The potential impacts of Brexit for European companies could be extreme. Strategic Risk examines how businesses have been preparing and what European risk managers should do next
Brexit has dominated the risk agenda for some years now, but while much has been made of the risks facing companies in the UK, there has been less focus on what this seismic political shift means for European businesses.
Now, with a conservative landslide victory in the UK general election, and the greatest Tory majority since Margaret Thatcher, it seems that Brexit is a certainty. But while we now have an indication of the direction of travel, and a ‘no deal’ Brexit has been largely ruled out, there is still a great deal of uncertainty over what the UK’s future relationship with the European bloc will look like.
The implications of Brexit are just as severe for firms that will remain in the EU - especially in those industries where the UK is a major buyer of goods and services - and so risk managers should have been planning accordingly.
Hans Læssøe, founder of AKTUS and former risk manager at The Lego Group,explains: “Largely, the situation is somewhat the same for EU risk managers in companies that deal with UK as it is for UK managers
“Questions they need to ask themselves include:
- How, if at all, will our trading with the UK be affected? (tariffs, currency rates, customs handling time, etc)
- Will a Brexit with more cumbersome access to the UK market mean that some competitors “bail out”?
- With regards to our UK based organisation – what has to be true for us to decide to move it, and if so, where and how?
- Are there other areas where we will need to change the way we do business?
Of course, it’s good and well saying that European institutions must be prepared for Brexit, but of course it is a moving feast, and understandably it has been difficult for risk managers to plan as the UK has struggled to find a way forward and make decisions about the future of its relationship with the EU.
Danny Wong, founder of GOAT Risk Solutions, says: “ If I was a risk manager in a European company I would be looking at a scenario where UK and the rest of EU had ‘no deal’ which would mean that for the goods and services that my company makes - selling into UK would have additional tariffs and delays getting into the country.
“I would then need to rapidly look at adjusting my business by looking at sales and marketing opportunities in other markets that I can access and probably preparing to shrink my business or be braced for a difficult period.
“Even if Brexit doesn’t impact the company directly, if the EU loses out on a major market, then the economy will certainly deteriorate further.
“I would unfortunately have to encourage the business to prepare for the worse i.e. fewer capital commitments, delay major decisions, recruitment and look to cut costs and invest in areas of longer-term efficiency savings such as AI.”
European risk association view – how are AMRAE members preparing for Brexit:
In 2019, in collaboration with AIRMIC, AMRAE conducted several interviews with European risk managers (including Airbus, Solvay, IPSEN or Lufthansa) .
Most risk managers said they had set up a dedicated structure to understand Brexit risks. They began by conducting an initial assessment of their exposure and set out to understand the threats arising from Brexit before implementing mitigation solutions
This planning usually took the form of a multidisciplinary approach (HR, legal, industrial, finance, supply chain, quality control, supply chain specialist) to fully understand the business unit’s risk exposure to Brexit (tariffs, supply chain friction and regulation).
All risk management teams involved had to interface very closely with other departments to coordinate these actions.
Examples of actions taken to prepare for the Brexit:
- Detailed checklist for all suppliers, notably for critical devices made in UK
- Stockpiling components to ensure production continuity
- Transfer of records to/from the EU
For companies with mature risk management:
- Brexit risk has become only one risk among many global risks;
- Brexit did not change much about the way political risks were managed. There has always been a strong focus on monitoring the worldwide evolution in terms of trade regulations and protectionism.
- Global political and trade instability is not a new challenge and it is even also sometimes a source of opportunities when large businesses are outsourcing some of their activities in reaction to such events
Of course, it’s not just risk managers and their organisations that have been impacted by the uncertainties of Brexit, and insurers and brokers have also been re-evaluating their models to ensure that they are ready for whatever may lie ahead.
Ailsa King, chief client officer, UK & Ireland, Marsh explains: “The insurance industry – including brokers – has undertaken a tremendous amount of work to prepare for Brexit and has implemented a number of measures for various scenarios, including a no-deal Brexit, to ensure that it can continue to provide services to European Economic Area (EEA) policyholders.
“As we move into 2020, risk managers should be taking a prudent approach, in mitigating the operational and strategic risks associated with Brexit and the continued uncertainty.
“Risk managers and boards should keep the following questions at the forefront of their minds:
- How will Brexit – or a change in the UK’s relationship with the EU - impact our business models, strategies, and processes?
- Are there adequate programmes in place to deal with these changes?
- How are our operations and services impacted by current and pending legislation?
- How is uncertainty impacting our workforce?
- Where do our highest pressure points lie?
- Have we tested our organisational resilience and crisis management?”
How to plan for Brexit
Alex Sidorenko chief executive of the Risk Academy outlines how European risk managers can plan for Brexit
One of the key roles of good risk managers is to stress test company business model to various internal and external shocks.
Running stress tests implies applying decision theory and quantitative risk analysis techniques to see how uncertainty affects the organisation’s ability to meet its objectives and continue to stay sustainable.
Here is how we would normally do it:
- Find the financial model or cash flow model used for strategic planning or budgeting - ironically most risk managers fail at this early stage and are unable to move further
- Identify the output metrics that will be stress tested. It could be cash flow, covenants or EBITDA or any other metric that is considered meaningful by management
- Test the financial model, find and fix errors, check whether the model is suitable for stochastic analysis, many aren’t
- Identify all assumptions / inputs that affect the output metrics selected above
- Run key assumptions check on all assumptions
- Replace single point estimates for each assumption with ranges and distributions, base the ranges on plausible Brexit scenarios
- Set correlations between assumptions
- Run the simulation to see how uncertainty associated with Brexit will affect the output metrics, determine key risks, propose mitigations to protect the company downside
- Now go backwards, run an optimiser to determine how much shock can the company sustain while still meeting its objectives and not breaking the covenants. Determine how plausible are the worst-case scenarios.
So, what does all this have to do with Brexit? Brexit has given all European risk managers a very plausible set of scenarios to justify and run stress testing. I encourage risk managers to run the simulations as soon as possible.