S1EP2 - Internal Audit and the Risk of Macroeconomic and Political Uncertainty

The following podcast was recorded prior to the outbreak of Coronavirus COVID-19 and therefore specific macroeconomic references are now out-of-date. The importance of Internal Audit in the face of Macroeconomic and Political Uncertainty, however, remains unchanged. Welcome to Ideagen Insights, Ideagen’s official Podcast Channel. In our second episode, Stephanie is joined by Ideagen’s Chief Operating Officer, Barney Kent, to discuss Internal Audit and the Risk of Macroeconomic and Political Uncertainty. Join Barney and Stephanie as they discuss;

• Macroeconomics - The Neglected Risk
• Raising the awareness of macroeconomics within an organisation
• How Agile Auditing can help an organisation adapt to emerging risks proactively
• Understanding risk appetite
• And not forgetting BREXIT, Trade Deals, US Elections and it's economy.

Transcript

Stephanie Jones:   0:00
The following podcast was recorded prior to the outbreak of Coronavirus, COVID-19 and therefore specific macroeconomic references are now out of date. The importance of internal audit in the face of macroeconomic and political uncertainty, however, remains unchanged.  

Stephanie Jones:   1:11
Welcome to Ideagen Insights everyone. My name is Stephanie Jones, and I am the product manager for Pentana Audit and Pentana Risk at Ideagen. I'd like to welcome you to Ideagen's official podcast series, where we focus on the biggest issues facing internal auditors across Europe and North America in 2020. In each of these episodes, we look at a specific topic identified as a key business risk by European and American chapters and institutes of the Institute of Internal Auditors and evaluate the impact that these will have on internal audit departments as they prepare for the year ahead. In today's podcast, I would like to focus on macroeconomic and political uncertainty, and I have with me today Barney Kent Barney, can you please go ahead and introduce yourself?

Barney Kent:   1:12
Hi, my name's Barney and I am the Chief Operating Officer of Ideagen PLC.

Stephanie Jones:   1:17
Thank you, Barney. Today we're going to talk about geopolitical instability and the macroeconomy. Now, this is considered a top risk for European chief audit executives in 2020 however, while nearly 1/3 of the European CAEs consider geopolitical instability and the macroeconomy a top-five risk for their organisation only 4% of these CAEs say that it is in their internal audit top five risk area to spend time on. So I was wondering if you could go through what some of these risks are and why you feel there's a disparity between it being a top risk for the organisation yet not something that internal audit is focusing on.

Barney Kent:   2:08
Yeah, no problems at all. I mean, I would completely concur with those statistics. I think macroeconomics is often the neglected risk within an organisation. I don't think it gets the attention that many of the other almost micro risks that an organisation has. I think it's for a variety of reasons. I think it's seen as daunting. Macroeconomics obviously deals with global situations and global situations when you are an organisation and often just a single department of the organisation is daunting is outside of your control. How can you control what happens on a global scale? It's very difficult to assign that accountability and responsibility for something like microeconomics. But I think it is completely wrong to say that that risk can't be managed. Clearly, it can't be mitigated, but it can certainly be managed. If you look at the current primary global risks, it's true we probably have more at the moment than we've ever had previously. I think everyone accepts the world is far more volatile at the moment and if we just look at some of the primary global risks, they are definitely there. But I certainly believe organisations can take a proactive stance, in managing them and I think a lot of organizations actually just take a reactive position. They will look to react as a situation evolved, but if you look at them in the short, medium and long term, there are certain initiatives that an organisation can take to mitigate. So the big primary global risks at the moment; I'm speaking to you from the UK but the big primary global risk at the moment is certainly the U. S. and China and that all important trade agreement that has global ramifications at a far more local level to us in the UK at the moment. Clearly, Brexit has been a real stagnation on the UK and the European economies. Other things, US Elections are coming up. That's always a slightly unpredictable time. There's a lot of talk about the US economy overheating. If you look at developed countries, the US Economy, the GDP of the US Economy has been at a very high level for a number of years now. Is that sustainable? That is a very big question. A lot of people seem to think that it is an unsustainable level at the moment for an economy the size of the US so a slowdown in the US Economy has massive ramifications around the world. We have a very turbulent Middle East, still. We have a far more increased environmental awareness, and that's going to see a very subtle but significant shift in the way organisations actually trade. That certainly is a macroeconomic event. You could also throw into that traditionally, organisations have very much traded to improve shareholder value. There is a growing movement now to say that that should be broadened. There should be far more depth and breaths as to why an organisation actually exists and moving away from shareholder value to what a lot of people are referring to as stakeholder value. That means that the concerns, the welfare, the benefit of the employees, the customers, the community, the broader community, the suppliers and the environment all take much more of a higher profile and how an organisation and why an organisation exists. All of those are crucially important, some of them are more sentiment, some of the more, obviously far more tangible, but there are more global risks at the moment than there probably has ever been and an organisation needs to be aware of them. They are there!  There is plenty of documentation around them. So, if an organisation takes a very proactive stance in trying to understand them, then you can put mitigation in how you try and overcome them.

