PWC - Resilience: Winning with Risk - What it is and why its needed - March 2013

www.pwc.com/resilience

Special focus on Global Risks Issue 3

A journal of strategy and risk

Resilience Winning with risk02 05 08 12 15Keeping the lights on Interview with Steve Holliday

Resilience: What it is and why it’s needed Lee Howell

Harnessing financial innovation to strengthen disaster resilience Erwann Michel-Kerjan

A new framework for disaster reduction Carlos Castillo Lauren Cook Oz Ozturk

Business-not- as-usual Richard GledhillDan Hamza-Goodacre Lit Ping Low

21 26 31 37 41Private equity: Value in responsible investment Shami Nissan Malcolm Preston

Bouncing back: Two Japanese corporations’ road to resilience David Jansen William Macmillan

Egypt: Weathering the storm Rehab Abdelhafez

Resilience in the eye of the storm Neil Kaufman

WEF Global Risks, one year onWorld Economic Forum, in collaboration with PwC

Contents

Letter from the publisher Dennis Chesley 01

CEO perspectives on resilience Steve Holliday, National Grid Group (UK) 02

Systemic Resilience

Resilient Countries Resilience: What it is and why it’s needed Lee Howell 05

Resilient Markets Harnessing financial innovation to strengthen disaster resilience Erwann Michel-Kerjan 08

A new framework for disaster reduction Carlos Castillo, Lauren Cook and Oz Ozturk 12

CEO perspectives on resilience Shikha Sharma, Axis Bank Ltd (India) 14

The Long-Term View

Climate Change Business-not-as-usual: Tackling the impact of climate change on supply chain risk Richard Gledhill, Dan Hamza-Goodacre and Lit Ping Low 15

Sustainability in PE Creating value through responsible investment: Are the hard and lean going soft? Shami Nissan and Malcolm Preston 21

CEO perspectives on resilience Seymur Tari, Turkven (Turkey) 25

Markets in Peril

Japan Bouncing back: Two Japanese corporations’ road to resilience David Jansen and William Macmillan 26

Egypt Egypt: Weathering the storm Rehab Abdelhafez 31

United States Picking up after Sandy: Resilience in the eye of the storm Neil Kaufman 37

CEO perspectives on resilience John Koustas, Danaos Corporation (Greece) 39

Resilience practices: One-year follow-up analysis on Global Risks 2012 cases

Overview 41

Case No. 1: The Seeds of Dystopia 42

Resilience in action: Tracking trends to challenge assumptions and steer the right course 45

Case No. 2: How Safe Are Our Safeguards? 46

Resilience in action: Taking advantage of windows of opportunity 49

Case No. 3: The Dark Side of Connectivity 50

Resilience in action: New behaviours for a new world 52

Resilience: Winning with risk I 1

We see three emerging themes of note: The first concerns time frames, the second concerns levels of analysis, and the third concerns tools and frameworks for helping organisations become more risk-resilient.

There are two dimensions of time frames that are important. The first concerns the relative usefulness of lessons from the past in dealing with future challenges. It would be naïve to think that there is nothing that can be learned from history, but it would be equally foolish to think that even a complete understanding of history will be enough to know how to confront future challenges. Every organisation must start by learning from its own past experience in terms of what it did and didn’t do well – the response to Hurricane Sandy is a clear case in point – so that it can better prepare itself for the future. Too many organisations fail to reflect on their experience. What are the ways in which your own organisation does so and how does it codify these lessons? But this codification must be augmented by looking at how peer organisations are becoming risk-resilient and what emerging ideas are coming from the academic and professional community, such as alternative risk transfer instruments. How does an organisation ensure that it has learned from its past without being trapped by it?

The second dimension of time concerns short- versus long-term perspectives, and all those in-between. Crises clearly require highly focused short-term thinking to respond to them. But having the capability to adapt to long-term trends is equally important. Companies in Japan have been forced to do both. Companies in Egypt are confronting a relatively inhospitable current environment, but which many believe has positive long-term prospects. Changing business models can also change the time frames in which companies operate, as is the case with the private equity industry today where the longer holding period of portfolio companies is making greater attention to environmental, social and governance issues more necessary and more attractive. Do the steps required to be a risk resilient organisation in the short-term and the long-term reinforce each other, or do choices need to be made about their relative emphasis?

The second theme centres on the importance of recognising the systems’ nature of the world we live in, which is comprised of different units of analysis. Risk-resilience is a concept that equally applies to governments, which are part of the larger system in which a company is embedded. The company, in turn, is the larger system in which groups and units are embedded, which themselves are the context for individuals.

Do actions taken by countries to become more risk-resilient always enable companies to become more so, or are there circumstances in which they have the opposite effect? Is an organisation of risk-resilient individuals, a risk-resilient organisation or not? More generally, under what conditions could actions taken at one level to become more resilient render higher and lower levels less effective? Relatedly, when do external trends multiply and when do they dampen inherent risks?

The third theme concerns the new tools and processes that are emerging to help organisations become more risk-resilient. These include financial instruments such as catastrophe bonds, along with data-driven research efforts to identify the characteristics of a risk-resilient organisation and practical processes such as stakeholder engagement. This begs the question of where these new tools and processes will come from. How can we identify areas where these are most needed and who is in the best position to develop them - subject matter experts or companies themselves? How can social media be leveraged so as to facilitate better problem-solving and not to deter or distract from real progress?

Dennis Chesley

Letter from the publisher By Dennis Chesley

In this third edition of Resilience: Winning with risk, we collect perspectives from practitioners on the ground confronting political, social and environmental change – from experts pursuing market solutions to systemic challenges – and from CEOs, formulating growth strategies against a landscape of challenging global risks. As a new year dawns with a mix of optimism and scepticism, we hope these perspectives help you think wisely and act skillfully about your organisation and its operating environment.

We hope you get value from this edition and look forward to your comments and suggestions. Dennis Chesley

Risk Consulting, Global Leader

2 I Resilience: Winning with risk

Q. In the light of the Fukushima crisis in Japan last year, do you see major demand and supply shocks coming in the environment you’re operating in?

Steve Holliday (SH): We are in a world where we need politicians to be quite brave and take decisions that are far-reaching. A threat to our business can come about when we’re investing in infrastructure that requires support over a long period of time and there is a sudden switch or U-turn in energy policy. You can find yourselves having made investments that are not in the long-term interest of consumers all of a sudden, or having to make a whole bunch of other investments very quickly to ensure you’ve got reliable supplies of energy. You can see that with the changes in Japan. You can see that with some of the changes in Europe in the last year. So it is very important to our business that there is consistency of policy and sticking with things and making sure that, as governments develop those policies and the regulations, they’re well-thought through and based on real evidence.

Of course, a number of these scenarios get close to Armageddon, but none of them would cover something like Fukushima, for example, where you decide to shut down all of the nuclear plants. You can’t handle that in the UK. That would not ensure reliable supplies. You couldn’t handle it in Japan, where, of course, they have had a very difficult power problem for quite a period of time. Because of Fukushima, Germany has taken a decision to shut its nuclear fleet down but that can’t be done overnight. It will have to be done over a period of years and replaced with other sorts of generation. So you think about those scenarios, across different timescales. How do we be sure that we’ve got reliable energy supplies we can afford for the next one year, three years and what are the different mixes that are five plus years out and how do we make sure our investments are robust against a range of scenarios? That’s exactly the way we think about our business.

Keeping the lights on

Q. How adaptable would your organisation be if a shock hit you in the centre of your activity? And at the board level, do you plan for such shocks?

SH: We have a very particular role in the UK because we sit at the heart of the electricity and gas market. So we model an enormous number of scenarios to try to think about potential shocks. What would happen if gas supplies from Europe shut off? Up to 40% of our gas potentially comes in liquefied natural gas (LNG) from the Middle East these days, so what would happen if something went wrong there? How do we make sure we’ve got robust scenarios? And, in fact, we can present that to the government and gain some assurance there. On the generation side, we have to run a system that is robust enough to cope with major power stations shutting down.

In this special interview conducted for PwC’s Global CEO Survey, Steve Holliday discusses the challenges faced by a global electric utility company, in an era where pressures to move away from coal to other sources of energy are growing. He notes that few countries have the luxury afforded by the US of heavily shifting towards natural gas, and must seek to find the right balance between coal, natural gas, nuclear and alternative renewable resources. Such strategic questions are made more challenging in an era where consumers, through social media, expect to have more voice in the decisions local utilities make.

Today’s large utility companies - many grown through acquisitions and mergers - bring the benefits of scale, but these need to be balanced with a local focus. Scale and the long-term time frames utility companies must operate in also make it difficult for these firms to become more adaptable, something that more local focus and changing energy scenarios demand.

Steve Holliday

Chief Executive Officer National Grid Group Plc. UK


As we think about the mix in the UK, there are lots of renewables, which are quite clearly a part of our future. We are rebuilding a nuclear fleet over a long 20-year timeframe, and hopefully finding a way that we can capture the carbon from coal and still consume coal – but that’s, in my view, still at least a decade away. Natural gas is going to continue to play an important role as a fuel for power in the UK, but the sources of natural gas have changed enormously. By 2020 more than 70% of the gas in the UK is going to be imported. That’s in complete contrast to the US, which a few years ago was importing and now sees an opportunity to export gas.

There’s an enormous amount of noise and excitement, of course, in other parts of the world about the possibilities of having shale gas, and being another US. Does it change the whole economy through availability of cheap fuel? I don’t think anywhere else is going to replicate the degree of gas that’s been available at such cheap prices in the US. If I’m wrong, I’d be delighted. It will certainly be great for the UK but I don’t think we’ve got anything like those levels of reserves or the ability to exploit them.

While we don’t yet have enough information to understand the recoverable gas levels in the UK anyway, clearly we have a very different situation trying to recover gas from a densely populated country and navigate the laws of who owns the subsurface and the permissions that you need to drill.

Somebody who owns the land in the US has a huge incentive to want to drill. It’s not the case in the UK and the complexity of this island means it’s just unlikely we’re going to be able to replicate what has happened in the US.

Q. How would you assess your organisation’s ability to adapt to change and disruptive events generally, compared to the past?

SH: It’s been a huge challenge to get an industry that by definition is thinking 20, 30 years ahead, is associated with slow thinking and which has historically liked to have a plan, to change into an industry that thinks much more flexibly, much more about scenarios and how to adapt to warning signs of change in those scenarios. Building flexibility into thinking processes has been a real journey the last three or four years. Part of that as well is just about organisational flexibility. How do you streamline the organisation with its layers? That has been a lot of what we’ve been doing in both the UK and the US. So there is just a speed of thought process, a speed of decision-making that is different today than it was in the past. Are we where we need to be yet? No, still not, and people who work with us or who are stakeholders would not yet describe us as agile. Yet the shape of the industry, the challenges we’ve got in terms of this unpredictability, the need for us to think about different scenarios, but also understand new technologies that are coming in and how we can quickly adopt them for our customers, all mean we’ve got to be agile to a degree we’ve never been before. That means changes in the way people work, particularly changes in structure about how you matrix the organisation more, how you share information more through new media, both across the UK organisation and between the UK and the US. We’re on a journey here, but we’ve got a long way to go.

Q. What’s your view on natural gas as a game-changer 50 years ago, and what do you see on the horizon in the power generation business that might change the game again quite radically?

SH: Natural gas certainly was a game-changer 50 years ago: we had in the UK, of course, a dash for gas. In the US right now it’s a game-changer again. Shale gas and cheap gas prices have completely changed the nature of the heating fuel business in the US, particularly in the cold parts in the north. In our own business, two years ago we were advertising to convince people that they should replace their old boiler that was both inefficient and very dirty. In fact, we used to campaign and say take three four- by-fours off the road by shifting from oil to gas – which is the equivalent in terms of carbon removal. We don’t need to advertise today: the price speaks for itself.

We can’t keep up with the number of people who want to change to natural gas. And it is a game-changer also in terms of generation. The US looks a little bit like the UK in terms of many of the old generators, both coal and nuclear, that are going to be retired in the next ten years. Today, they’re most likely to be replaced by natural gas fuel plants, much as here.


Q.Howmuchistheinfluenceof and the level of engagement with stakeholders growing in your business?

SH: The regulator and government have always been major stakeholders but today there is also a very different new set of stakeholders, right down to you and I. The public at large are stakeholders because they can take part in discussions on social media. They can influence our decisions and we actually want them to do that. So one of the changes that’s been going on inside National Grid for the last two years in particular, encouraged very much by the regulator in the UK, is to really consult with society, customers and local neighbours about what they want from their energy systems.

Part of our challenge has been to make sure that we are genuinely consulting. It’s a word that often gets misinterpreted by businesses into an ‘I’m going to show you what I plan to do and I’m sure you’re going to be happy with it, aren’t you?’ exercise. We try to build a process that genuinely goes out and listens. We try to get a conversation going and ask some questions about what people would like from their energy systems and what they value most. Their answers influence our plans. That’s exactly the way we’ve built our big plans in the UK and the most interesting part of that journey has been that as we’ve listened, surprise, surprise, we’ve actually learnt something. So we’ve not ended up actually getting to the answer we thought of when we started. The consulting process has actually changed the answer and that’s helped us obviously start to change the culture even more about genuinely listening.

The big challenge, of course, is social media and how we can use that to help explain some of the things that we’re doing in our business and, moreover, how can we keep this continuous conversation going on about the challenge of energy and what you’re paying for. It’s important to remind people just how important it is that we’ve got energy at our fingertips. We just don’t understand the value that we have in the UK and the US in flicking a switch and having something work all the time; it’s something that we’re going to have to pay more for in the future and we need to focus on helping customers reduce their energy consumption. So all of that is part of this big debate and interface with customers, lobby groups and NGOs, and it is escalating year-on-year. I do think we’re getting better at it, but I also recognise that it’s a skill set we’re going to have to continue to hone.

Q. How have you increased your impact on your new stakeholders and their communities? What benefitshasthatimpacthad for your organisation?

SH: One of the challenges I’ve been focused on for the last few years is how we bring the benefits of scale to customers and yet are really seen as being local. National Grid is made up of many companies that have come together through acquisition to be the organisation it is today, with the skills and the finance to do the things we need to do for society in the future. What that led to, though, was a real view from many customers about the loss of their local company at a time when everyone wants to get much more involved in decision-making on a local basis. So achieving this balance, between bringing the

benefits of international scale and yet going back almost 40 years to considering how to connect in locally to your communities, is difficult for an industry like ours. We don’t have the luxury of picking up a manufacturing plant and moving it down the road or moving it to another continent: the assets are in the communities. It’s not surprising therefore that there is a huge focus on reinventing things that used to exist when people spent more time in their communities, were more known in their communities: that is part of our licence to operate.

I also think it is part of the type of company we are, always have been, but want to remain in the future. If you want to come and work for National Grid, earn a good wage, have a really exciting career and be involved in some ground-breaking energy transformation in the countries in which we work, you also need to be a person who is happy to go into the community and volunteer and be engaged. It is part of the psyche of the organisation, but I think it’s just going to be increasingly a necessity for us to be able to feel with all of our customers that we’re part of their community. That will enable them to understand some of the things that we are going to need to do to ensure they’ve got power and heat, and they will be able to put a human face on it. So, in some ways, it sounds a bit like we’re inventing the past. We are to a degree, but in a different way.


From natural disasters to financial shocks, global risks are exogenous events, which go beyond the capacity of a country or corporation to manage on their own. Traditionally, the practice of risk management has focused almost entirely on preventable risks, where a culture of strict compliance can mitigate, or even avoid, worst-case outcomes. Filling the analytical gap on global risks, the World Economic Forum publishes annually its Global Risks report to assess the likelihood, impact and inter- linkage of 50 such risks. Its central prescription is that countries as well as companies need to focus much more on building their resilience.

What does it mean for a country to show resilience in the face of risks it cannot manage alone? A structural engineer would define resilience as the capacity to withstand more stress, and to return to normal after a stressful event. This is a suitable definition for

a bridge or a skyscraper, but not necessarily for a country. History has very few examples, if any, of a country that withstood a major stress only to return to its previous state.

In a national context, stress often reveals a variety of critical but lesser-known systems through which a country manages to adapt by finding different ways to carry out essential functions. This realisation is behind the effort by the World Economic Forum’s Risk Response Network (RRN) to develop a diagnostic tool to assess a country’s resilience to possible global risks.

National resilience, in the context of this initiative, involves the capability to:

1) adapt to changing contexts; 2) withstand sudden shocks; and 3) recover to a desired equilibrium, while preserving the continuity of its operations.

As global risks can be either sudden or slow-burning, the three elements in

this definition encompass both recoverability (the capacity for speedy recovery after a crisis) and adaptability (timely adaptation in response to a changing environment).

National resilience requires ‘systems thinking’ – that is, conceptualising a country as a system itself, which is both part of larger systems and comprised of smaller systems. Those larger systems include the global economy, the climate, communications networks that reach across borders, and so forth; in effect, the Global Risks report analyses risks that play out within these larger systems. The proposed diagnostic framework for assessing national resilience to global risks considers five subsystems that make up a country system – its economy, environment, society, governance and infrastructure – and works from a definition of resilience often used in a systems context: the ability to maintain core functions in the wake of a major disturbance.

Resilience: What it is and why it’s needed By Lee Howell

Risk resilience is as important for countries as it is for companies. From a systems-thinking perspective, a risk-resilient country is one that can adapt to changing contexts, withstand sudden shocks and recover to a desired equilibrium, and all while preserving the continuity of its operations. The ability to recover from a crisis and to adapt to a changing environment are both important. Preliminary research suggests that resilience is linked to leadership ability, transparency and efficiency in getting things done, and good relationships between the public and private sectors. The World Economic Forum’s Risk Response Network is developing a diagnostic tool to measure a country’s resilience in the face of global risks in terms of the five subsystems of redundancy, robustness, resourcefulness, response and recovery. This tool will be based on a combination of quantitative statistical data and perception-based data.

