Understanding How to Establish Your Company’s Risk Appetite

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) recently published new guidance on how companies can promote “risk appetite” as part of decision-making. It’s especially relevant in today’s uncertain marketplace.

Digesting the new guidance

The COSO guidance, “Risk Appetite — Critical to Success: Using Risk Appetite to Thrive in a Changing Word,” explains that management must learn how to anticipate and understand their risk when change happens. It defines risk appetite as, “The types and amount of risk, on a broad level, an organization is willing to accept in pursuit of value.”

This definition is intentionally broad to apply across an organization. The risk appetite may differ within various parts of your organization to remain relevant in changing business conditions. When establishing your risk appetite, the goal is to enhance long-term growth and innovation.

“Risk appetite is a fundamental part of setting strategy and objectives, providing context as the organization pursues a given level of performance,” said COSO Chairman Paul Sobel. He stressed the importance of recognizing that the choice of strategies and objectives requires an understanding of the appetite for risk.

In volatile times — like during the COVID-19 pandemic or when facing regulatory uncertainty from a contentious upcoming election — a business may need to alter its risk appetite to take advantage of growth opportunities as market conditions evolve.

Combining the ingredients

COSO lists six things to remember:

1. Risk appetite is not a separate framework.
2. Risk appetite and risk tolerance are different.
3. Risk appetite applies to more than the financial services industry.
4. Risk appetite is at the heart of decision-making.
5. Risk appetite is much more than a metric.
6. Risk appetite helps increase transparency.

Risk appetite applies through development of strategy and objective-setting. It focuses on overall goals of the business. Risk tolerance, on the other hand, applies to the execution of strategy and focuses on objectives and variation from plan.

To be effective, your company’s risk appetite should permeate its culture. To get the message out across the organization, management should consider creating an appetite statement that includes measurable benchmarks. For example, you might say, “ABC Co. isn’t comfortable accepting more than a 10% probability that it will incur losses of more than $200,000 in pursuit of emerging market opportunities.”

The choice of language and length of an appetite statement will vary by organization. Some statements require several sentences to balance brevity with clarity.

Recipe for success

Taking risks is essential to growing your business. However, risks can’t go unchecked. Setting and understanding risk appetite is an important element of corporate governance, strategic planning and decision-making. We can help you better understand and apply this concept, communicate your risk appetite to stakeholders and monitor progress. Contact us for more information.