Regulation and compliance biggest strategic risk, says Ernst & Young

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LONDON – Regulatory and compliance risk was ranked the greatest global strategic risk facing businesses in 2008 in ‘Strategic Business Risk 2008: the top 10 risks for global business,’ a report released by Ernst & Young and think tank Oxford Analytica. Global financial shocks, an aging consumer base and workforce, and emerging markets were at the top of the table. Industry consolidation/transition, energy shocks, execution of strategic transactions, cost inflation, radical greening and consumer demand shifts were in the lower tier.

Globalisation, and the increase of global rules and regulations, has resulted in an ever-growing burden for global firms, so it is no surprise this featured as the top risk for global businesses.

“Globalisation continues to cause a major compliance headache for many organisations, which are frequently being forced to manage diverse regulations as they expand into new markets,” says Fiona Sheridan, head of risk advisory services at Ernst & Young. “The response from business to these challenges has largely been either to back away from opportunities because of regulatory restrictions or to build up a ‘layer cake’ of internal risk activities that barely touch each other.”

The credit crunch is evidence of the widespread impact one financial event can have on the global market. This impact is not confined to the money markets but can affect real estate, biotechnology, oil and gas, and utilities, says the report.

One respondent stated: “A crisis in structured finance markets could lead to potential systematic problems. Sustainability of financial sector growth is more fragile than markets realise. There is the potential for dramatic fallout from excessive leverage.”

A new entry in the top 10 was ‘radical greening’, reflecting the rise of environmental concerns on international political agendas. Although it could have a significant effect on all areas of global business, it was considered a very low risk for the pharmaceutical, biotechnology, banking, telecoms, and media and entertainment sectors.

Gerard Gallagher, head of business risk services at Ernst & Young, is surprised by this finding. He believes these sectors do not consider radical greening a major risk to their business because they aren’t heavy energy users and their business is not dominated by carbon use or emissions. But he says they are wrong to think it does not touch their business.

“The carbon agenda is starting to cut across all sectors and affect consumer demand. These sectors could therefore be exposed if they view this as an operational risk rather than a strategic risk. For pharmaceutical companies, climate change affects disease and how disease is spread. This could have significant impact on pharmaceutical product distribution and future product development,” he said.

The survey also asked the analysts to identify risks outside the top 10 that have the potential to become globally significant within the next three to five years.

The five most likely to become serious factors are the war for talent, a disease pandemic, the rise (and possible fall) of private equity, the inability to innovate, and a setback from China.

Gallagher says: “The global heavyweights of tomorrow are already identifying these risks and developing strategies to use them as a point of competitive advantage in the race for increased market share. Someone’s challenge is frequently someone else’s opportunity – and how an organisation exploits strategic risk will be what separates the winners from the losers.”

Sheridan concludes: “This report is just a snapshot of the risks we see now. Risks, and the business perception of them, will change over time. If we had done this exercise 10 years ago, it is unlikely that climate change would have placed so highly. That is why it is so important for global businesses to be looking at all risks, not just the critical risks of today, but also those sitting just below the horizon. They could rapidly become critical. “CEOs need to be more open-minded about risk – they should look beyond financial and regulatory risks to the wider environment in which their organisation operates. It is important that all boards have strategic business risks on their radar – ignoring them is not an option as they can be the quickest and most permanent destroyers of stakeholder confidence, and that’s not good news for CEOs.”

The report gathered information from more than 70 analysts from around the world in more than 20 disciplines, including law, finance, the sciences, business strategy, geopolitics, regulation, medicine, economics and demographics. They were drawn from 12 of the world’s most important sectors: asset management, automotive, banking and capital markets, biotechnology, consumer products, insurance, media and entertainment, oil and gas, pharmaceuticals, real estate, telecommunications, and utilities. Interviews were open ended and no predetermined list of risks was used.