Lee Howell is Managing Director, Member of the Board at the World Economic Forum. He has editorial and operational oversight of the Forum’s three flagship events: the Annual Meeting in Davos, Switzerland; the Annual Meeting of New Champions in China; and the Summit on the Global Agenda in the UAE. Howell is also Editor- in-Chief of the Global Risks Report and responsible at the Managing Board for the following Forum communities: Network of Global Agenda Councils, Global University Leaders Forum and Risk Response Network. His prior responsibilities at the Forum include serving as Director, Annual Meeting Programme, New York and Senior Director for Asia.


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Resourcefulness Resourcefulness Resourcefulness Resourcefulness Resourcefulness

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Recovery Recovery Recovery Recovery Recovery

Macro System

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Country

The proposed framework of the RRN sets out to assess each of the five subsystems against five attributes of resilience drawn from the afore-mentioned systems thinking:

Redundancy – Having excess capacity and diverse ways to accomplish the same objectives

Robustness – Having fail-safes and firewalls and the ability for decision-making to become either more hierarchical or more modular when necessary

Resourcefulness – Having networks of trust that enable flexible self-organising to adapt to crises in novel ways

Response – Having good feedback mechanisms that enable the early recognition of emerging issues and the ability to mobilise quickly

Recovery – Having the capacity to rebound from a crisis by absorbing new information and adapting quickly to new circumstances

These five attributes of resilience will be applied to the five country sub-systems mentioned above. The aim is to combine quantitative statistical data with perceptions-based data in a methodology similar to the Forum’s well-established Global Competitive-ness Index. In practice, this is done by collecting perception-based data through two of the major Forum surveys administered annually: the Global Risks Perception Survey with over 1,000 respondents, which feeds into the Global Risks Report; and the Executive Opinion Survey, with over 14,000 respondents, which is a major component of the Global Competitiveness Report.

Respondents to this year’s Global Risks Perception Survey were asked, for each of the 50 global risks: “If this risk materialised in your country of expertise, what is the ability of the country to adapt and/or recover from the impact?” The responses from environmental and economic categories of risks provide expert perceptions of a particular country’s capacity for recovery in each of these subsystems.

Ten countries received enough responses in the 2013 Survey to be statistically significant, with Switzerland scoring highly on both counts and Italy and India at the lower end of the scale. Interestingly, Japan was perceived to be highly resilient environmentally, but significantly less so economically.

Meanwhile, respondents to the Executive Opinion Survey were asked “How would you assess your national government’s overall risk management effectiveness of monitoring, preparing for, responding to and mitigating against major global risks (e.g. financial crisis, natural disasters, climate change, pandemics, etc.)? (1 = Not effective in managing major global risks; 7 = Effective in managing major global risks)”. This is a first step towards ranking countries on the response capacity of their governance subsystem.

Of the ten countries that attained statistical significance in the Global Risks Perception Survey, the responses to the Executive Opinion Survey showed that governments in Germany, Switzerland and the UK were perceived by business leaders to have comparatively high-risk management effectiveness,

Figure 1 What is resilience?

Source: World Economic Forum


It is possible to identify three broad themes from these seven items. First, resilience appears to be linked to leadership ability – politicians must be able to command the attention of their people and get things done, particularly in a moment of crisis. Second, resilience is aided by transparency and efficiency in getting such things done. And third, resilience depends on good relationships between public and private sector stakeholders, allowing corporations to keep policy -makers informed about changing conditions and how they can help business to continue.

These are only preliminary findings, however, and much further work remains to be done as the RRN refines the understanding of both resilience at a country level and its measurement. By combining assessments of each of the five factors of resilience as they apply to each of the five country subsystems, the aim is to help national decision-makers to benchmark their country’s level of resilience, track progress and identify areas that may require strategic investment in the face of looming global risks.

Implications for key stakeholder groupsWhile lessons for stakeholder groups will become clearer as the proposed diagnostic framework is refined and developed, some initial considerations about how different groups might contribute to national resilience can be identified from research conducted so far:

Governments – Public trust and the capacity for effective and efficient action are essential in times of crisis. But they cannot be built in times of crisis – the groundwork must be done in advance.

Private sector – Businesses often have more presence locally than governments during crisis situations. Relationships of trust built through public–private platforms can work to benefit all.

NGOs – National resilience appears to be correlated with tackling corruption and wastefulness and improving transparency. These are areas where civil society organisations can play a watchdog role.

with Russia and Japan scoring comparatively poorly. In general, countries perceived as having high-risk management effectiveness tend also to score highly on overall competitiveness as ranked by responses to the other questions in the Executive Opinion Survey, which are used to compile the Global Competitiveness Index.

The RRN team performed statistical analysis of survey answers to examine how responses to the question on risk management effectiveness correlated with others. These perceptions of resilience were found to be statistically significantly correlated to seven other factors covered in the survey:

• Politicians’ ability to govern

• Business-government relations

• Reform implementation efficiency

• Public trust of politicians

• Wastefulness of government spending

• Measures to combat corruption and bribery

• Government provision of services for improved business performance


Harnessing financial innovation to strengthen disaster resilience By Erwann Michel-Kerjan

As extreme loss events become almost commonplace, societies’ ability to cover the costs is coming under severe strain. Insurers may no longer be able to offer affordable cover for all and governments may not have the funds to systematically fill the breach anymore. Working closely with governments and insurers, the capital markets’ ability to develop innovative and effective alternative risk transfer (ART) mechanisms is therefore going to be crucial in creating an economically sustainable way to protect the fast growing number of exposed businesses and communities.

Conventional wisdom once held that major crises and catastrophes are low-probability events. Corporate boards and government leaders now recognise that this view is outdated.

Catastrophes have unfolded at an unprecedented rate in the past few years, be they financial crises, large-scale natural disasters, intercontinental pandemics or major terrorist attacks. We also live in an environment marked by mounting food and water scarcity, high climate variability, nuclear pro- liferation and cyber risks. Twenty of the 30 most costly insured catastrophes worldwide from 1970 to 2011 have occurred since 2001.1 With the exception of the 9/11 terrorist attacks, they were all natural disasters.

Looking ahead, the frequency of high impact events could increase still further. A combination of a growing and rapidly urbanising population, particularly in coastal cities, and the increasing frequency of disasters due

to climate instability mean that companies and governments will have to learn how to better manage the risk of expected but unpredictable disastrous events. This includes developing more effective ways to proactively assess and manage extreme events before they occur, and also create the foundations for a more resilient society, if and when they do.

While risk managers certainly have an increasing role today, this new risk environment is too important to be left to risk managers alone. As a strategic matter, it must actively involve the board of directors and a nation’s top leadership.

This also presents opportunities all along the risk management cycle, from risk identification and assessment to risk reduction and financial hedging. Turning risk management into value creation in this new era of catastrophes demands new services, new types of protection, and innovative new

financial solutions. A strong demand for such services and products has already emerged and is likely to significantly increase in the next five years.

But the crux of the matter remains – who pays when the cost of restitution continues to escalate. Given the space restrictions of such an article, I will focus this examination of the potential solutions opened up by recent inno-vations on one type of risk — natural disasters, and one aspect of risk management — financial hedging.

1 Erwann Michel-Kerjan and Howard Kunreuther. Paying for Future Catastrophes. New York Times Sunday Review, November 24, 2012.

Erwann Michel-Kerjan teaches Value Creation at the Wharton Business School, University of Pennsylvania. He is the managing director of the Wharton Risk Management and Decision Processes Center, which – for nearly three decades – has been at the forefront of managing and financing extreme events. He is also chairman of the OECD Secretary-General Board on Financial Management of Catastrophes, collaborating with its 34 member countries on these issues. Honoured as a Young Global Leader by the World Economic Forum, he advises several multinationals, foundations and heads of state.


2 International Atomic Energy Agency statistics, updated 19.03.123 Data from Karen Clark and Company (2012). Insured Property Values in the US. 4 http://www.nasa.gov/topics/earth/features/2011-temps.html

Why is insurability under strain?While extreme events are not new (there have been financial crises and earthquakes before), recent events have been much more global in nature. This is the inevitable flip side of the ever-growing globalisation of social and economic activities. Twenty or 30 years ago, a large earthquake and tsunami in Japan or a massive flood in Thailand would have mainly been a Japanese or Thai issue. But today, such events affect businesses around the world, directly through disrupted global supply chains, and indirectly, for example, through an increased fear of nuclear risk. In a notable case in point, Germany – Europe’s largest economy in Europe – is planning to abandon nuclear power, which provides about 17% of its consumed energy,2 in response to the Fukushima disaster.

Several socioeconomic factors have had an influence on the escalating levels including rapidly increasing population, a higher degree of urbanisation and huge growth in value at risk. Take the east coast of China. We could very well see a massive typhoon hitting Hong Kong, Shanghai and then Dalian this year. The ripple effects would be worldwide and extreme. Or take the state of Florida in the US, one of the world’s hurricane peak zones, where the population increased about 600% in the past 50 years. Today in the US, a staggering $15 trillion of assets is insured in coastal counties alone from Texas to Maine.3 Many more people in harm’s way means more exposed assets, too. Mathematically, the same hurricane that had mild effects 50 years ago would be catastrophic today.

Furthermore, climate science teaches us that a warming planet is more likely to see more extreme climate events as well. According to NASA, nine of the ten hottest years on record have occurred since 2001,4 years in which we witnessed many large-scale floods, storms and droughts.

One easy solution would be to make sure people do not live and work in harm’s way, but this would be wishful thinking. There is typically a high correlation between economic activities and exposure to natural disasters (because living near the coast has obvious advantages), so such a withdrawal from vulnerable zones is just not going to happen on a sufficient scale.

Who pays?So if increasing natural disasters are the new norm, as I recently wrote in the editorial of the review Nature recently, it begs the question of who will pay for these increased losses and how better to organise risk-sharing mechanisms before other large-scale disasters happen.

In response to these historic losses and increasing exposures, we are already witnessing a radical change in the loss sharing between public and private sectors in many countries, with governments taking a more important role in what were traditionally private insurance markets and where they exist. Insurance markets are typically heavily regulated and private insurers have already severely reduced their exposure in many high risk zones because they are not authorised by regulators to increase their premiums as they would like to.

In some cases, the government covers the resulting risks, by heavily subsidising insurance premiums. But one might wonder whether they can continue to do so and to increase their de facto financial liability in the future, as budget deficits persist and as the financial burden of their debt becomes unsustainable, economically and politically. So this is also a matter of establishing more efficient financial management strategies in countries exposed to natural catastrophes, i.e. practically, most of the world.


Advantage for the issuer

On the other side of the transaction (see Figure 1), SPV BigCat raises capital by issuing a catastrophe bond. The investors’ funds provided in exchange for the bond notes constitute the initial principal of the bond and will be placed in safe investments. The bond pays in the case of a triggering event, as defined by the specifications of the issued bond (for example, an earthquake of moment magnitude (Mw) 7.0 or greater in a specific city or region of the country, or a major storm with highest sustained wind speed greater than 150 km per hour in a specific location). The payout could also be indemnity triggered: Depending on the level of loss incurred by the company or government, interest on the bond or the principal, or both, is forgiven. In that case, these funds are then quickly released to ProactiveOrg to help cover part of its loss from the event. Another key advantage for a firm, municipality or country in issuing a cat bond is that the money is ready to flow in just a few days or weeks, depending on the form of trigger. By design, the capital of the bond is commonly invested in risk-free assets, such as US Treasury money market funds. As a result, there is limited credit risk.

Alternative risk transfer instrumentsSome of the most innovative and sustainable solutions to meet the challenge of providing adequate coverage against extreme events might come from the financial world, working in collaboration with governments and the insurance industry.

Some of the ART instruments to make this possible include catastrophic bonds and weather derivatives are already in place. They provide the necessary capital to support a financial safety net that helps individuals, corporations, cities, countries and international organisations adequately protect exposed assets so that they are resilient when the next catastrophe strikes.

The field of ART grew out of a series of insurance capacity crises in the 1970s through to the 1990s, which led purchasers of traditional reinsurance coverage to seek more robust ways to buy protection. Catastrophe bonds are one type of insurance-linked instrument that has significantly grown in volume in recent years and is likely to continue to grow as a market as we witness more and more costly catastrophes in the coming years.

To illustrate how these bonds work, consider an organisation (this can also be a country), ProactiveOrg, which would like to cover part of its exposure against catastrophes. To do so, it creates a dedicated company, BigCat, whose only purpose is to finance the disaster costs of ProactiveOrg. Notably, BigCat is an independent company (typically located in Bermuda or the Cayman Islands where the tax treatment is more advantageous). In that sense, BigCat is a single-purpose insurer (also called a special-purpose vehicle, or SPV) for ProactiveOrg. When the insurance contract is signed, the sponsor (ProactiveOrg) pays premiums to BigCat.

Advantage for investors

Premiums collected from ProactiveOrg will be used to provide the investors with a high enough interest rate to compensate for a possible loss of their principal should a disaster occur. One of the main advantages for investors is that these instruments constitute a class of assets that can enhance their returns since they are not highly correlated with other financial risks (for example, fluctuations in interest rates, if the economy is in a recession or a boom).

Figure 1 Simplified structure of a catastrophe bond

Potential investors

Provide the firm or government with rapid capital post disasterHigh value if rigid budget procedures

Fast financial aid (the cash is disbursed in a few days)

Investment in thededicated cat bond

Payment of interest andprincipal of the cat bond(at maturity; no disaster)

PremiumsDisaster claims

(investors lose their investment)

Contract with special-purpose vehicle BigCat (Issuer)(principal invested in safe investments)

ProactiveOrg (Sponsor)


Once viewed as an alternative source of financial protection for reinsurance and insurance companies familiar with the risks and eager to diversify their exposure, catastrophe bonds have now become another family of investment products for alternative investors, such as hedge funds, dedicated funds and also money managers, pension funds or insurance companies. Given the current low-interest rate environment and high volatility of markets, these new assets could develop even more.

Since its inception in the early 1990s, the catastrophe bond market has generated about $45 billion of cumulative issuance.5 While most of it was to cover insurers, reinsurers, other firms including Universal Studios, Disney, Électricité de France and Dominion, along with several governments (California, Florida, Turkey, Taiwan and Mexico) have now used their own cat bonds for state-run disaster insurance programmes. There are also discussions now about linking ex post risk financing with ex ante risk reduction efforts – a portion of the nominal could be invested in reducing the exposure over time, which would lower the expected loss.

Weather derivatives are another financial innovation that can be used by organisations as part of a risk management strategy to reduce risk associated with adverse events or unexpected weather conditions.

The value of the asset depends on the number of hot days or rainy days in a city, for instance. This market is expanding fast too as economic returns for a lot of businesses in many countries are highly correlated with the weather (e.g. agriculture, energy and tourism) and also because the market is becoming more liquid. More countries are now investing in modern weather stations with live recording that can be used to develop these financial instruments further. In 2011, PwC estimated the total weather derivatives market to be $12 billion and growing.

Dynamic risk solutionsIn conclusion, risk financing is a key pillar of any comprehensive strategy aimed at strengthening resilience. Designing a tailored solution based on a business or government’s needs is critical to enabling them to contend with a more volatile and uncertain world.

The continuing development of ART is therefore encouraging, demonstrating how innovation can thrive in the face of new and escalating challenges. A key benefit is the ability to extend the capacity for absorption of losses beyond insurers and governments into the capital markets.

Investors find these instruments attractive because they provide them with high enough interest rates to compensate for a possible loss of their principal and because this class of assets is not highly correlated with other financial risks, such as fluctuations in interest rates.

The coming years are set to see further innovation and collaboration. The OECD (which focuses on high-income countries) and the World Bank (which focuses on low income countries), both of which I advise on strategic development, have now established dedicated expert teams to work closer with governments around the world on these issues. Several banks, hedge funds, money managers and consulting firms now do the same for corporate clients. Disaster financing became a priority for the G20 last year and I was pleased to address the G20 on the topic. My Wharton colleagues and I, who have been working on the WEF Global Risks Report since its inception in 2006, look forward to fruitful discussions on effective resilience with world leaders at the 2013 annual meeting of the World Economic Forum in Davos as well.

5 Kunreuther and Michel-Kerjan. At War with the Weather. MIT Press, 416 pages.


The subtitle of this journal, ‘Winning with risk,’ emphasises the opportunities that arise from conflict and change. But another critical motivator of resilience is risk-reduction. The stunning toll of natural disasters on lives, businesses and national economies has spiked interest in finding ways to sustainably reduce and manage disaster risk. In 2011, in Thailand alone, floods shut down 1,000 factories and forced more than 700,000 people out of work. In 2012, floods, typhoons and earthquakes caused more than $274 billion of economic losses in Asia. In October 2012, when Hurricane Sandy ravaged the North-Eastern United States coastline and impacted densely populated areas in its path, it was a powerful reminder to the public and private sectors, to governments and businesses alike, that is was time to act – together.

A new framework for disaster reduction By Carlos Castillo, Lauren Cook and Oz Ozturk

PwC and UNISDR (the UN Office for Disaster Risk Reduction) are developing a collaborative framework for disaster reduction intended to contribute to improved disaster resilience and provide economic, social and environmental benefits globally.

In December 2012, the Business Council for the United Nations – supported by PwC – brought together representatives from both private and public sectors to discuss “Disaster Risk Management: Preparedness and Resiliency.” Representatives from UNISDR, UNDP (United Nations Development Programme), Wal-Mart, Citigroup and Government amongst others, shared their views on how they are working together to improve the resilience efforts of communities around the world.

We define resilience as the ability to recognise, take, and rapidly and effectively adapt to changes.1 In the context of disaster, preparedness for different conclusions elevates the level of resilience. There is not one preparedness approach that will fit all outcomes. However, there are some common preparedness techniques – communication among key officials in the public and private sectors, testing of infrastructure, education efforts – that can be applied no matter the circumstance.

1 http://www.pwc.com/en_GX/gx/governance-risk-compliance-consulting-services/resilience/assets/resilience-issue-2.pdf

Carlos J. Castillo leads PwC’s disaster risk management services for the public sector, providing homeland security and emergency and disaster management advisory services to the Federal Government and others. A Certified Emergency Manager (CEM), Castillo brings more than 30 years of emergency and disaster management experience at the local, state, Federal and international levels. Prior to joining PwC, Castillo served as FEMA Assistant Administrator and led the Disaster Assistance Directorate, responsible for the disaster declarations process, Individual Assistance, and Public Assistance. Castillo has authored several articles on disaster management and lectures on the topic internationally.

