, including greater international coordination and increased transparency. Daniel Ralph, academic director at the CRS and professor of operations research at the Judge Business School, also believes that businesses need to prepare for future nasty surprises and large shocks. “Digital interconnectivity gives rise to benefits but also risk. With technology and connectivity, the chances of things going wrong can happen faster and at a larger scale,” Mr Ralph told Commercial Risk Europe at the summit. “In the smarter world we will see increasing frequency and size of unpredictable shocks,” he said. Risk managers will not be able to predict such events but they should be able to respond, according to Mr Ralph. “Risk managers will no longer be able to rely on a template for their response. Day to day, it might not feel different but the size and rapidity of shocks will increase, and that is a big change,” he said. The increased risk of big shocks will have implications for risk managers, according to Mr Ralph. “Organisations will need to spend more time and money on their response to unexpected events, which will put them under more pressure and will increase the cost of doing business,” he said. “In terms of surviving a shock, the bruises will get bigger faster, so to survive it will take a bigger budget and management will be under more pressure to respond,” he continued. In addition to technology, the globalisation of delivery networks and supply chains is contributing to more complexity and interconnectivity of risk, according to Carolyn Williams, director of corporate relations at the Institute of Risk Management (IRM). This view was backed up by the IRM’s work on the ‘Extended Enterprise’, which demonstrated the complexity of networks of organisations. “For risk functions, this means that their area of concern can’t stop at the boundary of their own organisation, but has to spread wider to take an interest in the management of risk by their key suppliers, customers, regulators and neighbours,” said Ms Williams. Early findings of the IRM’s Risk Agenda 2025 research suggest that organisations are increasingly conscious of the challenges imposed by an increasingly complex world and its inherent fragilities, explained Ms Williams. Those polled intend to increase risk resources accordingly, she added. A smarter world will also have implications for the future skills of risk managers. According to Ms Williams, risk managers will need to deal with external risks at a strategic and operational level. This will mean developing skills in risk modelling, analytics and scenario planning, particularly in the world of big data and advanced processing capabilities. The financial services sector has already moved in this direction and there are indications that other types of organisation are now following down this route, explained Ms Williams. During the summit, CRS revealed a number of research areas that will be of interest to corporations and their risk managers. For example, they are developing datasets and analytical tools to help companies understand whether they are a likely target for cybercriminals and cyberterrorists, and can help quantify their vulnerability to cloud computing or infrastructure outages. CRS is developing a tool that will enable corporations to access such models – complete with scenarios and underlying data. It will also model against a set of 22 threats capable of causing large shocks, ranging from financial market meltdowns and natural catastrophes to wars and cyber attacks. To date, corporates and risk managers have been slow to adopt developments in risk modelling and analytics that are being developed far beyond the catastrophe models first used in the insurance industry. While corporations are advanced in operational risk management, they are yet to readily embrace probabilistic risk modelling, according to Andrew Coburn, vice-president at catastrophe modelling firm RMS and director of research and innovation at the CRS. While risk managers will need to become more familiar with data and analytics, they also need to be smarter on the strategic business side to help organisations exploit opportunities and take advantage of disrupted markets, according to Ms Williams. “As well as ensuring that the central risk team is competent, organisations are also looking at spreading risk management skills out into the business, with the risk manager taking the role of facilitator and builder of capability. Enhanced ‘soft skills’ like influencing, collaborating and facilitating will be increasingly important in this decentralised scenario,” she said.

Bigger shocks demand more spend on risk management

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