Since late 2008, extraordinary volatility - in the form of currency fluctuations, new regulations, challenging business conditions and geopolitical events - has become the rule rather than the exception.
Many CFOs and other senior finance executives have learned to live with risk, adapting their operations to suit an environment typically characterised not only by high levels of risk but by capital constraints and the need to control and, if possible, reduce costs.
In such times, many CFOs have formed strong, mutually beneficial relationships with their Chief Risk Officers or CROs. One major area of common concern for CFOs and CROs is data integration.
Because regulators often increasingly require the integration of models into day-to-day business decisions, these models can be called upon to operate at a pace consistent with business demands. This can mean that the data inputs must be timely as well as reliable.
The CFO/CRO partnership
- and the overall integration of risk and finance - can affect management decisions related to risk appetite, entering or departing new businesses, capital sourcing and many other areas.
All such decisions can be dependent to a greater or lesser extent upon data quality. In addition, many businesses - including financial services firms -must now report their risks on a nearly real-time basis to regulatory authorities. This can increase the number of points of interaction at an operational level between risk and finance.
To reinforce and accelerate this integration, many CFOs and CROs have undertaken a number of initiatives including:
- Teamwork on data quality issues. Some organisations have hired a Chief Information Officer with responsibility for data quality issues for both the finance and the risk functions. At some other companies, the CRO and CFO meet regularly on a committee that reviews the quality of data.
- Improvements to data processes and systems. We have seen CROs and CFOs collaborating on major overhauls of corporate data processes and systems, including data-reengineering programs between risk and finance in an effort to deliver greater certainty regarding the accuracy, completeness and timeliness of data. Some other organisations have worked to develop common data warehouses, so that finance and risk are using the same source of information. Differing data sources can cause delays and may also become a source of unnecessary conflicts in the risk-finance working relationship.
- Joint development of risk and capital models. Risk models are often developed by the risk function but in close coordination with finance. Data fed into models often comes out of systems created by finance, and outputs from the models can in turn influence financial reporting.
- Greater use of risk analytics. More and more organisations are using sophisticated risk analytics, not only to support credit and financial decision making but to provide a stronger foundation for operational strategy. The risk function often provides analytics services to all functions, including finance, which can further foster integration.
- Responding to cost pressures. Risk and finance could once afford their own fiefdoms, but no longer. Improving efficiency can be furthered by the elimination of redundancy in data, processes and technology. In addition, emerging technologies for accounting rule engines and integrated risk and finance platforms may increasingly facilitate the integration of data, calculations and reporting as companies upgrade legacy IT systems over the next few years.
While there are compelling reasons for greater risk-finance integration, it is vitally important to consider safeguarding the independence of the risk function. Regulators, as well, tend to require independence of the risk function, even while encouraging further integration of risk into the business with a deeper understanding of various operational risk factors.
Despite these concerns, companies can derive significant benefits from a strong CFO-CRO partnership. From a strategic standpoint, the collaboration can help companies steer their business to where they can achieve better risk-adjusted returns.
Better measurement of risk-adjusted returns can lead to exits from high-risk businesses and the redeployment of resources to areas where there is a better chance of sustained profitability.
It has also been our experience that a “holistic” approach to risk management - integrating risk and finance - can result in a more competence in risk management.
Bringing together various types of risk, including credit risk, operational risk and market risk, can provide a much more realistic overall risk profile and stronger management of the volatile external business environment.
The business conditions that contribute to seemingly “permanent volatility” may not go away anytime soon, but working together, CFOs and CROs can help their organisations identify, quantify and manage this turbulent environment.