Article

The changing risk landscape for European listed firms

Large European organisations face a risk landscape increasingly characterised by interconnected external, financial, operational, and strategic risks that are highly susceptible to changes in the global environment. Geopolitical tensions, volatile financial markets, disrupted supply chains, and macroeconomic uncertainty act as both cause and effects of these risks.

Large European organisations face a risk landscape increasingly characterised by interconnected external, financial, operational, and strategic risks that are highly susceptible to changes in the global environment. Geopolitical tensions, volatile financial markets, disrupted supply chains, and macroeconomic uncertainty act as both cause and effects of these risks.

Marsh analysed over 1,650 annual reports from European listed companies for the fiscal year 2020 — published in 2021 — to provide an overview of the most frequently reported risks across 14 countries on an aggregated and individual basis. (Data from Denmark, Finland, Norway, and Sweden were aggregated and referenced as a single country, ‘Nordics’.) Our findings reveal a broad consensus on the importance of fundamental financial risks, while non-financial risks are becoming more prominent and more frequently reported on than in the past.

Deep transformative changes — such as the ongoing digital transformation and heightened environmental, social, and governance (ESG) risks — that affect most, if not all, sectors mean that organisations need to adapt their business strategies to remain relevant and avoid financial and reputational damage. The growing dependence on IT systems and digital infrastructure has increased the threat and impact from cyberattacks. And the COVID-19 pandemic has shaped changes in employee and consumer behaviour.

Top 10 European risks overview

Financial risks

Financial risks remained atop the agenda for European companies. Nearly three quarters (70%) of companies investigated reported financial risks around liquidity, credit, exchange rate, and interest rate. The requirements of the International Accounting Standards and Financial Reporting Standards (IAS/IFRS), as well as those set out by national stock exchanges, are key reasons why companies formally report financial risks more than other types.

In 7 out of 11 countries, one or several financial risks were the most frequently reported risk, with exchange rate risk most prominent. Adverse exchange rate developments in capital markets, between the time the business relationship is entered into and the time of the transaction, may create additional costs and pose planning challenges for sectors with complex global supply chains and with key clients and suppliers abroad, such as manufacturing, automotive, chemicals and life sciences, food and beverage, and technology.

The data also showed an upwards trend in companies’ 2020 reporting of these financial risks compared to 2019. Sustainable or ‘green’ financing has an influence on credit, liquidity, and interest rate risks. It can even be seen as creating new opportunities — the Oliver Wyman/CDP Europe report shows that banks representing 95% of all lending to European corporates have an ambition to align their lending and investment with the goals of the Paris agreement.

Pandemic risks

The profound impact of COVID-19 was unprecedented for policy and business decision-makers alike, testing companies’ resilience and revealing vulnerabilities and interdependencies across the entire value chain. It caused disruption in companies’ ability to operate due to workforce impacts, supply chain challenges, customer access, and a variety of regulations, all of which unfolded inconsistently across the operating territories of European multinationals.

The data showed that economic, social, and financial risks related to the COVID-19 pandemic were the second most frequently reported risk across all countries and ranked among the top 5 risks in 8 out of 11 countries.

Macro-scenario uncertainty risks

Risks related to macro-scenario uncertainty stem from market dynamics, societal trends, or financial and political instability. To a large degree, those external risks can be anticipated, monitored, and mitigated, not controlled. The knock-on effect from macro-scenario uncertainty can also play into the acceleration or severity of operational, financial, and strategic risks.

Changes linked to economic performance and capital markets locally and globally, as well as political and societal developments, all pose opportunities and threats to businesses, with some, like the COVID-19 pandemic, developing with rippling effects at a surprising velocity and magnitude. Interventionist governments, political unrest, or poor economic performance can lead to increased uncertainty.

Over half (51%) of the investigated companies reported on macro-scenario uncertainty in their 2020 annual reports. Belgium, Italy, Poland, and Turkey listed macro-scenario uncertainty in the top 5 most frequently reported risks; it placed in the top 10 risks for 9 of 11 countries.

Regulatory risks

Regulatory risks ranked fourth in this year’s study, unchanged from 2019, although the number of companies that reported on this type of risk increased. Regulatory risks are especially pronounced for globally operating companies subject to multiple jurisdictions and legislations. New and emerging regulatory frameworks related to ESG and the fast pace with which regulations were enacted during the pandemic highlight the importance of preparedness for external risks to avoid financial and legal repercussions. The EU taxonomy — a green classification system that translates the environmental goals of the European Union into clear criteria for sustainable economic activities — came into effect in 2020, paving the way for practical action plans and frameworks for companies, financial institutions, and governments.

Regulatory risk were among the top three risks in Austria, the Nordics, and Spain, and was ranked number one in France, where it was cited by 65% of the investigated companies.

Sectors that frequently reported on regulatory risk were financial institutions, power, chemicals and life sciences, and manufacturing. Basel III, GDPR, and new ESG regulations are important examples that need to be monitored and implemented by financial institutions, along with legislation on the horizon, such as the Digital Operational Resilience Act (DORA).

