The COVID-19 pandemic has led almost all of us to change how we think about, measure and respond to risk. This has also been true for organisations. The recent report from the Financial Reporting Lab (the Lab), Reporting on risks, uncertainties, opportunities and scenarios, considers how these changes are being reflected in company reporting.
For many companies, the COVID-19 pandemic led to a more interconnected approach to navigating risks and opportunities. As part of this new approach, there is now a greater focus on considering uncertainty as well as longer-term scenario and stress testing. Despite many companies beginning to change and improve how they manage risk, uncertainty and opportunities, this is not always translating into useful external disclosure. Is it time to close this gap?
Information investors want
Despite the outreach for the report being conducted during the COVID-19 pandemic, the findings apply to a diverse range of risks, uncertainties and associated opportunities, not just the pandemic itself. Through conversations with investors, the Lab identified four pillars of good disclosure relating to risks and opportunities (depicted in the diagram opposite).
Investors seek information that builds their understanding of:
A company’s governance and processes: risk management is only as effective as the underlying processes and overarching governance. Investors seek to understand the relevant governance structures and processes a company has in place, how effectively these have functioned over the period and how quickly these can be adapted to react to external (and internal) factors.
The nature of the risks and opportunities the company faces: investors seek information that sets context and best helps them understand the nature of the related risks and opportunities. They value a view of the company’s external environment and the relative importance of risks and opportunities to its strategy and business model.
The company’s approach to managing them: investors want to understand the company’s approach to managing risks and opportunities. They want information on how they link to, and have an impact on, the business model, strategy and purpose.
The company’s view on developments over time: investors need information regarding the different scenarios and stress tests performed. These are of most value where they tie into other risk-related information and the plans the company has made for the future.
How to close the gap
The Lab’s outreach identified a number of actions that companies can take to meet investors’ information needs:
On connection and consistency: regardless of the maturity of a company’s risk-related reporting, investors want consistent, company-specific information that accurately reflects a company’s processes. Investors seek reporting of a ‘joined-up story’ that links risk with the company’s purpose, business model and longer-term viability. This need for a consistent narrative throughout the annual reporting suite is likely to grow as more companies commence reporting on climate change and social aspects that have typically not been aligned to the annual report in the past.<
On governance and processes: investors highly value evidence of current and potential agility within the company. Clear descriptions of responsibility and accountability within its structures assist investors in building a picture and contributes to their confidence in management.<
On nature: insight into the risks that a company’s board has focused on during the year is useful. Showing how these same risks have been incorporated into the viability assessment and other scenarios and stress tests also adds value. Furthermore, good disclosures explain any change in both the assessment of the risk and the mitigating activities.
On approach: when explaining risks, uncertainties and opportunities, good disclosure details specific mitigating activities and actions. It clarifies which are those a company might take, which are those it will take and those which it has taken.
On scenarios and stress tests: these do not stand alone; they should make sense in the context of the remainder of the annual report. Reporting such scenarios and stress tests is not intended to be a perfect prediction of the future. Nevertheless, it should provide comfort to investors that a range of scenarios and outcomes are being considered.
On timescales: providing information of the anticipated timescale associated with current and emerging risks and opportunities allows investors to formulate a longer-term view of the company.
Rising to the challenge
The Lab encourages companies to reflect the evolution of their internal risk processes in their external reporting and to make disclosures on risks, uncertainties and opportunities a key part of their strategic narrative. To assist companies as they seek to enhance their reporting, the Lab has produced several resources. Lab reports, including the full Reporting on risks, uncertainties, opportunities and scenarios report and Task Force on Climate-related Financial Disclosures (TCFD): ahead of mandatory reporting, a developing practice report, are available on the Lab’s website at frc.org.uk/Lab. In addition, an Alliance Manchester Business School research report, commissioned by the FRC and also available on the website, focuses on current practice and disclosure trends associated with climate-related scenario analysis.
Following on from the risks, uncertainties, opportunities and scenarios project, the Lab invites interested parties to participate in a project that focuses on the reporting of digital and data risk. If you would like to find out more, contact the Lab at financialreportinglab@frc.org.uk
About the author
Andrew Hyland, Project Manager, Financial Reporting Lab
