Communicating risk information: The issue of risk disclosure

2. Communicating risk information: The issue of risk disclosure Professor Philip Linsley The University of York

3. Session outline • PART 1: • An introduction to how risk ideas have developed in recent years • PART 2: • The development of the idea of risk disclosure

4. ideas

5. Developing risk ideas Risk must be controlled Risk has a positive side Risk becomes connected to governance (and financial reporting) We need to decide on the bank’s risk appetite Then value at risk (VaR) develops (banks) Non-financial firms appoint risk officers Enterprise wide risk management (ERM) And then the banking crisis happens 2007 …. 1980s 1990s 2000s

6. The rise of a risk management industry Consulting Professional risk management organizations Risk management standards AS/NZS 4360: 1995 AS/NZS 4360: 2004 AS/NZS ISO 31000: 2009

7. Remember also …. This is just considering risk in a corporate context Risk has become an important issue in other areas …

8. Some important approaches to risk

9. Accounting & Risk

10. disclosure

11. Risk & business RISK IS IMPORTANT IN BUSINESS Volatile environment Essence of business Risk management developments BUT INVESTORS & OTHER STAKEHOLDERS HAVE LIMITED RISK KNOWLEDGE

12. Institute of Chartered Accountants in England & Wales (ICAEW) Financial Reporting of Risk – Proposals for a Statement of Business Risk (1998)

13. Accounts – complex – little on risk Corporate Governance Code ONLY REQUIRED Annual review of internal control systems to be reported to shareholders ICAEW ARGUED: OVERALL NEED FOR COHERENT VIEW OF RISK

14. UK quoted companies should report on their overall risk position 1. Identify & prioritise risks 2. Describe actions taken to manage risk 3. Identify how risk can be measured

15. Subsequent ICAEW Proposals No Surprises: The case for better risk reporting (1999) No Surprises: Working for better risk reporting (2002)

16. But what are the problems in disclosing risk?

17. ONE PROBLEM Would it be better to disclose past risk information or forward-looking (future) risk information?

18. But issues arise when you ask directors to disclose forward-looking (future) risk information Inherently uncertain Stakeholders relying on the information Safe harbour provision

19. ANOTHER PROBLEM What about commercially sensitive risk information?

20. But issues arise when you allow directors to exclude commercially sensitive risk information? Omissions imply whole risk picture unknown Some directors may declare all risk information is sensitive ‘Boilerplate’ arises

21. ANOTHER PROBLEM Should you allow directors to voluntarily disclose risk information?

22. Why would directors disclose risk information voluntarily? Benefits for stakeholders & company Encourages better risk management Cost of capital reduction

23. Why would directors disclose risk information voluntarily? Agency theory Jensen & Meckling (1976) Signalling theory Spence (1973)

24. TWO MORE PROBLEMS Would it be better to disclose risk information that is quantified or not? Is the annual report the best place to disclose risk?

25. Risk disclosure requirements in different countries

26. USA Item 1A of annual 10-K filing requires disclosure of risk factors

28. Obesity concerns may reduce demand for some of our products • Adverse weather conditions could reduce the demand for some of our products • Increased competition in the marketplace could hurt our business • If we do not anticipate evolving consumer preferences our business could suffer

29. UK Section 417 of the Companies Act 2006 requires description of principal risks and uncertainties in annual report

30. Germany Companies required to describe material risks and opportunities

31. NOTE 1.There have been a number of reports addressing this issue directly and indirectly 2. Financial firm’s risk disclosures are much more complex