Beyond box-ticking: responding to the challenge to drive long-term success

If there is one element of business highlighted by the pandemic it is the need for resilience. 

Companies who suffered most as Covid-19 tore through society and the economy were undoubtedly those least prepared with business models that were unable to adapt. Climate change had already underlined the importance of resilience, but it remained for many a theoretical exercise. Lockdowns, and the rupture they caused, brings the lesson crashing home.

Government proposals now aim to codify the importance of resilience with a new reporting obligation asking boards to be transparent about the way future shocks will affect their organisations. A new “resilience statement” demands companies look in detail at the risks and challenges they face over the short, medium and long term, how they will be managed and how business models can be flexed in response to the issues.

The change will not be without effort. The resilience statement will demand more thought, planning and resources from companies to prepare. But the measures are designed to provide greater openness and enable boards to deliver insights into the key threats and challenges their companies face alongside the preparations and mitigation needed to manage them. This new reporting will be demanding, but the long-term benefits are likely to outweigh any associated costs and should prove a valuable governance practice.

Mitigating uncertainties, risks and threats

The resilience statement proposal comes in the government’s consultation Restoring Trust in Audit and Corporate Governance published in March. The paper follows three major regulatory reviews ordered by the government in the wake of corporate collapses such as department store chain BHS in 2016 and the construction company, Carillion, two years later.

These reviews looked at the content of audits, the audit market and the regulation of auditors producing necessary (and long-awaited) reform proposals. While the spotlight fell on a number of headline measures, Sir Donald Brydon’s examination also focused on the need to replace the much-criticised “viability statement”, introduced in 2014. These statements stood accused of being formulaic, providing little useful information and failing to look sufficiently into the future.

Brydon’s proposal, endorsed in the consultation, is to do away with the viability statement and bring together the going concern statement along with more forward-looking reporting requirements in a new robust “resilience statement” that should prompt much deeper thinking among board members about the resilience and adaptability of their businesses.

Though still under consultation, the proposals say resilience statements should “set out a company’s approach to exploring and mitigating risks and uncertainties” over the short term (one to two years), the medium-term (five years) and the long term (undefined). It should provide “greater transparency” about material uncertainties and include “at least” two reverse stress testing scenarios.

While at this stage the proposals set out specific requirements, such as defining time-periods and mandating at least two reverse stress tests, overall they represent a significant shift in approach with companies expected to be more open and realistic about the risks, threats and opportunities they face while looking further forward in time than ever before. The pandemic has proved that this kind of information is highly valuable for investors thinking about the long-term prospects of companies.

Completing a resilience statement will call for a sizeable preparation effort and will require boards to engage in much more high-level thinking and planning over longer future periods.

Companies will be more used to assessing risks and threats over the short and medium term, but assessing the “long term” will, for most, be new and more challenging, although potentially the most important aspect of the resilience statement. Even though it will naturally be more speculative, it could offer investors significant insight into future contingency planning. A key challenge will be ensuring that reports are meaningful and resist falling into the trap viability statements fell victim to of becoming boilerplate and unhelpful.

Boards will need to consider carefully what to report, especially if they see troubling times on the horizon. The challenge will be for board members to recognise realistic and plausible events (rather than highly unlikely one-off episodes) and reflect on those as the foundation for contingency planning.

Confident boards will identify and utilise the risks and challenges they see and address them (publicly), secure in the knowledge that investors prefer problems and potential solutions out in the open. That will generate confidence that businesses are planning effectively should the unintended occur. Boards less sure of themselves may produce uninformative, predictable statements that may give rise to caution among investors. 

Preparing for reverse stress testing

Perhaps the biggest change for many companies will be reverse stress testing. With the proposals asking for a minimum of two, the requirement may represent a daunting challenge for those unfamiliar with the process.

In short, the testing asks that boards imagine how their companies might fail, the events that might trigger failure and the measures needed to avoid the inevitable. It will demand commitment to make it work well. The financial services sector is well versed in reverse stress testing but for companies in other sectors, this may be a new experience and involve a thorough review of internal processes to produce meaningful results.

The pandemic revealed the best-prepared companies invested considerable time and resource into their scenario planning using extensive data, for instance within their going concern assessments. Failure by companies to be realistic, specific and appropriately address long-term challenges to business models in their resilience statements may have adverse consequences. Indeed, lip service is unlikely to meet investor expectations and may also undermine confidence.

Its clear resilience reporting will call for significant change not least in learning new processes but also by pushing business time horizons further into the future. That presents boards with a new challenge to their strategic thinking. Board members should begin preparing themselves now.

Resilience statements may not, at first, appear to be a major step but they constitute an important change which, properly implemented, could prove invaluable to long-term success.