Stephanie Jones:   6:17
Yes, I love how you said being proactive instead of being reactive to perhaps events as they occur or different risks that end up emerging. 

Barney Kent:   6:30
Yes, as I say a lot of organisations, they take a proactive stance on huge swathes of how they run their organisation, but macroeconomics is often seen is a daunting global issue which they can't control. Therefore, you naturally retreat to a reactive position.  Again, I also think in a lot of other areas of an organisation, you can set up very clear accountability. A CFO is accountable for the finances of the organisation. A CTO is responsible for the technology. This is quite clear parameters as to how an organisation actually functions. I think when it comes to macroeconomics, it becomes a grey area. So there becomes an accountability issue when it looks at how macroeconomics will affect a company. But you can overcome that. I think if you take a proactive stance and you actually drop it down a level and say OK, accountability still rests at the very top of an organisation, but at a responsibility level, you can make people responsible for providing all of the data, giving that very 1st shot at what the risks are with each macroeconomic event. I think you can do that. And as soon as you start to just drop it down a level and say OK, you are responsible for just understanding macroeconomics suddenly you can take the proactive stance.

Stephanie Jones:   7:54
Yes, and given the mass of data that is available today in today's world, having those thresholds in place, perhaps, to indicate if a certain factor gets better or worse or improves or decline could help provide that first look, that first trigger that might indicate that something needs to be looked at further.

Barney Kent:   8:20
Definitely. I mean, the key to understanding macroeconomics is to raise its profile within the organisation. I mean, all organisations are investing more into L&D, that learning and development environment. But if you look at it a lot of organisations, they will put their L&D into more tangible skill sets; they will teach someone how to use Excel, they will improve awareness on product, they will get them certifications in various different aspects. If you just actually raise macroeconomics as an L&D Initiative and say we need to actually increase the base knowledge level in the entire organisation as to what macroeconomics means, the risks associated with it, but also the opportunities. I mean, you've got to remember, if there's a risk there is generally an opportunity on the other side of it - macroeconomics is an opportunity. So for me, the very first initiative any organisation should take is actually just have it as an L&D topic. Get people aware of the subject. You get people aware of the subject then suddenly the commercial realities of every deal, the commercial realities of just running a global organisation, it just becomes much clearer. That old phrase of knowledge is power - It is true to such an extent when it comes to Macroeconomics, you've got to make it a topic within the organisation.

Stephanie Jones:   9:49
I completely agree Barney, and I think that that's something that organisations can put in place to really help with this key risk. Another thing I was thinking was as you mentioned, these are global risks, these are things that an organisation typically cannot control or really have an effect over, however, what an organisation can control and have in place are things like monitoring systems. So how are changes identified?, like we mentioned - what is that trigger to say Okay, we need to do something about this particular macroeconomic risk. Another thing I think is while there may not be a particular risk that has emerged yet, in some cases, what are our contingency plans? What's that Methodology around contingency. If something happens, how will our company react to these large macroeconomic risks as they occur? And do we have insurance in place if necessary? What are those plans that we have? How are we prepared to handle things as they come up?

Barney Kent:   11:01
I totally agree. If we looked at some of the global risks that we spoke about a few minutes ago; the US-China aspect, Brexit, a global slowdown - if you look at it on a tangible level, what are the big ramifications of those? One of the obvious ones that always triggers on macroeconomic events is the currency market. So how is your organisation set up to handle large currency movements and there are so many things that companies can do on a proactive initiative on that. This goes back to the training of the sales team themselves for example. When they are putting these quotes out, when they are arranging contracts with customers around the world. If they have a concept of what the various currency ramifications are, it's huge - you can change the payment terms, you can look at forward contracts to offset some of the currency movement, an organisation can naturally hedge itself against currency by actually moving its resources around the world,  looking at its facility set up. If you have an office in the UK and you have an office in the US you are naturally hedging yourselves against the UK and the US Exchange rate by having costs in both areas. You can look at your entity structure  - again if you're trading in the US set up an Inc, if you are trading in the UK set up a limited company, if you are trading in Bulgaria set up a company in the EU, you can naturally do things, but it's about being completely aware of your organisation. What's its current state of play? Whats its direction of travel? Again, just understanding it, trying to project it out over 12, 24, 36 months and then just making subtle changes. By doing that, you mitigate risk to a huge extent.