Lauren Cook is a senior associate focused on issues of sustainability, corporate social responsibility and business interruption. Her work at the firm has also included projects in Banking and Capital Markets and National Advisory. As the current president of the New York City Green Team, she leads a growing team of 150+ members who are making a positive impact on the office, the surrounding community and the environment.

Oz Ozturk is a partner in PwC’s Consulting team and is the global leader of the UNISDR & PwC initiative on establishing private and public best practices in disaster management and resilience. He leads the Strategy, Operations & Technology consulting group based in Geneva, specialising in Business Strategy and Transformation, Digital & Consumer Behaviour, and Supply Chain Optimisation. Ozturk holds a Master’s degree from Stanford’s Graduate School of Business and is a chartered accountant. He has over 20 years experience in Management Consulting having worked for Coopers & Lybrand, IBM, and PwC in senior leadership positions supporting his clients in a trusted advisor capacity. In addition to his consulting expertise, he has held executive positions within industry as a CEO and CIO within the logistics sector and as a Solutions Vice President for a global software company.


A framework to combat the devastation before it startsPwC has been working with UNISDR for close to a year to collect and analyse data about these preparedness techniques and develop a framework that can be applied around the world. The insights and best practices from this global study will be used in conjunction with the UN’s 2013 Global Assessment of Risk report to be published in May. The PwC global study itself, led by PwC Partner Oz Ozturk, will be available as a standalone detailed report early this year. The findings will be used to establish better alignment between the private and public sector for disaster prevention and set the scene for the soon to be updated Hyogo framework in 2015.

As the number and severity of natural disasters increases at an alarming rate, this framework provides a pragmatic approach to combat the devastating impact before it starts. At the event, I (Carlos Castillo) boldly claimed that, “all disasters are preventable.” We say this because we believe disasters can be prevented through risk-based preparedness and mitigation efforts, leading to enhanced resilience. The power of the PwC and UNISDR partnership is that it incorporates all leading practices from the private sector on a global scale with the UNISDR leading practices in community disaster risk reduction.

There is a clear benefit for the public sector when it comes to these partnerships. As for corporate sector parties, their increasing interdependence with their communities and the public sector means they gain more than just good PR from partnering with other organisations to create more resilient communities. Steve Dozier, Vice President, Wal-Mart, highlighted this in terms of the interdependence of its associates, stores and communities following a disaster. He noted that the more rapidly their stores and other businesses can reopen and provide critical goods and services following a disaster, the more resilient communities become. For communities to recover quickly, Wal-Mart has to be prepared to support its own employees enabling them to return to work sooner. Rapid recovery also relies on the government’s help when it comes to assisting the private sector with crucial infrastructure needs.

Partnerships that have increased each others’ preparedness Recent examples of PPPs (Public Private Partnerships) provide realistic hope for the success of the global framework.

DHL against disasters – DHL instructed UN officials on how to prepare Beirut’s

International Airport for natural disasters. Beirut has the only operational commercial airport in the country, and the US had exports worth over a billion dollars to Lebanon in 2011 alone.

Joining forces in Florida – A US example with global implications was shared by Castillo from his experience as Miami-Dade County’s, Florida, emergency management director. The County formed alliances with local universities and corporations to harden their facilities against hurricanes, thereby reducing the need for additional evacuation shelters for students and staff.

Skilled up students – The Japanese government taught junior high and elementary school students survival skills that helped during the 2011 Tsunami.

Keeping money mobile – Citi’s mobile banking was so user-friendly that it generated $10 million in transactions during Hurricane Sandy.

Combining the intelligence and experience underlying these examples, the PwC and UNISDR initiative seeks to produce an applicable global framework – with possibly far-reaching economic, social and environmental implications – for preventing or recovering from disaster.

Figure 1 Disaster risk management framework

UNISDR and PwC – Working together to reduce disaster risks

Being prepared saves lives, and money

According to one panellist, “For every dollar spent on mitigation and preparedness activities the ROI is between $4 and $11.”

At either end of the range, the investment is worth it. While preparedness efforts aren’t as high-profile or visible as response and recovery efforts, they are ultimately more effective.


Shikha Sharma

Axis Bank Limited, India

A CEO’s perspective on resilience:

An interview with Shikha Sharma - Axis Bank Limited, India

Q. How would you rate your bank’s ability to adapt to changes or disruptive events now, as compared to the past?

Shikha Sharma (SS): One of the things that we’ve attempted to do is to reduce response times, enabling us to adapt and change rapidly if circumstances require it. We have got better at that.

Q. What changes are you making to enable your bank to adapt quickly or effectively to external changes?

SS: We are doing two things to help us adapt quickly to external change. The first is communicating a lot more with the team: if growing numbers of people understand more parts of the bank that helps change happen more easily. Because when change happens it doesn’t impact just one slice of the bank, it impacts the whole organisation. And if people understand each other, then implementing that change becomes easier.

The second thing we like to do is really work with partners. So, we don’t try and do everything ourselves. This dissipates the impact of the change and you have to absorb a little less. And if you work with high quality partners they help you manage some of that change. So those are the two things that we are currently focused on.

Q.Doyoufeeltheinfluenceofthebank’sstakeholders–employees,customers,government,regulators,usersofsocialmedia–haschanged?Andwhichofthesegroupshasgrownmoreininfluence?

SS: Unfortunately, the influence of all these stakeholders has increased. I think regulators have become a lot more alert and active in a fast changing environment where some issues have cropped up.

And a lot more knowledge is being shared among consumers. This means that consumer experience spreads much faster today than it might have done in an era of less connection. The same thing applies to employees: they live in a connected world and communicate through numerous networks. So the word about change spreads much faster.

And, of course, you are constantly under media scrutiny. There are many channels that you have to worry about.

Q. Are you changing the way you’re connecting with these stakeholders?

SS: Connecting with stakeholders is fundamentally about communicating openly and sharing information. So, one of the big changes that I have seen over my years in the financial services sector is that today there’s a lot more openness about the way data is shared in an organisation. I think that helps the organisation to adapt, it helps to bring change and it enables us to garner the knowledge of many more people rather than just the select few who had access to that data in the past.

Q. In response to stakeholders, have you increased your focus on areas where your bank can have a wider impact on the communities in which you operate?

SS: As the bank gets larger I think it becomes even more important for us to be conscious about the impact we have on the community and what the community thinks about us. As part of our active programme of working with communities, we have set up the Axis Foundation, and contribute 1% of the bank’s profits to it. Instead of trying to work in many different areas, what we have chosen to do over the last couple of years is to focus primarily on helping to give people access to library books. The idea is that if we can bring economic prosperity to the poorer sections of society, then that’s good for both the economy and the community.


In 2010, Russia suffered a severe heat wave. The resulting economic losses were estimated to be US$15bn as drought and wildfires destroyed crops, particularly wheat. The knock-on effect was export restrictions on wheat in Russia, which contributed to global price increases.

Anticipating and responding to risks is business-as-usual for all sectors. This example is from the agricultural sector. It is one of many one could choose from sectors that are dependent on physical produce, such as agricultural, fuel or mining and metals commodities. These industries are no strangers to dealing with the risks of supply-chain

Business-not-as-usual: Tackling the impact of climate change on supply chain risk By Richard Gledhill, Dan Hamza-Goodacre and Lit Ping Low

While climate change and increasing temperatures now seem inevitable, there are high levels of uncertainty about the manifestations and magnitude of their impact. What is certain, though, is that climate change will have a multiplier effect on supply chain risk. By looking closely at the nature of a sector and the concentration of supply, it is possible to gauge the magnitude of the impact, with agricultural commodities such as wheat, maize and especially rice more subject to supply change disruption than petroleum, gas, metal ores and scrap. Effective ways to manage the supply change disruptions created by climate change risks centre on three principles: 1) recognising that the risks cannot be viewed in isolation due to their interconnectivity; 2) ensuring that the appropriate risk management procedures are in place including scenario planning; and 3) developing global collaborative strategies to deal with heightened international resource scarcity.

disruption (e.g. wheat shortages), both man-made (export restrictions) and natural (weather, drought, etc.). What is changing is the complexity of the risks, their interdependence with other risks and the wide-reaching, contagious impact they have (e.g. global price rises).

But the other major factor set to exacerbate supply-chain risk is climate change. Often overlooked, climate change adds to complexity. It amplifies or alters existing risks, for example raw material availability (e.g. water, energy) or transport disruption due to extreme weather events. The resulting shocks on the global supply chain can be severe and persistent.

Richard Gledhill leads PwC’s global climate change network. He specialises in climate policy, carbon markets and climate finance. Gledhill advised on some of the earliest, largest transactions in the Clean Development Mechanism and has remained active in the carbon markets, also advised a number of donor governments and multilateral agencies on climate finance. He is a member of the Network Council of the Climate & Development Knowledge Network and a director of the International Emissions Trading Association.

Dan Hamza-Goodacre is an Assistant Director in PwC’s sustainability and climate change team. He has 15 years of experience working in the public and private sectors on strategies, policies and programmes for climate change. Dan is currently head of the £10m climate negotiations support programme for CDKN for the UK Government, and leads PwC’s work on climate change and agriculture. Prior to PwC he spent six years with the UK Environment Ministry in various roles including Head of the Secretary of State’s office, lead policy official for the government’s adaptation legislation (Climate Change Act).

Lit Ping Low is an Assistant Director in PwC’s sustainability and climate change group. Lit Ping is an economist working on climate change policy and regulatory issues with governments and the private sector. Lit Ping has also co-authored a number of publications aimed at business and policymakers on climate change including the Low Carbon Economy Index (PwC), Policy Maker’s Guide to Green Growth (CDKN) and Business Leadership on Climate Change Adaptation (UNFCCC).


So climate change is a ‘risk multiplier’. But businesses have yet to gain the full measure of its effect on their supply chains. How serious? How soon? How likely? How wide? How to mitigate?

Too late for two degrees?How serious is the risk of climate change from increased temperatures? It is not such a far-fetched issue as many thought. The latest update from the World Bank is that the global mean temperature has already increased by 0.8oC above pre-industrial levels. We can also look at estimates of global insured losses from major extreme weather events. In the last two decades losses have increased markedly, averaging tens of billions of dollars annually.1

1 Munich Re: Great weather catastrophes worldwide 1950–2011, as of January 2012

Which supply chains need to strengthen their links? What is the likelihood that climate change risk could disrupt certain supply chains? To answer this question, we have analysed the threats posed by climate change to a selection of commodities:

• agricultural (wheat, maize and rice)

• energy (petroleum and gas)

• mining (metal ores)

We have looked at the two major factors that have the greatest influence on risk exposure:

A 2oC vs. 4oC worldHow soon will things happen? The UN Intergovernmental Panel on Climate Change (IPCC) has projected that every continent will feel the impact of even a 2oC warming scenario by the 2020s.

Water availability and quality will be affected in many regions, with a domino effect on agriculture and health.

The frequency and intensity of extreme weather events may increase in many regions.

Small island states and lesser developed countries are least likely to be able to cope.

Scientists, for example those at the World Bank, are starting to map out what a 4oC warmer world would look like. The full scope of damages is still unclear, although implications on human security, economic and trade systems are all likely.

When the world experienced a 4oC global average temperature change in the past, it took millennia, not a century.

Every year, government representatives from around the world meet at the UN Framework Convention on Climate Change (UNFCCC). They have agreed to limit the average global temperature rise to 2oC, and identified actions to mitigate, and adapt to, climate change. In spite of these efforts, carbon emissions have continued to rise. In 2011, emissions levels were the highest ever recorded. Can we really limit the temperature increase 2oC? PwC’s latest Low Carbon Economy Index suggest that based on current progress, this is ‘highly unrealistic’.

One thing is clear though, businesses and governments need to start planning for a world with a changed climate. In particular, industries dependent on food, water, energy or ecosystem services need to scrutinise the resilience and viability of their supply chains.


We have mapped these factors in Figure 1. It shows the extent to which the top five country exporters of these commodities are exposed to climate change impacts (vertical axis), and the degree of global supply concentration of these commodities (horizontal axis).

Rattling the supply chains of rice Our analysis, which uses projections for the 2040s, indicates the following:

• The supply of agricultural commodities (maize, rice and wheat) is more concentrated than that of the other commodities considered (petroleum, gas and metal ores). This is dictated by the climatic conditions in Asia (rice), North America (maize, wheat) and South America (wheat).

1. The magnitude of impact of climate change on the commodity:

This depends on: i) how susceptible a commodity is to the effects of changes in temperature and precipitation, rise in sea levels and occurrence of storms and flooding; and, ii) how able the supplying country is to cope with the potential effects of climate change. This is based on factors such as political stability, governance, macro- and socioeconomic development of a country.

2. The concentration of suppliers:

In general, where a commodity can be sourced from a diverse range of suppliers, supply disruption can be lessened as buyers turn to alternative suppliers. Conversely, where a commodity is concentrated in a small number of suppliers, disruption for any one major supplier can have global implications.

• Rice production stood out as the commodity that is both expected to be affected by climate change and highly concentrated in production. As the impacts of climate change on rice are increasingly felt in South and South East Asia, the global supply of rice could be significantly affected, as buyers have little alternative sources of supply.

• Maize and wheat are also relatively concentrated in supply, but the effects of climate change on these crops are projected to be relatively less severe. A concentrated supply base for maize means that any disruption to its major producers (from climate change or otherwise) can have a pervasive global impact. Its role as feedstock also means that implications of supply disruptions on global food prices can be significant, as was evident in the US droughts in 2012.

• The diversified supply of petroleum, gas and metal ores means that supply issues in any one supplier are unlikely to trigger widespread disruptions. The supply availability of these commodities is more likely to be disrupted by other risks than by climate change. These include the finite nature of such resources, technological capacity and politics. But the effects of climate change are likely to interact with these other factors and lead to an amplification of risks globally. Commodity price volatility can be exacerbated not just by more frequent or severe extreme weather events, but also by the accompanying political or policy reactions.

0

10

20

30

40

50

60Size of bubble indicates value ofimports for top 5 global exporters

Higher concentration implies more difficult to switch

Higher magnitude implies more severeclimate impacts for top 5 countries

0 0.1 0.2 0.3

Concentration of supply (HHI)

0.4 0.5 0.6

Mag

nitu

de

of im

pac

ts

Metal Ores & Scrap

Petroleum

Gas

Rice

Maize Wheat

Figure 1 Climate change: impacts and diversification, selected key commodities

Source: PwC


Figure 2 Commodity supply chains at a glance

Commodity Global market 2011 Top 5 exporters Exposure to climate change

Rice $23.3bn Clustered in South and South East Asia, led by Thailand (28% of global exports), followed by Vietnam, India and Pakistan. The US is the 5th largest exporter.

High water intensity and specific climate requirements make rice exposed to changes in temperature and precipitation. These elements, as well as extreme weather conditions such as storms, pose serious threats to the supply chain of rice. The key exporters are also vulnerable to rising sea levels.

Wheat $48.3bn North America (US, Canada), South America (Argentina), Europe (EU) and Australia.

Climate changes in temperature can have a positive effect on the wheat yields in North America but are likely to have the opposite effect in Europe, Australia and South America. However, rising sea levels and greater occurrence of heavy rains and storms threaten all top 5 exporters.

Maize $23.6bn US, Argentina, Brazil, Ukraine and India.

Increases in temperature are projected to improve harvests in the US as well as other leading maize exporters (the 2012 droughts in the US, however, defied this projection). However, extreme weather conditions and storms pose damage risks which could lead to volatility in supply and therefore global food prices. Maize plays an important role in the food chain, as it is used for feeding livestock. Its availability affects the agriculture sector significantly.

Metal ores $389.4bn

Including:High-volume bulk

Commodities: copper, iron, bauxite

Lower-volume, high value commodities: chromium, nickel

Australia, Brazil, US, Chile and Canada.

Mining operations display different sensitivities to environmental conditions depending on the type of material and the geographical location. Recent severe weather events have caused damage to mining infrastructure and transport disruption particularly for bulk products. Water shortages can also affect the costs of extraction, which is often water-intensive.

Petroleum and gas

$2667.5bn for petroleum and related products

$319.5bn for gas

Largest exporting regions: the Middle East and Russia; additional suppliers: North America and parts of Europe, Africa and South East Asia.

Most of the key exporting countries have a combination of offshore and onshore extraction and transportation infrastructure e.g. oil rigs, oil wells, and pipelines and liquefied natural gas facilities.

Extraction of oil and petroleum-related goods can be affected by extreme weather events. The melting permafrost and ice flow patterns in the Arctic can destabilise infrastructure foundations. Sea level rise (and associated changes in ocean swell height or storm surges) can also affect both onshore and offshore activities.

Source: PwC analysis

1 Munich Re: Great weather catastrophes worldwide 1950-2011, as of January 2012


Figure 3 Supply chain disruptions: the contagion of impacts from a single event

Events Contagion of impacts

Heat wave and drought in Russia (2010)

Estimated economic losses from Russian heat wave at US$15bn including the destruction of crops (mainly wheat) from the drought and wildfires.

Drought in the US (2012)

A combination of dry conditions and extreme heat including record-breaking temperatures over the summer months, led to destruction of agricultural crops.

Scarcity of feed stock (corn) further affected meat and dairy prices.

Global food prices soared by 10% between June and July 2012, according to the World Bank.

Flooding in Thailand (2011)

Forty percent of the global production of hard disk drives (HDD) is concentrated in Thailand. The flooding of manufacturing plants led to global price increases of HDD and the electronics dependent on them.

The flooding of car manufacturing plants led to local and international disruptions, resulting in the postponement of the launch of new car models for some companies.

Insured losses were estimated at $15–20bn. Much of this is covered by insurers (and reinsurers) outside of Thailand. Business continuity claims make up a significant proportion of losses.

Flooding in Australia (2010–11)

Forty mines were affected by floods, including disruptions in transporting coal from mines to coastal ports for exports. Major global coal mining companies declared force majeure, legally releasing companies the obligation of contracted deliveries.


