Being in the business of helping our clients manage complex credit, economic and financial risks, perhaps not surprisingly we the Awbury Team has a certain necessary fascination with how to understand and analyze the material risks any Obligor faces.
Over time, a number of attempts have been made to provide a systematic classification of such risks, the latest (and most comprehensive of which) is the (Cambridge Taxonomy of Business Risks), which uses what one might call a quasi-Linnaean system involving 6 Primary Classes, 37 Families and 175 (sic) Types.
The results are useful because they provide what one might call a checklist (cf. Dr. Atul Gawande’s “The Checklist Manifesto”) for any risk analyst or underwriter to set against the nature and complexity of the entity she or he is reviewing and assessing.
Of course, it is easy to mock a list that contains 175 Types as being far too complicated to be useful. However, the mere fact of its existence should at least compel an analyst to look at the risks which a business faces holistically, and consider which ones are material; or, if they arose, could potentially lead to failure and default. And bear in mind that many regulators require companies to maintain Risk Registers- which, in reality, are analogous to a basic taxonomy of risk.
The Taxonomy does not weight the risks, because, quite clearly, that (and their relevance) varies from entity to entity. However, the authors do comment that, of the 6 Primary Classes (Financial, Geopolitical, Technology, Environment, Social and Governance), Governance risk is often underestimated; while “Geopolitical risks and possibly Financial, [may be] being overestimated. And, yes, “Infectious Disease” is in there as a Family!
The “art”, therefore, lies in looking at an entity and determining the material risks to which it is subject, particularly the potentially “existential” ones. As the pandemic has brutally demonstrated, the trope “lack of cash (and liquidity) kills companies” has never been more true, even if no business executive is ever likely to have planned for revenues to fall to (perhaps) zero for what was hitherto considered a viable and well-run business.
This just serves to emphasize that it is not the “usual” risks that are likely to cause systemic issues (although they may have an idiosyncratic impact), but rather the ones thought to be out in the tail of any distribution. Perhaps ironically, one could clearly argue that the pandemic was a 1-in-100 year risk which should have been factored into (re)insurer risk models (as it surely will now be!), as other 1-in-200-, 1-in-250- and 1-in-500-year risks habitually are for NatCat programmes. This is not, in any sense, to denigrate the (re)insurance industry, because it was governmental behaviour and actions that caused the most harm in economic and loss-exposure terms, not the disease- in other words, a second- not a first-order effect- and that clearly now belongs in any taxonomy of risk under “Government Action”!
The pandemic also demonstrates the fact that world of risk is not Aristotelian and fixed, but evolves and changes as forces and events act upon it- the SARS-COV-2 pandemic simply being the latest example. Checklists are useful, but only as a guide, not as an expression of the limits of risk. As we have written before, it is usually the risks that you do not foresee that cause the most harm.
The Awbury Team