Regulation and compliance issues edged out credit availability as the biggest risk concern for senior executives in an annual survey by Ernst & Young.
Based on interviews with more than 70 executives and analysts across 14 industry sectors, the accounting and consulting firm’s Business Risk Report for 2010, its third qualitative barometer on this subject, identified both fear of over-regulation and uncertainty about post-crisis statutory developments as significant clouds on the business horizon. On the ranking of top ten business risks, regulation and compliance rose to first place, ahead of access to credit, which was No. 1 in 2009. A slow recovery or double-dip recession ranked third, unchanged from last year.
Especially vocal on regulatory uncertainty were financial sector executives, who warned of an erosion of shareholder value in a sluggish growth climate. Said Daniel Hofmann, group chief economist of Zurich Financial Services: “New taxes and higher capital requirements will impair the industry’s ability to absorb risk, impose a competitive disadvantage when it comes to attracting capital relative to other financial market players, and more broadly constrain the industry’s ability to meet its social and economic function as ultimate holder of risk.”
The Ernst & Young conclusions published August 2 confirm – or add weight to – a prevailing sentiment among financial industry leaders and business economists that uncertainty regarding governmental and regulatory actions is hindering business investment and, in turn, slowing the recovery from the downturn of 2007-’09.
Adding currency to that critique was Federal Reserve Bank of Dallas president Richard Fisher, who in a July 29 speech in San Antonio aired what he said he has been saying within Federal Reserve Board and Federal Open Market Committee councils: “I have ascribed the economy’s slow growth pathology to what I call random refereeing – the current predilection of government to rewrite the rules in the middle of the game of recovery. Businesses and consumers are being confronted with so many potential changes in the taxes and regulations that govern their behavior that they are uncertain about how to proceed downfield. Awaiting clearer signals from the referees that are the nation’s fiscal authorities and regulators, they have gone into a defensive crouch.”
Fisher noted that newspaper reports and opinion columns have been hitting repeatedly on the uncertainty theme, but he added that he has observed it in his monitoring of regional business conditions and that “this view is by no means unique to bankers.”
“Uncertainty and risk are natural parts of business,” he said. “Capitalists handicap and deal with them every day. However, excessive uncertainty hinders one’s ability to even calculate the odds of potential outcomes, especially when that uncertainty involves irreversible decisions with long-term implications. Operating a business under conditions of excessive uncertainty is like playing a game when you don’t know the rules.”
That seems to be the mood captured by Ernst & Young, which sees the prominence of the regulation and compliance category as an overhang of the financial crisis, touching on sectors ranging from energy and life sciences to automobiles and technology, in addition to financial services. The firm quoted one anonymous panelist as saying, “Governments need to move fast to remove uncertainty, particularly regarding regulation of the financial sector.”
It also cited consultant and risk expert Avinash Persaud on the point that regulations are likely to favor banks with larger deposit bases, and with regulatory standards likely to shift in a short space of time, “to respond proactively to such fundamental changes may require companies to take a long view on possible regulations and consider alternate scenarios.”
Rounding out Ernst & Young’s top ten list, after regulation and compliance, access to credit, and slow recovery, were: managing talent, emerging markets, cost cutting, nontraditional entrants, radical greening, corporate social responsibility, and executing alliances and transactions.
“Within our report, the majority of the risks identified fall into four distinct quadrants: financial, compliance, strategic and operational,” commented Gerry Dixon, Ernst & Young’s global risk practice leader. “This highlights the importance of taking a broad, holistic view of risk issues, then focusing on the risks that matter most to your business – those that are present today and others just on the horizon.”
Dixon added, “By focusing on the risks that weigh most heavily on the organization, both holistically and from an industry perspective, companies will be able to develop a cohesive, integrated risk management process that will help sustain long-term business value. Companies must harness the vast resources they deploy to manage and identify the risks that exist across the enterprise - including internal audit, compliance, internal controls and operational risks. It is critical these areas work together to assist the organization in understanding and leveraging risks to create a strategic advantage.”
But the survey results indicate that the regulatory sphere is top of mind for many. As the Dallas Fed’s Fisher put it, “Regardless of how you feel about many of the recent reform efforts’ broad goals, I hope you see my point: This is not the best time for added uncertainty, especially when the banking industry appears to be on a very slow mend. Yet uncertainty reigns.”
