Building a taxonomy of emerging risks

Identifying the emerging risks facing any individual organisation can be extremely tough - after all none of us has a crystal ball that can tell us the future.

But the Cambridge Centre for Risk Studies has been developing a new taxonomy of risks with a view to helping businesses do just that.

Speaking to an audience of insurers and risk managers at a Lloyd’s of London event, Understanding the next 10 years of corporate risk, Oliver Carpenter a research assistant at the research centre said that the group has been working on a structured approach to identify the emerging risks facing companies.

To develop the new taxonomy, researchers took a three-step approach.

Step one – extensive review of risk registers

To better understand the risks organisations are facing, the group carried out an examination of risk registers published by public companies in the UK.

Carpenter said: “There’s a growing requirement for companies to disclose their risk and we read through a whole load and picked up over 1,000 different risks disclosed by a number of public companies in various sectors.

“They key thing we picked up from this is there’s a really wide variation in what businesses perceive [to be the top threats], even within an individual sector.”

The top risks identified by companies were not surprising and included factors such as corporate finance and operations, government and regulations and capital markets and economic conditions. These risks were stated in disclosures by most corporations.

More surprising were the risks that appeared lower down the list. These are the threats that weren’t identified by many businesses in the register and included consumer power, key personnel, business continuity and physical asset damage.

Carpenter commented: “These might be sector-specific risks, but you’d still expect to see a lot higher percentage of companies disclose them… But because there’s no consistent methodology - there’s no one way of doing this and as a result you miss out on key areas of the risk.”

Step two - historical reviews of distress

The next thing the group considered was historical incidences of corporate distress and what had been the root causes of these.

The idea here was to try and establish those risk factors and causal processes that have led to sectors or individual organisations struggling or collapsing to help identify emerging threats to businesses in the future.

Carpenter said: “The symptoms ranged from factors like profit warnings or credit downgrades to formal insolvency.

“Although there’s no definition of distress we tried to pick out a few key things, so we looked at shocks, operation efficiencies and financial performance, the ability to meet creditor obligations, and high sensitivity to the macro economy.

“So as an example, we saw in 2017 that oil and gas, energy and mining companies made the highest percentage of bankruptcies in that year. And as we all know, that’s a sector that’s experienced rapid change as we transition to a low carbon economy.”

“But if we look at Monarch, we can see that there’s not necessarily one cause of distress or bankruptcy, and in some cases there’s multiple.

“Monarch was subject to terrorism, not directly, but their two biggest markets were Egypt and Tunisia – so when they lost tourism that dried up Monarch’s custom.

“At the same time, I couldn’t mention corporate distress without mentioning Brexit and when we had a big fall in the pound it increased Monarch’s loss and eventually ended up with them going bankrupt in 2017.”

By looking at sectors and companies in this way, the Cambridge Centre for Risk Studies was able to map out the plethora of risks facing companies and highlight those threats that could lead to future business failures.

Step three – predicting the future

The final stage in identifying core emerging risks was to take these signals and look to the future to anticipate the unknowns, says Gardener.

He explained: “We anticipated risks and then mapped them to scenarios. So, we have a risk - for example a market crash - and then we have scenario which examines how that risk materialises to individual corporations, to the wider economy and to geopolitics.

“Sustainability and climate change is one of our key themes that’s really at the top of the corporate risk agenda even though [many businesses] don’t really understand it yet.

“We’re trying to provide scenarios, for example looking at [the impact of] consumer shift on a single product, or supply chain disruption due to Nat Cats and some less tangible and emerging risks which we haven’t really seen before.”