2 Experts continue to debate if some of these events can be scientifically linked to climate change. Scientists suggest that in the absence of climate change, the extreme heat waves in Europe, Russia and the United States would happen only once every several hundred years, adding to the evidence base that climate change is having an impact. Meanwhile, the flooding in Thailand, while considered severe and low probability, is believed to be not related to climate change.

The multiplier effect on a global scale How far-reaching will the effects be? Although the analysis focused on projected impacts, recent events have already demonstrated the ripple- effect globally. Extreme heat waves in Russia and the US, and other extreme weather events such as flooding and hurricanes, showed how one event in a country or region can have repercussions globally.2


Multiplier effect needs multilateral effortsHow can organisations start to mitigate the potential disruption on supply chains due to climate change risk? This year, the UN negotiations in Doha concluded with limited progress, with current pledges still falling short of what is needed. Businesses and governments can improve readiness by adopting these three principles:

Don’t view risks in isolation. Businesses need to identify not just the risks emerging from the impacts of climate change, but how the resulting impacts interact with existing risks.

Start scenario planning and put risk management procedures in place. Governments and the business community need to start considering risk management plans in a world with a climate change of not just 2oC, but also 4oC or even 6oC. Effects are already being felt in some regions and they are projected to worsen globally.

Collaborate and give greater attention to international resource security. Competition for scarce resources may intensify, and can be compounded by political and economic developments. Developing a collaborative and sustainable resource management strategy at a global level can help avoid the risks of ‘resource grab’ and conflicts.

Methodology and sources for analysis We used projections from the UK Met Office which assessed the exposure of these commodities to impacts of changes in temperature, precipitation, rise in sea levels and occurrence of storms and flooding for each major supplier. The impacts are projected for the 2040s.

For each country, we derived a vulnerability index. This reflects the ability of a country to cope with the potential effects of climate change. This index is a composite index comprising the Worldwide Governance Indicators (WGI), the Human Development Index (HDI) and the GAIN Vulnerability index. It therefore provides an indication of the political stability, governance, macro- and socioeconomic development of a country.

The vertical axis gives a ‘score’ of magnitude of climate change impacts. This score is attributed to each commodity by weighting the exposure of the top five major suppliers by their share of exports, and is a measure of the magnitude of risk of climate impacts on the top five major suppliers and adjusted by their vulnerability index. A higher score suggests that the risk of disruption to supply from climate change is greater for the commodity.

The horizontal axis gives the Herfindahl index (HHI) for each commodity. The HHI measures the share of global exports from a source country relative to the total export market. The HHI is an indicator of the amount of competition. The index is between 0 and 1, and a high number suggests the supply is concentrated in a few source countries.

Sources: 2011 data from UNCTAD database (commodity specific data and HHI concentration indexes), 2012 BP Statistical Review (gas and petroleum trade), Met Office Hadley Centre (2010)


“We avoided 300 million litres of water use.” Perhaps not something you’d expect to come from the report of a large private equity house. But it did – from the 2011 cumulative results of KRR’s Green Port- folio Program (GPP), which it launched in partnership with the Environmental Defense Fund (EDF) in 2008.

In the same year, Carlyle stated in their 2011 Corporate Citizenship report that the company expected to reduce costs by approximately $1.8 million per year, and eliminate about 5,000 metric tonnes of greenhouse gas emissions and 440,000 pounds of waste annually.

What’s going on in the corridors of private equity (PE) houses? When it comes to environmental, social and governance (ESG) issues, it wasn’t

Creating value through responsible investment: Are the hard and lean going soft? By Shami Nissan and Malcolm Preston

It is generally perceived that the private equity (PE) industry has lagged behind public companies in recognising the importance of effectively managing environmental, social, and governance (ESG) issues creating value for its shareholders. However, the ESG focus is increasing as the basic business model of the PE industry becomes more long-term, with more than 90% of the respondents in a recent survey of the PE industry believing that ESG activities can create value. While less than half have the necessary systems and reporting frameworks in place to support this focus, such developments are a priority. So how can PE move up the ESG awareness curve and what will be the impact on how the sector operates and generates returns?

so long ago that the PE industry was viewed as somewhat ‘behind the curve’ compared to the corporate sector. Are the notoriously ‘hard and lean’ softening in their attitudes towards ESG matters?

Cautiously optimistic, PwC spoke to the leaders of some of the largest PE houses in Europe and the US to find out more. Ninety-four percent of them said that their attention to ESG issues will rise over the next five years. It’s clear that things are changing, but it is still early days.

Is it possible though, that the industry could accelerate its responsible investment (RI) journey? And if so, as the PE industry starts to identify value, and measure and report on its ESG efforts, could there be some shared learning for all.

Shami Nissan is an assistant director of PwC’s Sustainability and Climate Change team in the UK. Shami has worked exclusively in the financial services arena, with a wide variety of major clients in the private equity, banking and insurance sub-sectors. She has extensive experience of developing strategy, policy and procedures for implementing a sustainability programme. She has also developed and delivered multiple training engagements on ESG/sustainability. Shami’s work with PE houses has included meeting with portfolio company Board members and senior management teams to identify ESG risks and opportunities.

Malcolm Preston is global head of sustainability services at PwC. His role is to drive the understanding of sustainability and climate change throughout PwC to ensure the risks and opportunities associated with these issues are considered in the advice given to clients, including reporting and assurance; complying with related regulation and taxes; mitigation of and adapting to climate change; international development; investment decisions; supply chain resilience (including integrity and security); and educating boards and engaging employees on sustainability issues.


So why this PE interest in responsible investment?It’s the story of the stick and the carrot.

Investor pressure was the main catalyst cited by some PE houses we spoke to. Indeed, 88% said they believe that investor attention to ESG issues will rise over the next five years. So the pressure is real and it’s not going away. Increasingly, in a competitive fundraising environment, a robust RI strategy may be a source of competitive advantage, helping PE houses to secure access to capital. Survey respondents also said that risk management, cost savings, ‘tone from the top’ and regulatory pressure were important drivers.

The good news is that they can also see the money. A resounding 94% of the participants surveyed believe that ESG activities can create value. They see the carrot. A growing number of PE houses are being proactive about the ESG risks and opportunities of their portfolio companies. How can they create value from ESG matters? What opportunities can they find? This is a step change from their seeing ESG issues as solely about risk and compliance – the stick.

It’s work in progress – but could it change fast?Whatever they say about their increased attention to ESG matters, our survey suggests that it is still ‘work in progress’ for PE houses. Of those we surveyed:

• Fifty percent lack a policy on ESG issues and/or RI.

• Only 40% have put systems in place to measure value created from initiatives (this is particularly relevant for initiatives addressing environmental and social issues which tend to have more direct impacts).

• Forty-seven percent do not report publicly on their ESG programmes or their RI strategies.

This stems from the nature of the industry. Since they invest ‘private’ capital, PE houses have been under less pressure (political, regulatory and stakeholder) than their listed counterparts to show accountability and transparency. But, as they told us, this picture is changing rapidly. Limited partners (LPs) are upping the pressure for greater transparency.

So take note all you existing and future investees of PE houses!

The PE industry may be playing ‘catch-up’ but leverage is what it does. Even though many PE houses say that the lack of in-house capacity/expertise is a barrier to implementing an RI approach, they can learn from those who have already paved the way. They can avoid pitfalls and potentially make progress at a faster pace. Without the scrutiny of quarterly reports that listed companies face, PE houses can make change happen fairly rapidly in their portfolio companies, through their ownership status and their presence on company boards.

As we have continued discussing ESG matters with more and more PE houses, our survey findings continue to be reinforced. Over the coming years, we can expect an increasing number of case studies and ESG success stories from the PE industry.

What’s needed for RI strategies to flourish?There are things beginning to happen that we’d like to see more of. Practices that could enhance the value of responsible investment strategies across the board, whether you’re a PE house, an investor, a limited partner, a portfolio company, or sitting in another industry.

1)Shifttheparadigm–andthen don’t forget the carrot

If we can see things differently, change can start to happen. Ninety-four percent of PE houses are now starting to see differently – ESG activities are opportunities for value creation, not just matters of risk and compliance. But have they focused enough on that carrot yet, or are they still more concerned about the stick?

Let’s look at due diligence.

All survey respondents say they do some type of ESG due diligence, pre-acquisition. This could be misleading though. All PE houses will carry out ‘traditional’ environmental, health and safety due diligence, typically at a site level. Things like contamination liabilities, asbestos risks and environmental regulatory compliance have all been at the centre of specialist investigations in the past. This is mainly about checking for any financial implications that could impact investment economics; or for legal and compliance reasons; or to uncover liabilities that would expose the PE house. It’s still about the stick.

Of course, this type of due diligence still has to be done. But adding ESG due diligence paints a fuller picture. It identifies a broader range of issues like climate change or water scarcity. These might impact the quality, availability or price of raw materials in the future. ESG due diligence considers opportunity: new markets; income streams; eco-efficiencies; new resources; employee motivation; employee loyalty. It’s about the carrot as well as the stick.

These kinds of ESG due diligence findings then need to be built into the 100-day plan (or other targets). If this doesn’t happen, there’s a risk that ESG action points will be sidelined as niche issues. They won’t be integrated into core business strategy and practice. ESG value creating opportunities will be missed. The carrot forgotten.


2)Measurethefinancialvaluecreated–yes,tangibleandintangible

While 94% see that ESG activities can create value, only 40% are measuring it. What’s more, the things that are being measured quantifiably tend to be the ‘easier to measure’ energy efficiency initiatives.

PE houses such as KKR and Doughty Hanson have successfully measured cost savings from eco-efficiency initiatives including waste reduction, raw material reduction and reduced energy/water use. This is data that can be expressed in financial terms.

However, even the more advanced PE houses are struggling to measure the less tangible benefits of ESG issue management. Why is this?

It’s difficult to get the information. To measure value created from environmental and social initiatives you need relevant financial data. For most PE houses this is not yet readily available at a portfolio level. Many interviewed said they’re not yet collecting ESG data systematically from portfolio companies.

Other PE houses are measuring and monitoring ESG improvements at their

portfolio companies. But they’re using qualitative techniques. They can’t attribute value in financial terms to any improvements, but they can still build a picture of progress. They can also compare performance company -to-company, and year-on-year.

Interestingly, houses that are monitoring and reviewing ESG performance at a portfolio level are increasingly asking the portfolio companies themselves to pay for the cost of carrying out these reviews. This is partly because they recognise that ESG management is about value creation as well as risk management and compliance.

So what’s the answer? Use existing valuation methodologies. These can effectively quantify both the intangible and tangible value from managing environmental and social issues. This kind of valuation exercise first requires access to data though. PE houses must have the ability to systematically collect relevant ESG and financial data from their portfolio companies.

As we saw at the beginning of this document, some PE houses are starting to capture and report impacts more fully. Let’s take a further look at KKR.

In 2008, KRR launched its Green Portfolio Program (GPP) in partnership with the Environmental Defense Fund (EDF). The GPP is an operational improvement programme. It uses an ‘environmental lens’ to assess critical business activities for KKR’s participating private equity portfolio companies. In 2011, KKR reported the following cumulative results from the programme:

• Financial savings of more than $365 million

• Avoided 810,000 metric tonnes of GHG emissions

• Avoided 2.2 million tonnes of waste

• Recycled more than 462,000 million tonnes of waste

• Avoided 300 million litres of water use


What’s the issue? What’s the KPI? How is it measured?

Environment: climate change Greenhouse gas intensity Tonnes of CO2 per annum/$ revenue

Social: employee attraction and retention

Job creation or employee turnover Net number of jobs created or number of jobs replaced

Governance: bribery and corruption Percentage of employees (for whom bribery and corruption is a relevant issue) that have completed training

Total percentage of employees (for whom bribery and corruption is a relevant issue) that have completed training in the last 12 months

The second piece of good news is that PE houses can share this knowledge effectively across their portfolio companies during the hold period. They can strive for consistent reporting from all portfolio companies. They might host knowledge-sharing conferences for portfolio companies to learn from each other. They can call on specialists to help transition portfolio companies through the process.

Some PE houses have already set mini- mum ESG reporting metrics or KPIs such as the ones above. They expect portfolio companies to measure, monitor and report upwards, based on these.

With consistent reporting in place, the PE house gets a view of individual company progress over time. They can also compare, company-to-company, typically within a given sector.

As they become more sophisticated in reporting, PE houses can engage more proactively with LPs. They can work together to shape and streamline future RI reporting to them rather than being on the back foot and struggling to

report similar, but different, information to individual LPs. CalPERS is doing just this by developing a ‘Manager Assessment Tool’ to help its manager selection process by ranking managers on key ESG issues.

Are we brave enough to go this far?So, fast-forward a few years. PE companies are taking a strategic, value creating approach to ESG issue management. They have increased their knowledge through innovative partnerships with NGOs. Deal teams have been trained on responsible investment. There’s more structure around measuring and reporting the value of ESG programmes. Portfolio companies are enjoying the benefits of a proactive ESG approach. LPs are receiving transparent, insightful information.

At this point the PE industry could be in a position to give something back. Sitting atop integrated reports, consol- idated from across their portfolio companies, using a consistent set of KPIs gives them a great advantage.

3)Rampupreporting–forthesake of all stakeholders

There has been a trend among some PE houses to report ESG progress on a case-study basis. This can be a particularly effective reporting tool post-exit, to show the value created while the company was owned by the PE house.

But soon case studies won’t be enough. LPs are paying much more attention to the data they are getting from PE houses. They are asking more of them in their questionnaires. They are pressuring for more transparency in ESG-related information.

The good news is that PE houses can benefit greatly from the progress in the

corporate sector on sustainability reporting and integrated reporting. Which key performance indicators (KPIs) should be included in reports? What metrics can be used to measure intangible value from ESG activities? Here’s an example:

At this aggregate level, sector-based ESG issues and opportunities will become apparent. By sharing the insight from the integrated reports back through their portfolio companies they can create a domino effect of sector-specific learning.

PE houses will have enhanced their understanding of the most useful KPIs to include in an integrated report from a sustainable accounting point of view. They can share these with the industry actors in the corporate sector.

Limited partners could use the insight gained from their private equity investments to the benefit of their public equity ones. And as LPs start demanding integrated reports and using the PE model for their public equity asset managers, they would drive further transparency in ESG-related information.


Q. Which stakeholder communities are most important to your organisation?

ST: In the business we’re in we have to be very single-minded. So our portfolio companies come first. But as a consequence of managing those businesses for growth, I believe we have played an important social role in creating employment. I personally believe that employment is the biggest contribution that we can provide to the country. In building thriving workplaces we create enormous social benefit. Nevertheless, to achieve those social goals, one always has to focus always on the health of the portfolio companies. In a growth environment like Turkey, building value in a company is synonymous with job creation. At any given time, you have to recruit an excess of employees in anticipation of next year’s growth. We are blessed with an economic environment in which our social contribution is in complete harmony with our business goals. So it’s a really, really nice phase we’re in. Our colleagues in the West are very jealous because ours is a nice environment to operate in.

Seymur Tari

Turkven, Turkey

1 Based on Private Equity International’s 2011 ranking of the top 300 private equity firms by size, ranked on the amount of private equity direct-investment capital each firm has raised over a five-year period (www.peimedia.com/Pages.aspx?pageID=3155).

Approach to the survey PwC spoke with 17 PE houses including:

• Six of the top ten largest global PE houses¹

• Eleven of the top 50 largest global PE houses¹

• Six mid-tier houses

• Ten with headquarters in Europe

• Seven with headquarters in the US

Members of senior management of each PE house were interviewed, and interviews were supplemented with desk-based research on each PE house including consideration of company websites and relevant reports (e.g. Citizenship/Corporate Responsibility reports). Interviews were undertaken during the period from November 2011 through to January 2012, and relied upon a common set of questions being posed to each participant.

Interviews, unless specifically agreed otherwise, were undertaken on a non-attributable basis.


An interview with Seymur Tari - Turkven, Turkey


The risk resilience of Japanese companies has been repeatedly put to the test in recent years.

The common view sees risk resilience in terms of how a company can respond to discrete ‘shocks’: natural disasters, cyber-attacks, fraud and regulatory actions, for example. Even strategic risk is normally viewed through this event-driven lens. Is the company equipped to deal with sudden strategic challenges such as a disruptive new market entrant, or a production or demand shortfall?

But resilience is not just about discrete events. It is also a question of how well companies weather more gradual disruption to their business. And while

Losing ground to gradual disruption

As in most developed economies, Japan has been grappling with slow, or nonexistent, economic growth, a changing workforce and the mutating shape of their key industries, among other disruptions. And Japanese companies seem to be struggling to find a new path in a changing world.

This once thriving economy has built global brands, managed complex sales and distribution channels, pioneered ground-breaking innovations and established premier positions in industries such as chemicals, aerospace, automotive, electronics and infrastructure.

shocks to the system are pretty obvious, gradual change is much more difficult to see happening – and equally important to prepare for.

Dealing with gradual and sudden disruption requires a strategically risk-resilient mindset. This is a mindset that embraces strategic risk-taking, and readies the organisation to recover from, or even capitalise on, sudden or gradual change.

So a highly resilient company will be ready to respond to gradual disruptions with a series of smaller and gradual changes. In contrast, failure to adopt a strategically resilient mindset in time can lead to a point where gradual disruptions must ultimately be resolved with dramatic changes.

Bouncing back: Two Japanese corporations’ road to resilience By David Jansen and William Macmillan

Recent years have severely tested the resilience of Japanese companies and the country as a whole. Japan has experienced severe catastrophes including earthquakes, typhoons and the Fukushima nuclear plant meltdown. These natural and man-made disasters have occurred in a country that is also grappling with a struggling economy and a shrinking workforce. In this article, we look at how two Japanese companies – Hitachi and Lawson, a convenience store group – have developed the resilience needed to cope with both dramatic events and gradual, but inevitable, long-term changes that threaten their existence. Their experience shows that a resilient organisation embraces bold leadership, is open to fresh and diverse perspectives, monitors mega-trends and is flexible. They also underline the importance of helping people to believe change is needed, unleashing innovation, building agility, fostering the right alliances and creating the appropriate culture.

