How do you build an effective risk appetite process?

A key governance and oversight challenge facing boards is to ensure that corporate decision-making is in line with the expectations of shareholders, the wider stakeholder community and the commitments made by management. However, in many organisations the parameters governing risk-return trade-offs are not clearly defined and, given the complexity facing most companies, an intuitive or rule-of-thumb approach is unlikely to provide optimal results.

Risk appetite is one steering mechanism that can help address this issue by providing a structured way of articulating (and making explicit) the risk-return trade-offs organisations are willing to make to achieve their strategic, commercial and financial objectives. It can also provide a mandate from the board to exco that defines the parameters the board would expect exco to operate within.

Boards that do not have a clearly articulated risk appetite statement are right to be concerned from a decision-making, governance and oversight and compliance perspective. As such, chairmen, heads of audit/risk committees and senior independent directors (SIDs) should take a lead in ensuring the discussion is firmly on the agenda.

In discussions with board members, it transpires that the risk appetite process is not always structured in such a way that:

• The process creates alignment between the various board members, be that executive or non-executive directors;
• The outcomes from the process make it easier to evaluate individual and sometimes competing calls for capital, be that for external or internal initiatives/transactions;
• There is a clear perception by the board that developing the risk appetite statement has been time well spent.

However, can alignment be created when there is a potential inherent conflict between the risk appetite of executive directors and the non-executive directors (NEDs)?

A good risk appetite discussion should, by its very nature, allow the board to address some challenging questions that otherwise tend to be addressed individually rather than holistically:

• Is our risk appetite incorporating the right risks (key source being principal risks)?
• What risks are meaningful/value-adding to include in a risk appetite statement?
• Does the risk appetite we express reflect the commercial objectives of the firm and investors’ expectations? (Risk appetite can be too low as well as too high.)• Is the risk appetite articulated as a risk-reduction target or as risk-return trade-offs?
• Does the overall risk appetite allow the firm to meet shareholders’ expectations and commitments made by management?

The process design should therefore reflect that NEDs and exco members on the board (typically the CEO and CFO) might have divergent perspectives on the desired and/or appropriate risk-return trade-offs to meet the agreed objectives. However, the design of the process should allow the board to surface these differences, where they exist, and to facilitate the board in arriving at an agreed position and a clear way forward.

Equally, the process should demonstrate to exco that a wellconsidered risk appetite framework can generate opportunities to take more risk (in a controlled way) to achieve objectives – this can often be a welcome surprise for senior management. It should also surface any areas where the NEDs have a higher risk appetite than exco anticipates – this could be in areas such as HR, accelerating implementation of strategic and operational improvement initiatives.

About the authorHans-Kristian (H-K) Bryn is an independent strategic risk management and governance adviser focused on value enhancement and protection. He works with excos and boards of listed companies to develop effective approaches to risk appetite, strategic and disruptive risks. linkedin.com/in/hanskristianbryn