Transparency, Discipline and Allignment
Firms that have existed for any length of time are likely to have risk management. Some of it was there from the start and the rest evolved in response to experiences. Much of it is very efficient and effective while some of the risk management is lacking in either efficiency of effectiveness. But some of the risk management that they might need is either missing or totally ineffective. It is somewhat hard to know, because risk management is rarely a major subject of discussion at the firm. Risk management happens in the background. It may be done without thinking. It may be done by people who do not know why they are doing it. Some risks of the firm are very tightly controlled while others are not. But the different treatment is not usually a conscious decision. The importance of risk management differs greatly in the minds of different people in the firm and sometimes the actions taken to reduce risk actually work against the desired strategy of the firm. The proponents of carefully managed risk may be thought of as the business prevention department and they are commonly found to be at war with the business expansion department.
Enterprise Risk Management (ERM) is an approach to risk management that provides three key advantages over traditional, ad hoc, evolved risk management. Those advantages are:
ERM takes risk management out of the background and makes it an open and transparent primary activity of the firm. ERM does not push any particular approach to risk, but it does promote openly discussing and deciding and documenting and communicating the approach to each major risk. The risk appetite and tolerances are decided and spoken out loud and in advance in an ERM process, rather than in arrears (and after a major loss) as is more often the case with a traditional risk management program.
Transparency is like the math teacher you had in high school who insisted that you show your work. Even if you were one of those super bright math geeks who could just do it all in your head and immediately write down the correct answer. When you wrote down all of the steps, it was transparent to the math teacher that you really did know what you were doing. Transparency means the same sort of thing with ERM. It means showing your work. If you do not like having to slow down and show your work, you will not like ERM.
ERM is based upon setting up formal risk control cycles. A control cycle is a discipline for assuring that the risk controlling process takes place. A discipline, in this context, is a repeatable process that if you consistently follow the process you can expect that the outcomes from that process will be more reliable and consistent.
A pick-up sports team may or may not have talent, but it is guaranteed not to have discipline. A school team may have a little talent or a lot and some school teams have some discipline as well. A professional sports team usually has plenty of talent. Often professional teams also have some discipline. The championship sports teams usually have a little more talent than most teams (it is extremely difficult in most sports to have lots more talent than average), but they usually have much more discipline than the teams in the lower half of the league. Discipline allows the team to consistently get the best out of their most talented players. Discipline in ERM means that the firm is more likely to be able to expect to have the risks that they want to have.
ERM is focused on Enterprise Risks. In RISKVIEWS mind, Enterprise Risks are those risks that could result in losses that would require the firm to make major, unexpected changes to plans or that would disrupt the firm (without necessarily causing losses) in such a way that the firm cannot successfully execute the plans. Enterprise Risks need to be a major consideration in setting plans. Through discussions of Risk Appetite and Tolerance and returns for risks and the costs of risk mitigations, ERM provides a focus on alignment of the risk management with the strategic objectives of the firm.
To use another sports analogy, picture the football huddle where the quarterback says “ok. Everyone run their favorite play!” Without ERM, that is what is happening, at least regarding ERM at some companies.
Alignment feeds off of the Transparency of ERM and Discipline provides the payback for the Alignment.