David Jansen is an experienced PwC partner who provides strategic advice to corporations, governments and heads of state on issues including globalisation, governance, mergers and acquisitions, and transformation. David recently authored the report, Revitalising Corporate Japan: A Prescription For Growth, and is a frequent lecturer on the issues facing Japanese corporations in their quest for global, profitable growth. He currently divides his time between Tokyo and New York.

William Macmillan is a senior associate and a member of PwC’s global Japan Business Network and was a contributor to the recently released report, Revitalising Corporate Japan: A Prescription for Growth. A graduate of the Wharton School of the University of Pennsylvania, William splits his time between New York and Tokyo. Specialising in post-disaster reconstruction he is currently helping develop innovative strategies in a variety of reconstruction initiatives in the Tohoku region.


Today however, many formerly leading companies are losing ground to new rivals in foreign markets at the same time as the domestic market continues a two-decade long slide. Gradual disruptions are grinding down these once great giants.

Time for change?

In a recent interview with PwC, Atsushi Saito, CEO of the Tokyo Stock Exchange Group (TSE) and former President of the Industrial Revitalisation Corporation of Japan, described the situation like this: “Even though many Japanese companies still boast very strong marketing power, production power, or engineering power, they are losing their global position. Japan’s first-class companies are now reviewing their strategies and feeling the necessity for radical change, but the question is how quickly and how effectively can they do this. Everybody can imagine change and talk about change, but the point is to what degree can they really change?”

There is a growing consensus through-out corporate Japan that it needs to ‘transform’ itself in response to the last 20 years of gradual disruption. Transformation or ‘radical change’ as the TSE’s CEO put it, is dramatic. But this is the bitter pill that has to be swallowed for those Japanese companies wanting to position them-selves for faster recovery from future challenges and changes. The time for small and gradual changes is over.

Although most business leaders would rather avoid the drastic, the good news is that if dramatic change is well-executed and sustained, it is also a route to resilience. That has certainly been the story of two of Japan’s leading companies, which have made bold, and sometimes challenging, moves to restore their competitiveness and strategic resilience. The challenging

corollary has been a departure from time-honoured practices, the relinquishing of many traditional ties and the need for difficult trade-offs between competing priorities.

Healing Hitachi In many ways, Hitachi exemplified a traditional Japanese approach to business. As one of the largest and most prestigious Japanese companies, Hitachi’s wide-ranging business units stretched from consulting and business services to aeroplanes and nuclear reactors. But this sprawling empire became increasingly unmanageable over time. In 2009, Hitachi posted the largest loss ever by a manufacturing company in Japan, 787.3 billion JPY or $8.03 billion at 2009 exchange rates.

The response was a new broom that saw Takashi Kawamura named as chairman, and in 2010, Hiroaki Nakanishi taking over as CEO. Together they began substantial reform.

Broadening the board

The new leadership recognised that an organisation competing in a global marketplace needed to embrace more diversity within. As seasoned executives at one of Japan’s most prestigious companies, they had the political capital to insist on a more global approach to management.

While the business lines were diverse, the business leadership was not. They started right at the top – with the board. As a result, Hitachi now has seven external board members on its 13-member board. Another rarity for Japanese corporations, the board also has three non-Japanese members: George Buckley, former CEO of 3M, Phillip Yeo, the chairman of Singapore’s government development agency and Sir Stephen Gommersall, former British ambassador to Japan and current CEO of Hitachi Europe.

Forging a global perspective

The imperative to be global has filtered out from the board all the way through the organisation. In another example, Nakanishi has put in place a system to benchmark Hitachi business units against their international peers as well as their local rivals, such as Toshiba and Mitsubishi. This forces managers to focus on global trends as one way of escaping the ‘Galapagos syndrome’, which stems from excessive focus on the domestic market. Armed with this broader perspective, managers are better able to assess the potential for new competitors emerging from a new geography, like Indonesia or South Korea. This is resilience in practice – generating knowledge to be better prepared to respond to changing circumstances.

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HitachiH

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Figure 1 Hitachi stock performance relative to selected peers

Index FY 2010=100

Source: Nikkei and Thomson Reuters, November 2012


1 Since Nakanishi took the helm in 2010, the firm has added more than 16% to its market cap, compared with a decline of 15% in the broader Nikkei 225 Index.

Aligning the organisation with market demands

At Hitachi there are clear signs of a new spirit of boldness – fuelling readiness to take the difficult steps needed to bring the business closer to the market. In November 2012, Hitachi finally closed down its television manufacturing business, a move other troubled Japanese consumer electronics companies have been unwilling or unable to make.

In a recent story in The Economist, Nakanishi gave another anecdote. He described persuading the company management to invest the $800 million dollars necessary to turn the hard-disk drive unit business around. Rather than resting on this accomplishment, Nakanishi subsequently sold the business this year for almost $5 billion.

This defines the spirit of boldness that is helping to transform Hitachi into a more resilient and successful organisation. Hitachi leadership is having the courage to break with the past and the financial rewards are clearly measurable. Since Nakanishi took the helm in 2010, the firm has added more than 16% to its market cap, compared with a decline of 15% in the broader Nikkei 225 Index.1

Reinvigorating Lawson Lawson is a major convenience store operator in Japan. In preparing for its IPO in July 2000, Lawson was opening more than 1000 stores a year in the already crowded Japanese marketplace. In the year after its flotation, the company’s share price fell by nearly forty percent. There was a clear need for drastic measures. During this period of turmoil, Lawson brought in Takeshi Niinami from Mistubishi Corporation, a major shareholder, to turn the company around. Appointed CEO in May 2002, he was charged with reversing the company’s decline, and restoring investor confidence.

Creating a convincing case for change

When he arrived, Niinami described encountering deep scepticism from the Lawson employees. He picked up the challenge by visiting Lawson convenience stores all over Japan. In an interview with PwC he described how face-to-face interaction was necessary to increase motivation: “I wanted to convey my passion and emotion, whatever it is, because I was unknown to them, and because I was a trading house guy [not a retail guy]. But I wanted to share my vision with them, and strong passion should be conveyed directly.”

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Figure 2 Hitachi return on equity compared to selected peers


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LawsonL Nikkei 225N FamilyMartF Seven & I HoldingsS

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Figure 3 Lawson stock performance compared to selected peers

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Fostering the right alliances

This credibility was exceptionally important in achieving one of Niinami’s most important short-term goals. In order to establish the right business alliances that the company needed for its future operations, Niinami knew he would have to uproot long established interests leftover from the previous management.

But this was no easy task. In many Japanese companies strong links between shareholders and management, including widespread cross-shareholding complemented by lending relationships and supply arrangements, provide an informal safety net for many Japanese companies. This has in turn created a corporate culture that places great emphasis on preserving long-established relationships, be they with lenders, former partners, or suppliers. This corporate philosophy has one clear advantage, management can be confident that their lenders and suppliers are tied into their long-term survival. In practice, however, this often decreases the speed with which decisions are made and promotes an extremely headquarters-centric management of the company.

Buildingagilityandflexibility

At Lawson, the headquarters-centric style stifled innovation at the store level. But a resilient organisation ensures that the best ideas can be implemented no matter where they are born. So a radical transformation of the organisational structure was needed to give local units the autonomy to respond to changing circumstances. Niinami describes the new management

approach he instituted like this: “I delegated decision-making authority to the general managers of our regional headquarters for day-to-day management. By empowering people, I could raise their motivation and increased their productivity. This was completely different from the usual practice of the Japanese retail industry.”

Creating the appropriate culture

In a move that would bring painful short-term consequences to some, Niinami put an end to the ‘job for life’ employment philosophy common to many Japanese businesses, which offers security and guaranteed promotion in return for loyalty. He recognised the need for full meritocracy in promotions to create a culture that fosters fresh thinking and enhances motivation. The company’s headcount shrunk by 20% in one year. But these changes didn’t end with the rank and file employee. Niinami took the risk of reducing the size of the board from 21 members to just 9, removing 18 insiders.

A more diverse workforce stimulates more diverse ideas – necessary for resilient organisations to rapidly react to change. Lawson fully embraced the challenge of diversity, by naming two women to its board and requiring that 50% of all new hires are women. These are pioneering moves in a nation ranked 101st of 135 in gender equality, according to the World Economic Forum.

Unleashing innovation

This fresh thinking released a wave of innovation within Lawson, breeding the strategic resilience necessary to survive these tough economic times. One example is the recently launched ‘Natural Lawson’ product line of fresh and organic foods targeted towards a population increasingly focused on sustainability. Another new business idea is the launching of pharmacies aimed at Japan’s rapidly ageing population.

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Figure 4 Lawson return on equity compared to selected peers



1. Breaking with the past

The level of risk the Hitachi and Lawson leadership were willing to take, and the sacrifices the companies had to make to improve the company’s financial performance were greater than once would have been thinkable in corporate Japan. At Hitachi, Nakanishi took the bold step of closing the once iconic TV business as part of a broader shift away from consumer goods. Niinami of Lawson was willing to break with the entrenched interests of large shareholders and form new alliances.

2. Open to new ideas

A substantial restructuring of the board was a feature of both turnarounds. The fresh global perspectives on Hitachi’s board are anchoring a pivot towards international markets and competitors. And as Lawson embraced full meritocracy in its employment practices, it was able to enlist the entire knowledge of the organisation to innovate in line with the changing market.

While the long-term pay-off is greater ability to adapt to changes - a hallmark of resilient companies - the trade-off would not have been small. Both Hitachi and Lawson leaders will have had to weigh those benefits against the risk of compromising Japanese cultural norms where loyalty to company employees is long-heralded, as well as creating uncertainty and dissatisfaction for employees who assumed career security.

Atsushi Saito of the TSE evocatively describes this change as “destroying the triangle” – dismantling the age-based and hierarchical system of talent management. In practice, this means identifying and promoting talent that does not come from the traditional sources for Japanese companies.

3. Broadening horizons

At Hitachi, managers were instructed to benchmark against international competition as the company reoriented itself towards providing infrastructure solutions around the world. It’s a tactic that will prepare it to pre-empt and rival a new set of competitors. Lawson has identified an ageing population in Japan and a society more focused on sustainability as demographic trends that open up market opportunities.

In monitoring new competition or identifying new markets, both illustrate risk resiliency. By analysing what’s going on ‘out there’, they have improved their ability to assess risk and turn it to their advantage.

4. Strengtheningflexibility

At Lawson in particular, the company recognised the need to decentralise decision-making in a move that ran counter to Japan’s headquarters -centric approach. While the trade-off would have been a release of control and perhaps increased inconsistency in decision-making, the upside is a flexible and nimble organisation. At Lawson it also released innovation and gave rise to motivation.

Local units are empowered by, and better able than, their headquarters to respond to changes with speed and agility.

The measures taken by the two companies by no means comprise an extensive list of reasons why Japanese companies are struggling. However, they provide a practical understanding of some key and ultimately successful steps that each company took to be more resilient.

Trade-offs and pay-offsThere was nothing easy in what Hitachi and Lawson achieved. They have taken strategic risks that none of their predecessors were willing to attempt. Leadership at both firms has also accepted that it may sometimes be necessary to go against the loyalty to employees and close relationships between management and shareholders so central to the Japanese ‘path’. This does not imply that moving away from these cultural underpinnings is always necessary. But it does underline the importance of embracing fresh ideas and new tools. It also demonstrates that the steps needed to build resilience and success in today’s environment may be unpopular and difficult for many.

Here, we have set out some of the fresh thinking and potential compromises that will form part of the road to resilience.


Egypt is undergoing a major change of mood from the initial euphoria spurred by the revolution of January 2011. The initial stirrings of a ‘lost generation’ of disaffected and mostly educated, middle-class youth provided the catalyst for a public uprising that quickly brought in people from across different walks of life, united by their dismay with the government and its preferential policies. But, two years after the highs of the revolution, the initial optimism is now tempered by challenging developments. The country now faces escalating government debt, depleted foreign exchange reserves and decreasing inwards investment (see Figure 1).

Egypt: Weathering the storm By Rehab Abdelhafez

The bloom is coming off the rose in post-Arab Spring Egypt as economic conditions deteriorate and political tensions rise between the ruling Islamist party and the country’s educated middle class. What are the implications for companies operating in Egypt? To answer this question, we interviewed four local companies and three foreign-owned multinational corporations (MNCs) about what risks they face, how these risks affect the way they manage their operations and what is expected to improve or get worse over the medium- to long-term. The results provide valuable insights, highlighting the greater vulnerability of smaller local companies compared to multinationals, given their different exposures and inherent structural differences.

The political transition has generated some desired outcomes, with an elected president taking office in mid-2012. However, political uncertainty remains high and the development of many of the institutions needed to stabilise the country has been held up by legal challenges. The unity of the uprising has given way to a widening rift between Islamists – who landed a majority in parliamentary elections and won the presidential race – and the more liberal and socialist movements. Change has not come as fast as people hoped and discontent is spreading among ever more groups of the population. In this volatile environment, it is difficult to anticipate how events will unfold and the implications thereof.

To gauge the business impact of this changing economic and political environment and the risks it is creating, we spoke with three MNCs operating in the business-to-consumer domain (automotive, personal care and soft drinks), and four local family-owned companies operating in the business-to-business area (facility management, printing, construction and automotive tires trading).

Rehab Abdelhafez is a senior manager with 14 years’ experience in market assessment and strategy services across various industries. Rehab was involved in strategy formulation and business planning projects for private and public sector clients in Egypt and the Middle East region. She has also worked with development and donor organisations on key strategic assignments including the World Bank and the UN, as well as other international NGOs. Rehab has advised clients on other strategic issues such as organisation structure and design, human resource function improvement, recruitment, corporate citizenship and access to finance.


Figure 1 Egypt - key economic indicators

2007a 2008a 2009a 2010a 2011a 2012f 2013f

Population 76.9 78.3 79.7 81.1 82.5d 84.1 85.6

GDP

Nominal GDP (US$ bn) 132.2 164.8 187.3 214.4 231.1 256.3 256.5

Real GDP growth (%) 7.1 7.2 4.7 5.1 1.8 1.9 3.5

GDP per head (US$ at PPP) 5,265 5,666 5,889 6,154d 6,286d 6,402 6,634

Expenditure On GDP (% Real Change)

Private consumption 8.8 5.7 5.7 4.1 5.0 6.0 5.6

Government consumption 0.2 2.1 5.6 4.5 3.8 3.0 4.3

Gross fixed investment 23.7 14.8 -10.2 7.7 -5.6 -0.9 4.0

Foreign Exchange

Exchange rate E£:US$ (av) 5.63 5.43 5.55 5.63 5.94 6.05 6.82

Exchange rate E£:€ (av) 7.72 7.99 7.73 7.47 8.26 7.70 8.61

Total International Reserves (US$ mn) 31,374 33,849 33,933 35,792 17,659 15,265 16,186

Source: Economist Intelligence Unit-Egypt Country Report (October 2012)

a: actual, f: EIU forecast

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Source: Ministry of Investment Annual Report, 2010

The interviewees were asked four questions1:

1. What are the new risks that you have to deal with now, compared to before the 25 January 2011 revolution?

2. How are these risks affecting the way you manage the business?

3. In your view, what aspects of the business environment will improve, and what aspects will deteriorate in the medium- to long-term?

4. What are the medium-term expectations for your business in Egypt?

Despite the limitations of the small sample size, the responses provide useful insights about the business perspective on the evolving macro-context in Egypt. These can be used to draw some important lessons.

1 I would like to thank all the interviewed senior executives and owners/managers for their quick response and cooperation in providing their invaluable input for this analysis.


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Figure 3 Net foreign direct investments flow


Two sides of growthBefore we look at the results, it is useful to compare the relative development and fortunes of the two sides of the economy.

Growth in the Egyptian economy during the period 2004–2010 reached as high as 6–7%, with strong impetus coming from foreign investment (see Figures 3 and 4). The increasing opening up of the economy in the wake of the 1990s structural adjustment programme attracted many more MNCs to start operations in the country.

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However, the more sizable portion of investment and economic activity is carried out by domestic family-owned businesses and local enterprises, which range in size from small to large, with few achieving international status in recent years (Figure 5 provides an overview of the movements in private sector investment as a proportion of GDP).

These small domestic businesses have contributed significantly to economic growth despite red tape, lack of finance and inconsistent legal protection, as well as seeing many of the best opportunities still going to firms favoured by the previous regime.2 Many of the firms – but some larger ones as well – are managing their operations ‘informally’ in a lot of respects. They lack the formal organisational structure and systems of their corporate counterparts. Their tax and accounting returns may fall short of compliance and hence their contribution may therefore not be fully captured in official economic data.

MNCs can choose where in the world they operate, moving into a new market when the advantages outweigh the risks associated with doing business in that locality. In recent years, Egypt’s appeal to MNCs has increased as a result of certain measures. It is the largest market by population within the Middle East and North Africa region, and its youth represent half of its population,3 with

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Figure 5 Proportion of private sector investment to GDP


2 ‘From Privilege to Competition: Unlocking Private-led Growth in the Middle East and North Africa’, the World Bank, 2009.3 About 25% of population are in the 18–29 years age group. Source: Egypt Human Development Report 2010, UNDP.4 Egypt ranked 118 out of 176 in Transparency International Corruption Perceptions Index in 2012, and ranked 110 out of 181 in the World Bank’s Ease of Doing Business Index in 2011.5 Sirmon, D. & Hitt, M. ‘Managing Resources: Linking Unique Resources, Management, and Wealth Creation in Family Firms’, Entrepreneurship: Theory & Practice, Vol. 27, No. 4, pp. 339–358.6 Sieger, P., Zellweger, T., Nason, R.S. and Clinton, E. (2011). ‘Portfolio Entrepreneurship in Family Firms: A Resource-Based Perspective’, Strategic Entrepreneurship Journal, Vol.5, No. 4, pp. 307–326.

increasing aspirations and desire for global exposure. The cost of labour, capital and land is relatively cheap, and the government has offered multiple incentives in the form of tax breaks, privatised companies at attractive values and provided a relatively straightforward legal environment. Combined with the political stability of the country, it was an appealing choice for many, despite ranking rather low on measures such as ease of doing business or corruption.4

Family businesses follow a different trajectory, reflecting the ‘the unique bundle of resources created by the interaction of family and business’.5 These include human capital, social capital, patient financial capital, survivability capital and reputation capital.6 Family business success further depends on the elements of governance, structure and cost, and how these are deployed to manage the unique resources to create wealth for the organisations and the families.


