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- New processes for the ongoing
monitoring of risk management and internal control systems need to
be in place from the start of your new financial period –
from 1 January 2015 for a December year end reporter.
- Remember, risk appetite needs to be
decided and risks quantified.
- Clear and rapid allocation of
responsibilities for the new requirements is vital if you are not
- Companies need to tell their story in
their annual reporting – it is entirely possible we will see
a story of gradual implementation.
We are issuing this further briefing to increase
awareness as we believe the new requirements need more focus by
boards in the corporate sector. The updated UK Corporate Governance
Code and the Guidance on Risk management, internal control and
related financial and business reporting were published by the FRC
in September 2014.
The updates to the UK Corporate Governance Code issued in
September 2014 included significant changes to the Code's
requirements on risk management and internal control systems. The
changes are designed to emphasise the importance of board
monitoring of the company's risk management and internal
control systems throughout the year, rather than undertaking a
one-off, annual review. The requirements also encourage deeper
involvement by boards in risk management and internal controls. The
disclosures required for future annual reports (periods beginning
on or after 1 October 2014) are a big step ahead of current
practice in telling the stewardship story.
|The board should monitor the
company's risk management and internal control systems and, at
least annually, carry out a review of their effectiveness, and
report on that review in the annual report. The monitoring and
review should cover all material controls, including financial,
operational and compliance controls (Code Principle C.2.3). The
board should explain what actions have been or are being taken to
remedy any signficant failings or weaknesses (Guidance on Risk
management, internal control and related financial and business
reporting para 58).
In order to monitor risk management and internal control
effectively, boards will need to ensure that processes and
information flows are in place to be able to answer the following
key questions at regular intervals throughout the year:
- How effectively have risks been
assessed, quantified and the principal risks determined?
- How have the principal risks been
managed or mitigated?
- Have necessary actions been taken
promptly to remedy any significant failings or weaknesses in
- Whether the causes of the failing or
weakness indicate poor decision-taking, a need for more extensive
monitoring or a reassessment of the effectiveness of
management's ongoing processes?
There are a number of challenges arising which need to be
Robust assessment of principal risks
- Agreeing the level of risk the
organisation is willing to take to achieve its strategic objectives
(determining its "risk appetite").
- Organisations will have to ensure
that they are operating a robust mechanism to identify their
'principal' risks – in addition, organisations will
need to assess and disclose both the likelihood and impact of the
principal risks identified; both individually and in
- For many companies this will involve
a significant evolution of their risk management processes;
especially in the consideration of strategic risks, and how these
risks are identified and managed; and in the processes in place to
assess and quantify the potential impact of principal risks both
individually and in aggregate.
- To identify and manage risk
effectively and efficiently we believe organisations should
consider and challenge how integrated their governance framework
is, and how effectively the constituent parts link together.
Longer term viability statement
- Organisations will have to prepare a
'viability statement'; stating that they have a reasonable
expectation that their company will remain viable for a period they
need to define. The quantification, probablity and timing of the
net impact of risks will need to be considered in the viability
- Careful consideration will be needed
to provide a meaningful statement.
- Boards will have to decide early on
how much work is required to support their making this statement.
In some cases the assessment may be relatively qualitative, for
others, more complex modelling solutions may be appropriate.
Monitoring risk management and internal control
- An increased focus on monitoring an
organisation's system of risk management and internal control
will encourage companies to challenge how effective their current
monitoring processes are.
- Management should consider a number
of aspects of their risk management and internal control monitoring
processes: from the management information they collate, to the
effectiveness and co-ordination of the various assurance functions
within their business, to the opportunities improved technology can
bring in real-time understanding of the control environment.
- Governance responsibilities in this
area will need to be clearly defined.
Risk reporting and disclosure
- External reporting of the principal
risks identified will need to become increasingly specific to each
- Disclosure will increasingly focus on
how boards are mitigating risks, since reporting now includes
likelihood and impact.
Internal control failings and weaknesses
- Companies will need to explain in the
annual report what actions have been or are being taken to mitigate
significant failings or weaknesses in material controls identified
in the period.
- As with the viability statement this
will require the board to carefully consider what are their
"material controls" and what "significant"
means in their context and the level of detail to disclose.
Key mobilisation steps
We believe the following key steps are needed to be in a
position to start meeting these new requirements:
- Agree a framework for articulating
- Revisit and reassess those risks
deemed to be principal risks. Consider the likelihood of those
principal risks and the quantification of likely impact, both
individually and in aggregate.
- Review the organisation's risk
and control governance structure in light of the new guidance to
produce a gap analysis.
- Ensure "ongoing monitoring"
is built in to the board/committee process and agendas from the
start of the year.
- Agree definitions for identifying
material controls and review the monitoring and reporting systems
which identify significant failings or weaknesses in risk
management and internal control systems. Also, consider whether
there is a need to revisit internal audit/risk scope and reporting
- Agree a clear accountability
structure and timetabled action plan.
- For the majority of businesses,
especially those in less regulated industries, the adoption of the
new requirements and guidance could represent a significant
challenge. For example, there now needs to be a clear articulation
of risk appetite and principal risks need to be sufficiently
quantified; board/ committee agendas need to demonstrate sufficient
time dedicated to monitoring principal risks on a continuous basis;
boards need also to consider if the constituent parts of their
governance framework (e.g. management information, technology,
assurance) are sufficiently linked together.
- The quantification and scenario
planning will directly inform the future viability statement in
your annual report (for periods commencing on or after 1 October
- Early thought should be given to how
the board will wish to address the recommendation to "explain
what actions have been or are being taken to remedy any significant
failings or weaknesses", the definition of which is left to
boards. Boards will wish to consider this definition early so they
receive scored reports on failings and weaknesses during the year,
for example from internal audit, within this new context.
- In due course boards will wish to
consider what internal assurance processes they wish to adopt,
particularly if they assert a failing or weakness has now been
- Embraced well, the enhanced risk
management processes and disclosures will be a significant step
forward in stewardship; embraced reluctantly, little value will be
derived and discussions during the 2015 reporting season will be
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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