Financial Crisis Intensifies Interest in Risk Management Among CFOs

Improved risk management is the top priority of CFOs in reaction to the current financial crisis, ahead of short- and long-term access to capital, according to a Towers Perrin survey of finance executives at major U.S. corporations.

Towers Perrin commissioned the survey by CFO Research Services, an affiliate of The Economist and CFO magazine, to gain insights on how companies view the seriousness of the financial crisis for their businesses. It also sought to learn about the likely impact on the way they conduct business.

The responses came from 125 top finance executives representing a solid cross section of American industry and were collected during the week of September 22, as Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke began making the rounds on Capitol Hill to pitch the administration's $700 billion rescue plan.

Risk management practices gain greater attention among CFOs

Here are some of the findings that stand out:

• Only 4% of respondents perceived the recent financial market meltdown as having a severe impact on their financial prospects. Although the majority acknowledged that the crisis would dampen profit expectations and leave a potentially lasting dent in the world economy, only five respondents feared a major negative impact on their financial results.
• Nonetheless, approximately 72% of respondents expressed concern about their own companies' risk management practices and ability to meet strategic plans. This suggests that finance executives, regardless of industry, perceive a need to invest in more effective risk identification, measurement and management procedures.
• In a related finding, a sizable minority (42%) foresaw more energized involvement by boards of directors in risk management policies, processes and systems, and a comparable minority foresaw intensified employee-level engagement.
• 61% expressed concern about raising short-term capital — a sobering percentage of the executives surveyed but hardly surprising given ballooning spreads in the commercial paper market.

Risk management practices on the top of the agenda for many CFOs

It is interesting that, despite the evident impact of the current financial crisis on liquidity and consumer confidence, more than half (55%) of the CFOs agree that they plan to put their risk management practices under a microscope and that this investigation will in many instances reach all levels of the organization, from the board down and from the shop floor up.

What Standard & Poor's stated so plainly when it announced the inclusion earlier this year of an explicit ERM component in its rating of corporate securities is echoed by America's leading finance executives: Effective risk management depends on effective risk culture — i.e., genuine awareness and control of risk throughout the organization, and genuine line-of-sight accountability.

Role of financial institutions in the current crisis

Given these findings, it is unsurprising that 62% of finance executives blame poor or lax risk management at financial institutions as a major contributor to the current financial mess. Nearly as many — 59% — cited the complexity of financial instruments, and 57% blamed financial market speculation.

In their written comments, although many respondents advocated better regulation of lending practices and derivatives, a still greater number focused on heightened vigilance by boards, management, investors and even regulators to risk management practices and risk-related incentives.

Towers Perrin assessment of critical risk management practices

In addition to the scope and intensity of risk awareness and control, we infer another dimension of risk management advocacy from this survey: the need for better risk measurement and aggregation.

Clearly, investors and financial institutions are still struggling to get their hands around the secondary and tertiary effects of the subprime debacle. Finance executives need risk management practices that identify and put order-of-magnitude values around their concentrations of exposure to demand-, cost- and financing-related risks.

CFOs are acutely aware that most business-plan stress testing is based on observed variability and correlations of business drivers during calmer economic periods. The survey results tacitly acknowledge what students of bubble economies have opined all along — that correlation factors double and redouble as stock market or economic fundamentals dip outside a normal range of values.

The upshot: We are still struggling to stay afloat in a Class V run through stormy whitewater rapids. The first-order quest of finance executives, given the survey responses, is to take three important steps:

• Get a better grip on the conditions that can expose a company (or the economy) to the risks associated with the current financial crisis.
• Measure the potential combined impact on short- and long-term financing needs.
• Then stock the balance sheet with the right mix and amount of provisions to weather the storm better than competitors.

With these and other steps, CFOs can look at future risk events as competitive opportunities that can minimize exposure to balance-sheet risk.

Please direct any questions to:

Prakash Shimpi
Enterprise Risk Management Practice Leader
(212) 309-3956
prakash.shimpi@towersperrin.com