Family businesses face new risksThe family managers and owners interviewed felt changes in the business environment generated risks and issues they had not experienced in the past, despite some being in operation for many decades.

The number one risk cited was uncertainty about where the country is heading. This had spurred many to put investment and expansion plans on hold, though some are now forging ahead, despite the risks.

The lack of clarity about economic policy, currency devaluation and interest rates is the second most important concern, directly affecting their cost of operation, size of demand and expectations about wage rises. The current discussion of subsidy removal is raising concern about increased inflation, and accordingly demands for higher pay. In addition, the depreciation of the Egyptian pound is raising the cost of imported material for some companies, although for others this might increase their ability to compete internationally.

Labour issues are the third important topic of concern for family-owned companies. Workers are now able to express their demands more freely, but the capacity to meet their demands for higher pay is curtailed by the squeeze on business.

The fourth recurring theme was the change in the level and nature of competition. One indicated that the ‘big players’ who prevailed during the past decades have started to decline due to the loss of their privileged position with the fallen regime. Others are seeing new competitors

7 Taleb, N. and Blyth, M. ‘The Black Swan of Cairo’, Foreign Affairs, May-June 2011, Vol. 90, No. 3, p. 33-39

emerging, local or regional, as the market continues to attract new investors. A third indicated that they are being undercut by illegally smuggled goods, which are increasingly entering the country, due to loosening border controls.

In addition to these risk areas, the ‘Black Swan of Cairo’7 has had its implications on their businesses at a strategic level. Service companies have seen their clients reduce their expenditures, which is squeezing their profit margins, disrupting their cash cycle or pushing them to compete with a different set of players. For example, a company offering facility management and energy services suddenly found their strategic competitive advantage wiped away after the revolution. They went to market with the proposition of innovative, integrated solutions. Their clients are seeing this as a luxury now, and new clients are less willing to try. The company now has to sell services separately in order to win new business. This has, in effect, taken them ‘down the pyramid’ to compete with a completely different group of service providers offering individual services such as security and cleaning.

Other companies have seen the demand for their business shrink, or stop altogether. Government business is on hold with no new opportunities proffered until certain political issues are in place such as a valid constitution and a functioning parliament. The private sector has recently started to resume activity, in the construction sector for example, and work is starting to pick up. Some of these companies have closed shop for now, or are opting for regional business opportunities instead.

However, the future is expected to be brighter. All those interviewed agreed that once the current ‘transitional’ stage is over, things would be better and the prospects for their business are strong. They all felt positive about the future, and shared hopes of things eventually moving in the right direction. All were particularly keen for a more level playing field, improved regulations and better quality education that will provide better skilled human resources, hence cutting down on the need to ‘start from scratch’ when training staff.

MNCs push throughMNCs interviewed saw the situation differently. Despite everything, they saw no fundamental change in the business environment and attendant risks. They are aware of some labour unrest and security concerns, but this has not spurred them to scale back investment.

The issue of greatest concern was the perception of ‘government paralysis’, making government officials wary of taking a stance on major decisions or even following through on decisions already in place. This is manifesting itself in areas such as prolonged product approval.

One company indicated that there is now increasing focus on Egypt from headquarters, though the size of their business is small in global terms. The bad publicity in the press requires them to extend more effort in convincing the executives in HQ that the business is resilient and the prospects are as good as before, if not even better.

Interviewed MNCs shared the optimism of local companies. They too strongly believed the market has significant growth potential and are proceeding with their plans including expansion and injecting more investment in the country.


Local family business

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Several None

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Positive outlookDespite popular concerns and the gloomy image portrayed in local and international media, business remains resilient and confident. It is particularly interesting to note that the buoyant outlook cuts across local family firms and MNCs alike.

MNCs can in some ways be more resilient as they can offset risks in one market with opportunities in others. Indeed, some see the situation in Egypt as an opportunity. For example, security concerns are increasing demand for certain products such as four-wheel-drive vehicles. The government is also seeking new sources of investment and is likely to do more to support business, even if the policy paralysis may hold up some developments. All the MNCs we spoke with said they would continue with their planned investments at this time so as to be best positioned for the market when it rides up again, which they all expect it will.

The prospects for local businesses are more challenging and this is reflected in their investment plans. They are generally smaller in size, at earlier stages on the maturity curve, and are family-owned where the personal wealth of the owners is directly affected by the state of their business. They were used to a very stable environment and are mostly dependent on a limited customer base and the commitment of their workers.

As a result, they are seeing several new risks and challenges in the current economic and political instability.

Another factor behind the different perspectives can be the customer base. The interviewed MNCs happened to be serving consumers from mostly higher income groups.These had been least affected by the economic and political turmoil in Egypt. Local companies serve other businesses, of various sizes, which are facing a squeeze in demand. Those working with government had been most affected due to the government’s inability to take decisions on new projects in light of the political instability. This indicates that possible diversification of the customer base is a key factor of success especially for smaller local companies.

A third factor behind the differing perspectives is the companies’ strategic management maturity. MNCs are used to operating in highly competitive and fast moving business environments. Many of Egypt’s local companies are more familiar with the relatively unchanging and less than competitive environment that prevailed historically. As competition increases including illegal sources of goods, the challenge is how to develop the necessary efficiency and agility to vie with the new entrants.

Based on this, it may be possible to draw a few lessons for companies to be resilient in unstable conditions. Size and geographic diversification support global companies in minimising the impact of black swan events. For local companies, customer diversification will spread the risk of business stagnation among the various segments. Additionally, having a clear competitive advantage that is not easily wiped by external shocks is another lesson. As the example of the facilities management company highlights, the challenge for others is how to remain relevant when demand comes under pressure.

Lastly, it is important for companies, local and multinational, to focus on the longer-term prospects of their markets and plan accordingly. While turbulent conditions may affect the company’s performance in the short-term, they also present opportunities for better longer-term results when stability is achieved. Wiser firms with better clarity on their longer-term business strategy are more able to take investment decisions during high-risk situations, whereby they achieve a better market position when the market becomes more appealing to competitors in quieter times.


Picking up after Sandy: Resilience in the eye of the storm By Neil Kaufman

Hurricane Sandy has forced business and community leaders to question the effectiveness of their disaster preparation and planning. What can Sandy teach us about developing a comprehensive and practical risk resilience programme?

Where were you when Hurricane Sandy hit? I know that’s going to become one of those questions that people ask when they hear I live in Manhattan. The answer is that I was right there. As the storm approached, with its eye looking straight at us, I was wondering how to prepare, how much to prepare, how much would my family, friends and neighbours be affected?

And then afterwards, assessing the impact, working together with those friends and neighbours to do everything we could for anybody who needed it. We wondered how quickly we would be able to get back on our feet again. And with so much devastation, what would things feel like when we did?

Of course, my thoughts weren’t immediately on my work at that time, but I knew many of my clients would also have been affected by the hurricane. My job is to help businesses ensure they can keep their key operations running in the event of an accident, a disaster such as Hurricane Sandy, an emergency or threats. Never more pertinent, this is known as business continuity management (BCM). BCM is a key component of risk resiliency as it can fortify a company’s long-term ability to withstand external threats. Some businesses were more prepared than others.

From weathering Sandy live with my family to getting back into the corporate field and helping clients recover afterwards, there had to be something to learn. This article shares some of my reflections on what this storm taught us about disaster resilience.

Could anyone really have been prepared for this?Hurricane Sandy affected 24 states in the US. It swept up the entire eastern seaboard from Florida to Maine and west across the Appalachian Mountains to Michigan and Wisconsin. There was severe damage in New Jersey and New York. The people of New York City experienced flooding in streets, tunnels and subway lines and lost power in and around major parts of the metropolis. A construction crane atop a $1.5 billion luxury high-rise in midtown Manhattan collapsed in high winds and dangled precariously. This prompted precautionary evacuations and many of the surrounding streets were cleared. There were power outages and soon after, gasoline shortages.

Neil Kaufman director and the US financial services lead for Business Continuity Management (BCM). He has over 21 years of management consulting, operational and crisis communications experience. Neil’s responsibilities include the creation of standards and training materials, as well as managing and participating in planning engagements. He has developed and implemented programmes for various clients during times of severe crisis. Neil is a frequent speaker at educational seminars like RIMS and the AICPA. He has published articles on business continuity planning solutions and concepts, and their real world applications. Neil received a B.A. in liberal arts from Clark University and an MBA in finance from DePaul University. He is a Certified Business Continuity Professional (CBCP).


For some, these resource constraints lingered for weeks and many businesses and communities continued to struggle. From a very personal perspective, some of my friends lost homes, clothing, cherished possessions and a lifetime of collected memories in family photos – forever gone. I saw amazing efforts of neighbours helping each other. My office mate shared a portable generator with his neighbours to make a community dinner and then took turns waiting in lines for gasoline. I was proud to see my own son working in a kitchen at an evacuation shelter for displaced victims of the storm in lower Manhattan.

Going concern or long gone?While many businesses may have had plans in place for the hurricane response, the quality of those plans tended to vary widely. Those companies that did not have BCM procedures in place as part of their overall approach to risk management, learned some painful lessons. In the aftermath, Hurricane Sandy had many business leaders questioning just how robust their preparations were. How comprehensive were their BCM programmes? Will future storms have an even greater impact on preparedness and long-term resiliency? Would a good plan be the difference between going concern and long gone?

If we look at the experience of Sandy and the nature of the response, some common pitfalls and practical priorities emerge:

Get real about the reality before you really have to. Even with a plan, disaster recovery won’t go completely as planned. Once the hurricane was over, the unexpected continued to happen, slowing recovery significantly in some cases. This is what businesses learnt from the harsh realities they encountered:

You are on your own. Don’t expect assistance from agencies and local authorities. Outside assistance wasn’t able to address many companies’ recovery needs. Those that fared better had prepared for loss of life support systems (e.g. having generators that were tested and not located on ground floors scheduled diesel fuel deliveries for those generators). Organisations that had reviewed their needs in advance were better placed.

Plan the work, and work the plan. More often than not training and education had not been carried out throughout the entire organisation. Only people involved in continuity planning understood the programme and the overall plan. Training and exercising both senior management and line management is critical.

Don’t live in a silo. IT recovery capabilities were not well-aligned with the business recovery requirements. Loss of critical infrastructure and telecommunications had not been considered and universally planned for. This hampered business recovery. Recovery strategies and remote locations had not examined various disaster scenarios that could include a geographic event. Many organisations’ recovery priorities were neither broadly known nor kept up to date. The result was slower responses and misaligned strategies. Organisations that had pre-vetted those priorities and strategies were able to get back on their feet faster.

Silence was not golden. The ability to communicate in multiple ways (land lines, cell phones, satellite phones, social media) was essential to staying connected. Having multiple suppliers for service was critical to avoiding a busy signal or a dropped network. Many businesses wrongly calculated that staff would be able to access their work applications with remote computer connectivity for email and workflow.

All hands can’t be on deck. Just like me, most people were not available to focus on recovery since many were dealing with personal losses and damage. Organisations had to deal with the loss of, or inaccessibility to, key personnel while also supporting the needs of their families. Better prepared organisations had robust substitutes identified for key recovery functions.

Know your suppliers. Key suppliers did not have continuity plans to ensure the resiliency of their services. Key suppliers were not thoroughly integrated into the recovery strategy of many organisations. Supplier management pre- and post-event became a point of widespread discussion.

Readthefineprint.Insurance did not cover all the losses from business interruption and property damage. Service level agreements from vendors which read ‘best efforts’ were a wake-up call for many. What’s more, the fine print often referenced ‘force majeure’ exceptions to the vendor taking responsibility for these ‘acts of god’. Reviewing coverage and policy limitations is part of staying prepared. Those companies that had planned for key supplier outages were able to implement supplier redundancy programmes and enact contingency plans sooner.


It’s a race against time, so save time in advanceIn a crisis, time is a valuable and scarce resource. In a crisis people can achieve great things. But don’t overestimate the ability of employees to quickly and effectively put in the massive effort necessary to keep the company operational – without a documented and tested plan.

Having a predefined strategy for business continuity significantly reduces response time as many key crisis management decisions will already have been made and validated.

If it happened again, how ready are you really?

Safeguarding your business is possibleYou can’t plan for every possible scenario. You can’t mitigate every impact on your business from every disruption or disaster. However, planning for some basic scenarios can buffer your organisation when the unexpected happens. Well-thought-through and regularly evaluated and updated BCM and IT disaster recovery plans can help your business to reduce potential financial losses, reputational and legal liability. Their aim is to increase recovery speed and enable a more orderly recovery. Develop these plans with the insight from your broader risk management programme and your organisation will be in a better position to reduce those risks of greatest concern to leadership.

Q. What changes are you making to enable your organisation to adapt quickly and effectively to change?

JK: Our business is closely correlated with consumer demand, which, in Europe, is presently down. Europe-Far East trade has declined, as has Europe-US trade. But worldwide the trade is still relatively healthy. Yes– East–West trade is central to worldwide trade. But in other parts of the world, trade is growing – across South America, for example. Still, that does not compensate for a drop in European demand. At this time, our company has completed its expansion of new facilities. For the time being, we are on hold and deleveraging. This is the key statement describing our present business strategy. In this environment, most companies just want to be on safe ground and stay in preservation mode, rather than go for expansion. To be honest, it’s better to be in a cash-rich position. We are simply in an environment where it is very difficult to identify the risks we might face. Financing is important - but it’s the first time we’ve see the banking system in such a mess. How can you expand an economy without bank debt? It’s just not possible. Rather than imposing things in a forceful way, we need to give the process of deleveraging more time.

John Koustas

Danaos Corporation, Greece


An interview with John Koustas - Danaos Corporation, Greece


Being ready for the unexpected in a new risk paradigmWant to ensure your organisation is as prepared as possible? Here are six ways to improve disaster resilience.

1. Make resilience part of the corporate DNA – Integrate risk management across the organisation and allocate senior management time to it. Combine traditional risk management (financial, operational, compliance-type risks) with individual risks such as BCM. Risk identification and assessment is not an episodic event, but a continuous process.

2. Revisit planning assumptions – Continuity plans need to consider new scenarios whose probabilities appear to have increased. In light of this, are the overall risk-planning assumptions still valid? Consider the areas of people, technology, communications, infrastructure, transportation and geography.

3. Perform and/or update threat analyses – Expand the existing plan to include the new scenarios and threats from recent events. Identify the correlated risk in your physical footprint and your technology, and mitigate the risk.

4. Develop/review/rehearse your crisis management and incident management procedures – These provide strategic command and control mechanisms that enable swift strategic and tactical response to more complex crisis events. Create a cross-functional, senior level crisis management team. Make the plan part of your organisational culture with defined roles and responsibilities and rigorous training.

5. Focus on supplier dependencies – If your risk assessment determines that a regional interruption is a prudent planning scenario, then your local suppliers and/or the transportation systems they rely on to provide their services to you will be impacted. Assess the criticality of your suppliers, secure multiple sources for critical processes and assess your suppliers’ preparedness to deal with disasters.

6. Annually assess your programme – Companies should begin by assessing their current BCM programme against the new ISO Standard;1 identify areas of necessary remediation; and prepare for formal ISO Certification.

1 The International Organization for Standardization (ISO) has officially launched its first international business continuity management (BCM) standard titled: ISO 22301, ‘Societal Security – Business Continuity Management Systems – Requirements.’ For more information go to www.iso.org


As noted in the Special Report in the World Economic Forum’s Global Risks 2013 report, a working definition of resilience for a country (or an organisation) is its capability to adapt to changing contexts, withstand shocks and recover to a desired equilibrium while preserving the continuity of its operations. Resilience implies the capacity for both speedy recovery after a shock (such as a market crash or natural disaster) and timely adaptation in response to a changing environment (such as a demographic transition or climate change).

on what resilience practices might be relevant in each case. The examples are drawn from practices that have already proved their efficacy as well as practices that are currently being tried and, though unproven, seem promising.

reports.weforum.org/global-risks-2013/www.weforum.org/reports/global-risks-2012-seventh-edition

Resilience practices: One-year follow-up analysis on Global Risks 2012 cases

Building resilience against highly uncertain and unpredictable external risks can complement traditional risk management, especially in today’s interdependent and interconnected world.

Resilience must be achieved in balance with other objectives, such as efficiency – for example, investing in operational redundancy may enhance resilience but constrain short-term efficiency. To further the debate on the importance of resilience and the best ways to build it, the World Economic Forum has collaborated with PwC to develop a one-year follow-up analysis of the three risk cases presented in the Global Risks 2012 report: The Seeds of Dystopia, How Safe Are Our Safeguards?, and The Dark Side of Connectivity, focusing

This article can also be found in the online version of the World Economic Forum’s Global Risks 2013 report http://reports.weforum.org/global-risks-2013/view/section-seven-online-only-contentresilience-practices-one-year-follow-up-analysis-of-global-risks-2012-cases/

Sidebars accompanying the case analyses on the following pages were authored by PwC staff to further explore resilience in action.

Project leadsDennis Chesley Partner and Global Risk Leader PwC

Chiemi Hayashi Director World Economic Forum

Christopher Michaelson Director PwC

Katarina Hruba Project Associate World Economic Forum

Ed Simmons Consultant PwC

The Seeds of Dystopia Marissa O. Michel Director PwC

Mena Cammett Associate PwC

Mary Cline Director Eurasia Group

Courtney Rickert McCaffrey Analyst Eurasia Group

Alexandra Rogan Associate Eurasia Group

How Safe Are Our Safeguards?Bruce Oliver Director PwC

Bill Helming Managing Director PwC

Anthony Ho Manager PwC

The Dark Side of ConnectivityDave Burg Partner PwC

Martin Caddick Director PwC

Neal Pollard Director PwC


Description of the case

Mismanagement of population ageing and sustained high levels of youth unemployment remain pressing challenges across developed and emerging markets. ‘Seeds of Dystopia’ case highlighted the potential for fiscal and demographic trends to prompt the emergence of a new class of fragile states with widespread social instability and discontent.