Stephanie Jones:   13:01
Yes, I think that those examples that you just gave are very concrete examples of what you can do to mitigate some of that risk. As far as internal audit and some of the things that internal audit can consider when they're developing their internal audit plan, and feel free to add on to any of these things that that I'm going to mention, you can't always control these global risks. But as you have alluded to and expressed, what internal audit can do is really make an assessment, an opinion on the organisation's level of flexibility and adapting to changes that occur. So that's just one thing that I think the internal audit can do. Another thing is to have different models to assess financial risk that is associated when costs, for instance, may change. So as the market goes up and down, or as maybe supply chains and suppliers actions that they take as that impacts an organisation, how does the organisation react to that? And I think the biggest thing is something that can help is for an internal audit to be agile and how they audit. So I know that one of the current buzzwords around internal auditing is agile auditing and being able to adapt as things come up. So rather than waiting for your next audit planning cycle, to start to incorporate some of these global risks and their impact into your audit plan, rather than waiting for that, then being agile as a department to approach and look at things as they occur and not waiting for that next audit cycle. So putting some of those practices in place can help internal audit departments look at these emerging risks in a very proactive manner, as you've mentioned.

Barney Kent:   15:10
Yes, the other point I would add on to that is that I think companies have to have a very defined and ideally quantified appetite for risk. I think some organisations, certainly the ones in growth and hypergrowth models will naturally have a higher appetite for risk than a more mature organisation. I think there needs to be an understanding of that appetite. If you are happy to have all of your business trading through one entity or trading through one currency or trading through one company, you are naturally, inherently going to have a higher risk of being unsettled by a macroeconomic event rather than if you go for a broader and more diverse global model - again, it's about understanding the appetite.

Stephanie Jones:   15:58
Yes, I think that's a very good point. And is that risk appetite consistent throughout your organisation? If your risk appetite overall in all areas is low, but then when it comes to macroeconomic risks, it's high, then that sends a different message as well, so just have it consistent.

Barney Kent:   16:16
I completely agree, completely agree with that.

Stephanie Jones:   16:18
All right, is there any other item that you would like to talk through? Any other point that we did not cover?

Barney Kent:   16:28
The only other comment I would make on macroeconomics is that a lot of people get their information from the media. I think very few people read the economic journals from cover to cover before gauging their views on macroeconomics and I think the media are increasingly giving a negative perspective when it comes to macroeconomics. If you look at some of the core numbers behind the global economies, the picture is not as bleak as the media portrays. I think it's important when companies are looking at this, they're not just forming their views from the main media channels, they are actually delving a little bit deeper than that. As you say, if you look at the global stock markets around the world, they were all up last year. You have got professional organisations investing billions of dollars and spending millions of dollars on research. They are still comfortable sending the world's stock markets up. Investment is still high. Sure, there's been some aspects, and let us take Brexit which has suppressed certain silos of economy. But on the whole, the global picture is pretty rosy at the moment. I mean, people talk about the US-China situation and that that there's almost a sort of a trade war between them, but if you actually look at the facts that just isn't the case. I mean, I found an interesting article the other day that if you look at Chinese research collaboration, so the real investments for the future  - who is the primary recipient of that? It is the US.  43% of all Chinese research collaborations are with the US. It's a very strong functioning relationship at the moment. It's just that you've got two very dominant characters going toe for toe on a trade agreement, and that seems to capture the news. So as I say that the broader picture is that global economics is in a good position at the moment. There are a lot of risks, and there is this cloud on the horizon about are we due a global slowdown. But the biggest thing I would stress is that if you're going to start making really critical business decisions based on macroeconomics, delve deeper than that first layer of media news because I think it's really important.

Stephanie Jones:   18:57
I agree with you Barney and it tends to become a very emotional discussion, especially when someone is just looking at the media or Twitter or however you're getting your information. And that's something where I do feel like internal audit can really step in and help an organisation. Internal audit's capacity to look at data, to be very independent in providing guidance and assurance and opinions is really something that internal audit can do to help an organisation, as you start to consider macroeconomic risks. So I think that's a very, very valid point. And Barney, I just want to thank you for your expertise and your insight into the current state of our world. And I know that you and I are talking across the Atlantic here, so we come at it from two very different perspectives. I think you did a great job of talking about our world today and the global risks that we face from a macroeconomic point of view and going through just what companies can do to mitigate and manage those risks, as well as internal audit specifically and how we as auditors can help our organisation. So thank you for that.

Barney Kent:   20:23
Not a problem. It's been an absolute pleasure, thank you very much,

Stephanie Jones:   20:26
Thank you.