Human capital risks

The COVID-19 pandemic highlighted human capital as a fundamental business asset and jump-started a global movement towards hybrid working, making companies increasingly aware of people risks. Almost half (44%) of the investigated companies reported on human capital in their 2020 annual reports, compared to 35% in 2019. A new approach to managing people risk should stem from the collaboration of HR and risk professionals to create a productive work environment to attract and retain top talent in the market.

With the exception of Spain, human capital risks ranked in the top 10 of all investigated countries, with Austria, the Netherlands, and France ranking it in their top 3 risks.

Competition risks

In 8 out of 11 countries, competition was recognised as an important risk, with it being ranked sixth in the top 10 risk ranking overall. It was not identified in the top 10 risk ranking in Austria, Belgium, or Turkey.

Legal and compliance (L&C) risks

Risks arising from the violation or unfavorable impact of regulations, sanctions, anti-trust laws, and legal disputes can cause severe financial, operational, and reputational damage. This is why L&C risks remain a frequent concern, reported by more than 40% of companies. Sectors that frequently highlighted L&C risks were financial institutions, technology, and the chemicals and life sciences sector.

In 2021, 38 cases were filed against companies around the world on the basis of climate change. For example, a Dutch court ruled that Shell must reduce its emissions by 45% by 2030, an acceleration of the company’s existing pledge.

Consumers and activist groups are taking an increased interest in the reported actions that underline an organization’s claims, especially related to ESG issues. Reputational damage is a threat to an organization’s bottom line, but equally can attract talent in a competitive labour market. Despite these developments, L&C risks ranked seventh, falling from second place in 2019.

Concerns over L&C risks are especially pronounced in Austria, Belgium, the Netherlands, and Turkey, where it was among the top three most frequently reported risks.

Environmental, social, and governance risks

The ESG risk landscape includes well-known risks that companies have been anticipating and managing for many years, including employee health and safety, natural catastrophe events, and contingency and supply chain planning. ESG, however, includes less-established risks connected to biodiversity, deforestation, diversity and inclusion, privacy and data protection, energy transition, and others that are being increasingly monitored by companies’ stakeholders.

In recent years, and spotlighted by the pandemic, ESG risks gained C-suite attention due to the growing pressure from policymakers and other stakeholders. Among the investigated companies, 35% reported on ESG risk in 2020, with the highest frequency in Belgium, the Nordics, and Turkey, where ESG risks ranked second. However, in most countries ESG risks were not in the top 10 risks, despite its broad impact.

Strategy definition/implementation risk

Aligning risk management with business strategy supports a company’s agility in response to shocks, such as a global pandemic, and may allow it to bounce back quicker compared to competitors. It also supports the mitigation of financial exposures, business interruption, and reputational damages.

The 2020 data showed that large global organisations face a multitude of financial and non-financial risks that are sometimes interlinked and can threaten business models and strategy implementation. While the ongoing digital transformation enables data collection for improved decision-making, efficiency gains related to production, and/or improved customer access, it also comes with increased cyber risk, unexpected competitors, and new market opportunities.

Risks arising from unfavorable business strategy or the inability to implement core strategies were reported by 34% of the investigated companies in 2020, compared to 41% in 2019. Strategic definition/implementation risk was part of the top 10 ranking in France, Greece, Italy, Spain, and the Netherlands and ranked highly for the financial institutions, technology, retail, and automotive sectors.

Client risks

About one-third of companies reported risks related to clients — including changes in consumer behaviour, hostile behaviour against a company, and dependencies on individual clients — in their top 10 ranking. These risks have increased in importance since 2019, when they were not among the top 10 risks; in 2020 it was included in the top 10 risk ranking in Austria, France, and Poland.

How is the risk landscape likely to shift

Financial risks continue to dominate the risk rankings across large European organisations due in part to the disclosure obligations under IAS/IFRS, but also because managing credit risk, exchange rate risks, liquidity risks, and interest rate risks are fundamental business principles.

Although all the investigated companies were impacted by COVID-19, only 57% chose to report pandemic risk in their annual reports. In some countries — including Belgium, Spain, and the Netherlands — there were many non-financial risks that were a more frequent concern. This could be due to factors including strong confidence in handling future pandemic risk; a focus on risks that were exacerbated by the pandemic, but not labeled as such, including human capital risk or macro-scenario uncertainty; or a low risk perception by the organisation.

Cyber risk continues to grow globally. However, there was a drop in the percentage of companies reporting cyber risk to less than one-third in 2020 compared to 40% in 2019. This is despite the continuing digitalization across most industries and the push for virtual business dealings, transactions, and an expanded IT infrastructure with an increase in the number of employees working from home.

The data showed little progress in the frequency and risk perception of ESG risks, with approximately one-third of companies referencing one or several ESG risks in their 2020 annual reports. The new Corporate Sustainability Reporting Directive that is being introduced across the European Union will oblige close to 50,000 organisations to begin reporting on a range of non-financial data from 2023.

Considering the continuing conflict in Ukraine and related geopolitical risks, it’s likely that macro-scenario uncertainty, supply chain interruption, and ongoing inflation will likely remain unstable while the conflict persists.

You should contact your insurance broker or advisor to discuss how the changes in the European risk landscape directly impacts your business and how you can better protect your interests.