The case asserts that dystopia will ensue if the social contract is no longer believed in by wide segments of the population. As youth see a lack of opportunities and the aged are concerned about smaller or nonexistent benefits after a lifetime of work, social pressures increase. These phenomena are closely linked to each other as well as to political and policy reform, productivity, education, and other macro-trends. To address them, innovative and sustainable solutions are needed.

1 Concepts and Dilemmas of State Building in Fragile Situations – From Fragility to Resilience, 2008, New York: Organization for Economic Co-operation and Development, http://www.oecd.org/dac/conflictandfragility/41100930.pdf

2 Case Study SELCO: Solar Lighting for the Poor, 2011, New York: United Nations Development Programme, http://www.growinginclusivemarkets.org/media/cases/India_SELCO_2011.pdf

Resilience practices

These practices for understanding, measuring and ultimately improving resilience are drawn from research of numerous case studies from around the world. While most relate directly to governments as the primary enabler of the social contract and, therefore, societal and economic stability, the cases also reflect the critical role stakeholders from across society will necessarily play.

Resilience practice 1: Seek holistic insights and involve a range of stakeholders Any approach to building resilience must draw upon holistic insights related to ageing, youth unemployment, inequality, fiscal imbalances and the social contract.1 Collaboration among the private sector, civil society, local and national governments, and multilateral organisations in creating a modern and sustainable social contract is crucial.

For example, SELCO is a social enterprise in India that makes solar panels and lights. 2 Through multi-stakeholder partnerships with international institutions and rural state-owned banks, SELCO provides loans to rural Indian households and institutions such as schools to purchase solar lighting systems, which enables them to obtain energy and internet connectivity. These in turn provide an improved working environment for

young entrepreneurs and offer greater opportunities to earn income and educate children. Social resilience could be enhanced through such efforts, which create create educational and employment opportunities, addressing the growing resentment about inequality between rural and urban areas in India.

Because it is based on a holistic understanding of the socioeconomic context, this multi-stakeholder collaboration allows for competing interests to be appropriately represented and managed, minimising the risk that solutions will prove unfavourable to any group of stakeholders.

Case No. 1: The Seeds of Dystopia

Image: Bruce Oliver


This example illustrates that continuous monitoring of trends and revisiting assumptions allows for routine evaluation of what truly enhances resilience over the short-, mid- and long-term. It also enables stakeholders to challenge assumptions that may no longer be valid.

Resilience practice 3: Promote inclusive and open attitudes toward immigrants Countries with flexible immigration policies often have more resilient labour markets, as migrants are more able to fill the gaps left by retiring workers. The strong growth of the Canadian economy in recent years (particularly in the natural resources sector in the western provinces), coupled with the increasing retirement rate of its ageing workforce has led to a shortage of skilled workers in the country. The government has taken advantage of its society’s openness to immigrants through the Federal Skilled Workers Program, which in 2011 admitted more than 57,000 skilled immigrants to Canada.6

These immigrants helped meet the Canadian economy’s growing demand for labour.

Over the course of 2011, full-time employment increased by 190,000 jobs while the unemployment rate fell slightly from 7.6% to 7.5%7 – outperforming the OECD average of 8.2%.8 Based on data from the Gallup World Poll, the OECD calculates an index of its members’ community tolerance of minority groups and migrants. Canada topped this index.9

The Canadian example illustrates that the efficacy of immigration policies is influenced by social norms, as more tolerant and accepting societies make it easier for migrants to be economically active and civically engaged. These norms also foster greater social resilience.

Resilience practice 2: Monitor trends and revisit assumptions Monitoring and analysis – including forecasting and scenario planning – of trends in ageing, technology, labour and youth engagement enables stakeholders to regularly reassess assumptions and risks and correct strategies as needed.3 These processes improve responsiveness of policies and strategies to changing environments and to potential crises.

The UN Millennium Development Goals demonstrate the use of highly successful adaptive strategies based on continuous monitoring and analysis. The economists who manage the UN Millennium Development Goals constantly gather data to enable them to identify best practices and negative trends which need to be rectified. For example, UNICEF and UNESCO Institute of Statistics established a global initiative to gather data and analyses about out-of-school children. The initiative, which involves 26 countries from seven regions, aims to develop “context-appropriate policies and strategies for increasing enrolment and attendance of excluded and marginalized children.” 4, 5 More data-driven, targeted education policies could improve countries’ prospects of achieving the millennium development goal of universal primary education. Such initiatives are essential to fostering socioeconomic resilience because education boosts citizen engagement and the skill level of the labour force.

3 Wilkinson, L, ‘How to Build Scenarios’, Wired Magazine, http://www.wired.com/wired/scenarios/build.html, 20094 Reaching out-of-school children is crucial for development, June, 2012, UNESCO Institute of Statistics, http://www.uis.unesco.org/FactSheets/Documents/fs-18-OOSC-2.pdf5 ‘Global Initiative on Out-of-School Children’, UNESCO Institute of Statistics, http://www.uis.unesco.org/Education/Pages/out-of-school-children.aspx, 2012 6 ‘Citizenship and Immigration Canada, Fact Sheet – Federal Skilled Worker Program’, Government of Canada, http://www.cic.gc.ca/english/resources/publications/employers/federal-skilled-

worker-program.asp, 20127 Labour Force Survey: 2011 year-end review, 2011, Ottawa: Statistics Canada. http://www.statcan.gc.ca/pub/75-001-x/2012002/article/11639-eng.pdf8 ‘Employment and policies data’, Organisation for Economic Co-operation and Development, Directorate for Employment, Labour and Social Affairs, 2011, http://www.oecd.org/els/

employmentpoliciesanddata/howdoesyourcountrycompare-canada.htm9 Society at a Glance in 2011: OECD Social Indicators, 2011, Berlin: Organization for Economic Co-operation and Development, http://www.oecd.org/berlin/47570353.pdf


Resilience practice 4: Diversify risk through innovative financing Innovative financing can increase resilience by providing additional resources from alternative sources such as the private sector and individual donors, to foster vital projects and initiatives despite economic shocks which may reduce or redirect limited state resources. Impact investing, an example of an innovative financing tool, marries state funding with private investment. These initiatives to diversify sources of financial support allow governments to leverage private capital to meet social needs and ensure continuity of services by diversifying sources of finance.

For example, the US Government has committed US$1 billion over five years to the Small Business Association (SBA) Impact Investment Initiative,10 which will provide capital to invest with the private sector in companies in underserved and vulnerable communities.11 The first SBA initiative was the InvestMichigan! Mezzanine Fund, launched in 2011 in partnership with the State of Michigan Retirement Systems and Dow Chemical Company, which contributed US$35 million and US$15 million, respectively.12 The InvestMichigan! Mezzanine Fund aims to provide stable funding, which has historically been hard to find for job-creating start-up and early-stage companies in Michigan. Stability comes from a diversity of funding sources, combining the private sector funding and Michigan’s pension fund. The fund targets high-growth enterprises that can accelerate job creation,13 which is vital as Michigan’s economy suffers from a relatively high unemployment rate of 9.1%.14 In partnering with the private sector, impact investing also seeks to leverage efficient management, provide social benefits and promote knowledge sharing. The Invest Michgan! Mezzanine Fund, for instance, connects local private-sector leaders with businesses that benefit from the fund’s investments to enable individuals to share knowledge.15

The investor diversity enabled by initiatives such as the InvestMichigan! Mezzanine Fund can provide funding stability during crises. Additionally, impact investing typically provides for outcome-dependent returns, so it is in investors’ interest to ensure that projects are successfully designed to meet social needs and are sustainable and efficient. Overall, such successful programmes can strengthen a country’s socioeconomic resilience.

(This Seeds of Dystopia One-Year Follow-Up analysis has been produced in collaboration with PwC and Eurasia Group.)

10 ‘Impact Investment Initiative’, U.S. Small Businesses Administration, http://www.sba.gov/content/impact-investment-initiative, 201111 ‘Start-Up America Impact Investment SBIC Initiative’, U.S. Small Businesses Administration, http://www.sba.gov/sites/default/files/files/Impact_Investment_Policy_Memo_April_2011.pdf, 201112 ‘SBA Licenses First Impact Investment Fund in Michigan’, U.S. Small Businesses Administration, http://www.sba.gov/content/sba-licenses-first-impact-investment-fund-michigan, 201113 Ibid14 ‘State Unemployment Continues to Fall in October 2012’, National Conference of State Legislatures, http://www.ncsl.org/issues-research/labor/state-unemployment-update.aspx , 201215 ‘Invest Michigan!’. State of Michigan, Officer of the Governor, http://www.michigan.gov/documents/gov/Invest_Michigan_223205_7.pdf, 2008


16 Lawrence Wilkinson. ‘How to Build Scenarios’, Wired Magazine, 2009. Accessed on the web at http://www.wired.com/wired/scenarios/build.html 17 Global Facility for Disaster Reduction and Recovery, ‘Open Data for Resilience Initiative’, 2012, Accessed on the web at https://www.gfdrr.org/gfdrr/opendri18 George Dvorsky, ‘The Unintended Consequences of China’s One Child Policy’, IO9, 2012, accessed on the web at http://io9.com/5948528/the-unintended-consequences-of-chinas-one+child-policy 19 Yardley, Jim, ‘China Sticking with One Child Policy’, New York Times, 11 March 2008, accessed on the web at http://www.nytimes.com/2008/03/11/world/asia/11china.html?_r=020 Eurasia Group, ‘The Politics and Business of Demographic Change’, Eurasia Group Global Trends Quarterly, First Quarter 201221 Associated Press, ‘Chinese Government Think Tank Urges End to One-Child Policy’, CBS News, Oct 31, 2012, accessed on the web at http://www.cbsnews.com/8301-202_162-57543253/

chinese-government-think-tank-urges-end-to-one-child-policy/22 Tania Branigan, ‘China Considers Relaxing One-Child Policy’, The Guardian, March 8, 2011, accessed on the web at http://www.guardian.co.uk/world/2011/mar/08/china-relaxing-one-child-policy

Given today’s dynamic global environment, the contours of our most pressing strategic challenges are constantly changing. Our approaches to tackling these problems must also be flexible and responsive to circumstances, as solutions that were once a perfect fit for the problem at hand lose their relevance, and once-effective approaches become stale.

Monitoring and analysis, to include forecasting and scenario planning, enable governments, corporations and others to regularly reassess assumptions and risks, change course as needed and develop new opportunities for sustained growth.16 The ability to anticipate and adjust to future scenarios is a key facet of resilience. Routinely evaluating strategic and policy initiatives enhances resilience over the near-, mid- and long-term by allowing stakeholders to challenge assumptions that may have been correct at a point in time, but become invalid over time. Additionally, regular analysis allows for the identification of risks and opportunities. Stakeholders can use data and information gathered through monitoring to develop likely scenarios to forecast how key risks and strategic challenges will play out in the medium- to long-term.17 Continuous monitoring and analysis of trends can be applied across sectors to provide a check on the appropriateness, sustainability, relevance and costs of different approaches to tackling strategic challenges. Organisations that do this well can weather the challenges ahead, while those that fail to revisit their own approaches and assumptions may be left behind.

Righting demographic imbalances

Demographic imbalances, particularly rapidly ageing populations with low replacement birth rates, provide a perfect example of global strategic challenges that are best addressed by the consistent monitoring and evaluation of trends.

Analysis of China’s population initiatives highlights the importance of continuous monitoring and evaluation in crafting policy interventions to address demographic imbalances. Facing overpopulation that had the potential to outstrip national food supplies and cause environmental stresses in the 1950s, the Chinese government instituted a series of practices over 20 years aimed at introducing the concept of family planning to curb birth rates.18 The government researched and tested policies, practices and campaigns across urban and rural areas, culminating in the family planning policy now known as ‘one child’.

While estimates vary considerably, the Chinese government claims to have prevented 400 million births and kept the

country’s population growth relatively low.19 However, in the intervening 30 years, the policy, combined with a cultural preference for boys, has created a severe gender imbalance – the 2010 census revealed that there are at least 20 million more men than women, presenting a social and domestic security challenge. State officials are focusing closely on how to improve employment opportunities for young men, a move that in part stems from concerns over potential delinquency and social unrest, while also attempting to manage a significant elder dependency problem.

The government maintains that the policy will largely remain in place for at least the next ten years, despite it becoming clear in the mid-1990s that gender imbalances and an ageing population had the potential to impact the labour markets and employment rates across the country as soon as 2015.20 While the potential for overpopulation will remain a concern for a country of China’s size, underlying assumptions about the long-term demographic health of China and the ongoing viability of the one child policy may have shifted, and a reassessment of the policy may be in order to enhance China’s long-term societal resilience.

Indications are that the government is engaging in some level of review, as evidenced by the publication of a report by a government-backed think tank urging a re-examination of the policy to reverse China’s ‘ageing crisis’.21 Re-evaluation of the policy has begun to show itself in the regulatory sphere as well; in some cases the government has been gradually easing regulations, including allowing couples comprised of two only-children to have more than one child. This is to alleviate what is known as the “4-2-1” issue, or the possibility that an only child will shoulder the burden of care for two parents and four grandparents. Some experts who have analysed this issue advocate implementing a uniform two-child rule as a means of easing enforcement and rebalancing the population. Continued analysis and input from academic circles may be swaying those in a position to make policy changes; in 2011, an official in the Chinese government’s National Committee of Population, Resources and Environment indicated that officials were studying proposals for a two-child policy, and predicted that urban couples with a female child might be permitted to have a second child as early as 2015.22 The continuous transformation of China’s one-child policy reflects the importance of continuous monitoring and evaluation, and the government’s continued ability to revise its sweeping policy initiatives taking into account feedback and trend analysis from other stakeholders will be vital to maintaining social resilience moving forward.

Resilience in action: Tracking trends to challenge assumptions and steer the right course

By Mena Cammett and Marissa O. Michel


Resilience practice 1: Question the validity of assumptions underlying safeguards

In an ever-changing world, it is likely that key assumptions underlying a safeguard will ultimately become invalid, and responses to crises based on flawed assumptions will compromise rapid recovery and adaptation. Therefore, processes must exist to monitor and challenge the validity of the assumptions underlying safeguards.

Financial system stability

The financial crisis of 2007–2009 demonstrated that the assumption that a ‘microprudential’ approach, one focused on the health of individual financial institutions, would safeguard financial stability was no longer valid.23 In response, regulators adopted a ‘macroprudential’ approach, which addresses the whole financial system, and regulators enhanced their ability to question the validity of assumptions underlying this new approach. For example, the United States established the Financial Stability Oversight Council (FSOC), which identifies “risks that could arise outside the financial services marketplace.”24 The FSOC monitors risks to the stability of the US financial system that may arise outside of the existing regulatory structure.


Societal safeguards need to be reinvented on an ongoing basis, given the ever-changing nature of global risks. With rapid global change, safeguards can become imbalanced where they do not provide adequate protection, or otherwise stifle innovation.

The ‘How Safe Are Our Safeguards?’ case explored whether current processes for developing societal safeguards can effectively build resilience against cross-border risks in a complex and interdependent world marked by uncertainty, innovation and rapidly changing conditions.


Comparable practices that may foster resilience in the face of cross-border risks in a complex and interdependent world can be found in two very different areas: financial system stability and the prevention of pandemic influenza. Safeguards in both areas have been challenged and continue to evolve in ways that are expected to foster more effective responses to future crises.

23 Yellen, J., ‘Pursuing Financial Stability at the Federal Reserve’, Federal Reserve Bank of Chicago, http://www.federalreserve.gov/newsevents/speech/yellen20111111a.pdf, 201124 ‘Subtitle A, Financial Stability Oversight Council – Section 112(a), Purposes and Duties of the Council’, Dodd–Frank Wall Street Reform and Consumer Protection Act,

http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm, 2011

Pandemicinfluenzapreparedness

Questioning the underlying assumptions behind pandemic influenza vaccine manufacturing is a continuing part of World Health Organization (WHO) strategies. For example, the 2009 H1N1 pandemic led WHO to challenge the assumption that large multinational pharmaceutical companies could ramp up production fast enough for all affected populations. The pandemic demonstrated that low-income nations would be supplied only after the wealthy nations had ensured adequate

Case No. 2: How Safe Are Our Safeguards?

Image: Bruce Oliver


25 ‘Report of the second WHO Consultation on the Global Action Plan for Influenza Vaccines (GAP)’, World Health Organization, http://whqlibdoc.who.int/publications/2012/9789241564410_eng.pdf, 201126 Tarullo, D., ‘Developing Tools for Dynamic Capital Supervision’, Board of Governors of the United States Federal Reserve Board, http://www.federalreserve.gov/newsevents/speech/

tarullo20120410a.htm, 201227 Dutta, K., Babbel, D., ‘Scenario Analysis in the Measurement of Operational Risk Capital: A Change of Measure Approach’, 2010, http://fic.wharton.upenn.edu/fic/papers/10/10-10.pdf28 ‘EU-wide Stress Testing’, European Banking Authority, http://eba.europa.eu/EU-wide-stress-testing.aspx, 201129 ‘Section 165(i), Stress Tests’, Dodd–Frank Wall Street Reform and Consumer Protection Act, http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm, 201130 ‘Section 166 - Early remediation requirements’, Dodd–Frank Wall Street Reform and Consumer Protection Act, http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm, 201131 ‘WHO Global Influenza Surveillance Network (GISN) Surveillance and Vaccine Development’, WHO Collaborating Centre for Reference and Research on Influenza, http://www.influenzacentre.

org/centre_GISN.htm, 201232 lbid33 Tarullo, D., ‘Regulating Systemic Risk’, Board of Governors of the United States Federal Reserve Board, http://www.federalreserve.gov/newsevents/speech/tarullo20110331a.pdf, 201134 ‘Section 165(d) Resolution Plan and Credit Exposure Reports’. Dodd–Frank Wall Street Reform and Consumer Protection Act, http://www.gpo.gov/fdsys/pkg/

PLAW-111publ203/html/PLAW-111publ203.htm, 201135 ‘Title II – Orderly Liquidation Authority’, Dodd–Frank Wall Street Reform and Consumer Protection Act, http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm, 201136 ‘Section 165(f) – Enhanced Public Disclosures’, Dodd–Frank Wall Street Reform and Consumer Protection Act, http://www.gpo.gov/fdsys/pkg/PLAW-111publ203/html/PLAW-111publ203.htm, 201137 Tarullo, D., ‘Regulatory Reform since the Financial Crisis’, Board of Governors of the United States Federal Reserve Board, http://www.federalreserve.gov/newsevents/speech/tarullo20120502a.htm, 2012

coverage for their own populations. As a result of challenging the assumption, a new vaccine manufacturing schema was created to enable developing nations to establish domestic vaccine manufacturing capabilities and ultimately to reduce their dependence on wealthier nations.25

The output of the microprudential approach and the potential speed of flu vaccine production are both examples of assumptions which needed to be questioned in order to make financial and health systems more resilient to future crises.

Resilience practice 2: Build forward-looking elements into safeguards

For a safeguard to strengthen resilience in the face of a dynamic and evolving risk, regulators must look over the horizon to be able to recognise issues early and mobilise quickly to recover from crises.


The financial crisis of 2007–2009 arose in part because traditional regulatory safeguards such as capital ratios did not capture evolving risks of systemic impacts.26 In response, regulators incorporated forward-looking elements27 into their regulatory frameworks. For example, both the European Banking Authority28 and the US Federal Reserve conduct stress tests using scenario methodologies29, to better understand the variety of possible future developments in order to prevent future crises and mitigate the impacts of crises, by enabling early detection and intervention.30


Safeguards against pandemic influenza also employ forward-looking elements, consistent with the dynamic nature of the risk. Because new strains of the flu virus evolve quickly, WHO’s Global Influenza Surveillance Network31

meets twice each year to analyse monitoring data and to project which influenza strains are most likely to infect populations in 6–12 months. Based on those projections, the Network recommends suitable strains to be included in the influenza vaccines for each new flu season.32

Forward-looking safeguard elements, from stress-testing in finance to projections in vaccine planning, help to identify areas of emerging risk in the respective systems, and enhance resilience by enabling early response to emerging risks.

Resilience practice 3: Leverage market and other incentives

To foster resilience, safeguards should strike a balance between protecting society from risk, such as by enhancing the ability to recover from crises, and enabling society to benefit from risk-taking. This can often best be achieved by using incentives when feasible rather than restricting or directing activities.


The financial crisis of 2007–2009 highlighted systemic risks posed by creditors’ assumptions that large financial institutions are ‘too big to fail’ and will always be rescued by government – given that government rescues are an inefficient way of facilitating crisis recovery.33 To enhance market discipline on risk-taking, the US Federal Deposit Insurance Corporation now has the authority to liquidate large non-bank financial institutions and impose losses on investors including shareholders and creditors. Larger banking institutions must submit plans for orderly liquidation34, 35 and make enhanced public disclosures of risk information.36, 37 These measures provide the information and incentives for investors to demand management action to shore up the stability of financial institutions.


Resilience practice 4: Coordinate actions across borders and organisations

Safeguards to protect global systems are beyond the capability of any one country to put into place; therefore, governance structures must coordinate action across borders to identify, prevent and respond to crises.


Recognising the interconnectedness of global financial markets and institutions, G20 countries established the Financial Stability Board (FSB) to coordinate financial services regulators and international standard-setting bodies.40 In November 2011, the FSB collaborated with financial regulators from numerous countries to develop Key Attributes of Effective Resolution Regimes for Financial Institutions, which provides guidelines for recovery and resolution planning for banks and financial institutions41. As a result of that international coordination, these leading practice guidelines are being implemented globally with the aim of better equipping the global financial system to respond to future disturbances.42

PandemicinfluenzapreparednessInfluenza and other infectious diseases are inherently cross-border challenges in today’s globalised world. Accordingly, stakeholders leverage WHO, which works closely with other multilateral organisations, government agencies and key laboratories to coordinate and manage the surveillance of, and response to, global public health threats. For example, leverage WHO plays an integral role in coordinating activities under the Global Action Plan for Influenza Vaccines, a comprehensive strategy to promote the production of influenza vaccines.43 A coordinated global response to a pandemic would be difficult without this level of organisation.

Having cross-border organisations such as the FSB and WHO in place prior to the onset of a crisis can improve responses and enable stakeholders to adapt more nimbly and effectively to future cross-border crises.


Separate funding from the US government increased economic incentives for the pharmaceutical firm Novartis38 to make additional long-term investments in seasonal influenza vaccine programmes. Without this government support, the private sector alone lacks clear incentives to make such long-term investments. This funding initiative provided a cost-effective means to ensure domestic vaccine production capacity in the event of a pandemic flu outbreak, and it provided mutual benefits to both the US Government and Novartis39.

In both cases, action to adjust incentives – by requiring information disclosure in finance and providing economic incentives to invest in vaccine production – increased the resilience of systems without the need for restricting or directing activities.

38 ‘HHS creates new centers to develop, manufacture medical countermeasures’, U.S. Department of Health & Human Services, http://www.hhs.gov/news/press/2012pres/06/20120618a.html, 201239 Reengineering the Influenza Vaccine Production Enterprise to Meet the Challenges of Pandemic Influenza. August, 2010, Washington DC: Executive Office of the President, President’s Council of Advisors

on Science and Technology, http://www.whitehouse.gov/sites/default/files/microsites/ostp/PCAST-Influenza-Vaccinology-Report.pdf40 ‘About the FSB; History’, Financial Stability Board, http://www.financialstabilityboard.org/about/history.htm, 201241 Key Attributes of Effective Resolution Regimes for Financial Institutions, October, 2011, Basel: Financial Stability Board, http://www.financialstabilityboard.org/publications/r_111104cc.pdf42 Progress of Financial Reforms, October, 2012, Basel: Financial Stability Board, http://www.financialstabilityboard.org/publications/r_121105.pdf43 ‘Global Action Plan for Influenza Vaccines (GAP)’, World Health Organization, http://www.who.int/influenza_vaccines_plan/en/, 2011


Short-term objectives tend to get in the way of long-term objectives. Safeguards known to be outdated and ineffective can remain in place where change would be difficult, expensive and/or unpopular. Those barriers can, however, weaken from time to time as crises or shifts in the balance of power temporarily increase stakeholder appetite to bear short-term pain for long-term gain. The ability of an organisation, country, or society to thrive in the face of change, therefore, may depend on its ability to identify and take advantage of windows of opportunity to make the changes necessary to meet long-term objectives.

Clearly, maintaining the status quo while waiting for a window of opportunity is a terrible strategy for achieving long-term objectives. Windows of opportunity seldom open wide enough or at the right time. And actions taken during windows of opportunity tend to include unhelpful overreaction and opportunistic overreaching. On the other hand, where necessary changes are otherwise impossible to accomplish, waiting to pounce upon an imperfect but available opportunity may be the only strategy – terrible though it may be. Organisations, countries and societies can ill afford to miss such openings.

Climate change

Climate change is a clear example of an issue where short-term objectives have impaired the ability to meet long-term objectives. As Lord Stern, a leading climate scientist 44 said, “Although climate changes challenges are clear, public policy is moving slowly. Its progress must be unblocked.” 45

Unfortunately, climate change also illustrates that it may be easier to recognise windows of opportunity only after they have begun to close. The period of 2006–2008 may have been such a window. During that period, the case for responding to climate change was made in many influential ways: the government of the UK released the 2006 Stern Review on the Economics of Climate Change;46 the United Nations Intergovernmental Panel on Climate Change issued its Fourth Assessment Report;47 ‘An Inconvenient Truth’ was awarded the Oscar for Best Documentary of 2007; Al Gore and the Intergovernmental Panel on Climate Change were co-awardees of the 2007 Nobel Peace Prize; and climate change was on the World Economic Forums Annual Meeting agenda.48 While there was no universal agreement about specific causes and solutions, public consciousness about climate change was high; the economic and political case for action was relatively strong; and many organisations were spurred to action. Yet no significant actions were taken.

Since that time, the urgency of mitigating the pace and impacts of climate change has dropped precipitously, a decline highlighted in PwC’s annual CEO Surveys between 2008 and 2012.49 Currently, climate change is struggling for sufficient attention and resources. Moreover, there remains a strong push to question the underlying science of whether human activity has had any meaningful impact on climate. In retrospect, the period of 2006–2008 might have been a missed, imperfect but workable, opportunity for even more effective action on climate change.

Resilience in action: Taking advantage of windows of opportunity

By Bruce Oliver

44 I.G. Patel, Professor of Economics and Government, India Observatory, London School of Economics, http://www.weforum.org/content/tackling-climate-change45 http://www.weforum.org/content/tackling-climate-change46 http://webarchive.nationalarchives.gov.uk/+/http:/www.hm-treasury.gov.uk/stern_review_report.htm47 http://www.ipcc-wg2.gov/publications/AR4/index.html48 ‘Water is today’s issue; it is the oil of this century’ Andrew N. Liveris, Chairman and Chief Executive Officer, Dow Chemical Company, USA. Prize laureate Al Gore and Irish musician Bono made

this point as they underscored the connection between climate change and poverty.” http://www3.weforum.org/docs/WEF_AM08_Report.pdf, p. 15, 2008.29 The key findings of PwC’s 11th Annual Global CEO Survey, released early 2008, included the finding that: “CEOs want governments to play a more prominent role on the international stage ...

in leading efforts to address climate change” and that “CEOs acknowledge that governments cannot, in isolation, tackle climate change – and that collaboration within the business community will be critical,” http://www.pwc.com/th/en/publications/11th-annual-global-ceo-survey.jhtml, p. 9, 2008. In contrast, the key findings of PwC’s 15th Annual Global CEO Survey, released early 2012, included no mention of the issue of climate change. http://www.pwc.com/gx/en/ceo-survey/pdf/15th-global-pwc-ceo-survey.pdf, 2012.



The Dark Side of Connectivity case explored the online security risks associated with the critical infrastructure that underpins our daily lives and depends increasingly on hyperconnected online systems. The case highlighted the need for public–private cooperation to secure a healthy cyberspace.

Over two billion people worldwide50 now have direct access to the internet. Consumer devices, social media and networked connections could drive change faster than businesses and governments can keep up. In addition, criminal abusers of cyber networks have been quick to exploit the growing opportunities presented by society’s reliance on these technologies, with ever-growing sophistication.


Resilience in cyberspace means more than preventing future cyber attacks: it means reducing recovery times following such attacks. The resilience of our cyberspace depends on strong leadership, capable of keeping up with the pace of change. This leadership must come from the top of government and business, not just technology management. Improving resilience also requires investing in infrastructure that builds and sustains trust among systems and users.

50 ‘Internet Usage Statistics’, Internet World Stats, 2012, http://www.internetworldstats.com/stats.htm

Resilience practice 1: Assign top-level responsibility for cyber resilience

Resilient cyber strategies should be developed at no lower than the board level within each organisation to enable effective identification of trends, adaptation to changing business contexts, efficient response to systemic shocks and continuity of business operations.

Many large banks have transferred responsibility for cybersecurity from IT divisions to group security, along with crisis management, and have provided board-level oversight. Fortune 500 corporations have created chief information security officer positions, not only in their chief information office, but in their general counsel offices, reflecting the need for top-level accountability and the consideration of a variety of key corporate functions: contract review, enterprise risk management, assurance and compliance, human resources and workforce management, and regulatory reporting. These shifts reflect the degree to which cyber-security decisions involve much more than technology management – they also include risk and liability management.

These trends highlight the importance of strategic perspectives and cross-functional collaboration at the most senior levels. Such collaborative decision-making can guide corporate-wide investments and capabilities – not just technology investments – to anticipate and adapt to emerging trends, respond to shocks and decrease recovery time. These strategies improve corporations’ abilities to respond to crisis by marshalling enterprise-wide resources and strengthening collaborative, cross-functional processes.

Case No. 3: The Dark Side of Connectivity

Image: Bruce Oliver


51 Critical Infrastructure Resilience Strategy (2010). Australian Government. http://www.tisn.gov.au/Documents/Australian+Government+s+Critical+Infrastructure+Resilience+Strategy.pdf.52 Hopkins, N. “Britain in talks on cybersecurity hotline with China and Russia”. The Guardian, http://www.guardian.co.uk/politics/2012/oct/04/britain-cybersecurity-hotline-china-russia, 2012.53 “Bilateral Discussions on Cooperation in Cybersecurity”. China Institute of Contemporary International Relations (CICIR) – Center for Strategic and International Studies (CSIS), http://www.

cicir.ac.cn/chinese/newsView.aspx?nid=3878, 201254 lbid.55 Soyon, K. “S. Korea, US Discussing Combined Cyber Warfare Drills” KBS World Radio News, http://world.kbs.co.kr/english/news/news_Po_detail.htm?No=93141&id=Po, 2012.56 “South Korea, U.S. Hold Defense, Foreign Affairs Talks”. U S Department of Defense, http://www.defense.gov/News/NewsArticle.aspx?ID=116749, 2012.

Resilience practice 3: Coordinate among governments during crises

Formalised bilateral procedures between governments, which could be used in the event of a cyber crisis, are important to facilitating fast, decisive action and limiting damage from cyber attacks.

In light of this recognition, the UK held formative talks with China and Russia in 2012 to establish cyber crisis communication channels.52 The proposed communication channels could help identify the sources of cyber attacks and limit misunder-standing that may lead to escalation. Such channels are becoming ever more important with the increased ability of cyber attackers to use proxy servers to mask their identities online as ‘agents of the state’.53

Similarly, South Korea has also entered into bilateral cyber cooperation agreements with other nations including China, Japan and the US.54, 55, 56 These bilateral agreements include procedures that provide for formal cyber crisis coordination, realistic bilateral cyber-attack testing and the ability to share technical information between government agencies in the event of a cyber attack. Such elements allow for advanced preparation and the ability to share crucial information to identify attack sources and coordinate responses quickly across national borders.

Documented success stories of these strategies are scarce, due in part to the confidentiality surrounding both testing exercises and real cyber attacks. Nonetheless, established formal communication channels between governments in a crisis are crucial to enable quick and clear collaboration to avoid damage and prevent escalation through miscommunication.

Resilience practice 2: Share cyber knowledge in trusted public-private forums

Trusted knowledge sharing between public and private stakeholders improves understanding of, and response to, cyber threats that can affect critical infrastructure.

For instance, the Australian government has established the Trusted Information Sharing Network (TISN),51 a network of government representatives, business stakeholders and cyber experts, to address the risks of cyber threats to critical infrastructure that could severely damage Australia’s economy, social systems, or national security. It aims to use the network to increase awareness of cyber risks to critical infrastructure, share strategies to reduce cyber risk, and provide a feedback mechanism to highlight private sector cyber issues to the government. It allows for resilience practices to be shared across the supply chain so that there is mutual benefit in avoiding the failure of a key link in the chain. The TISN enables critical infrastructure organisations to improve understanding of risks and provides a platform for responding quickly when cyber threats do materialise.

Due to the rapidly changing nature of cyber threats, governments and the private sector need to have mechanisms to share knowledge in trusted networks, so that critical organisations have the latest information to respond quickly and effectively to cyber attacks. Such responsiveness to shocks is at the heart of cyber resilience.

Resilience practice 4: Design-resilient electronic devices and online systems

Encryption is a crucial element of resilient information sharing. Design and use of properly encrypted devices and online systems will improve the resilience of information-sharing against malicious attacks or simple human error when systems’ protection fails.

BlackBerry® devices, for example, provide secure, encrypted communication, and Apple’s latest products include similar security technology. Half of businesses that have outsourced processes over the internet ensure that their data is encrypted. Furthermore, Trusted Platform Modules (TPMs) provide both device encryption and device authentication, embedded in the hardware of the device. This assures data protection as well as device authentication even when software-based digital certificates are compromised or forged. TPM chips are used by nearly all personal computer and notebook manu-facturers, yet relatively few corporations take advantage of these chips to authenticate devices on corporate networks throughout the enterprise, for example.

Tools such as encrypted communication and enterprise-wide TPM strengthen resilience by protecting data as it moves across systems, irrespective of uneven system security. Such trust infrastructure, crucial for information-sharing resilience, enables corporate enterprises to adapt over successive generations to emerging consumer technology, which can change as rapidly as the next trend in smart phones. It also fosters resilience by ensuring a general level of reliability by minimising disruptions if one link in the chain fails.


Resilience in action: New behaviours for a new world

By Martin Caddick and Neal Pollard

Cyber systems are already recognised as being as important as physical assets for our critical infrastructure. But they are more than this. Cyberspace is a virtual extension to our physical world which mirrors our cities by facilitating communication, trade, culture and social activity. It has become an integral part of how the developed world lives, and with a low cost of entry, it could become even more important in the developing world. But, unlike our physical society, which has matured over many thousands of years into a complex structure of behaviours, customs and rules, cyberspace is new. It has not developed mature patterns of behaviour and customs. The speed of development has left a generation gap where the average teenager has a better understanding of cyberspace than most of our leaders.

The implications of all this are not well-understood, and tried and tested approaches, based on generations of experience of the physical world, may or may not work. Potential risks are not matched by appropriate caution and behaviour (for example, our willingness to share information on Facebook or to manage what we say on Twitter).

Not only does cyberspace lack the natural and instinctive resilience of our physical society, but we have not had the chance to design our systems to reduce risk in a way that takes human behaviours into account. In high-risk occupations (health, air and nuclear industries, for example) systems are carefully designed, taking into account how people behave naturally to minimise the risk this poses.

We need to learn new ways to behave and new ways to cope with human behaviour to create a safe cyber world.

Some disconnects between the physical and cyber worlds

Physical Cyber

Risks and likely consequences relatively visible, and can be kept in perspective

Working online in comparative safety gives a false sense of security, and the risks and consequences are not realised. Illustrated by teenage hackers.

Seventy percent of communication is non-verbal, and this can be seen in the physical world, reducing misunderstanding.

Without non-verbal communication, there are more misunderstandings and less empathy, leading to ill-judged posts. Illustrated by celebrity use of Twitter.

Cause and effect is constrained by physical limitations, giving the opportunity to react to and mitigate materialising risks.

Effect is often almost immediate due to speed of communications, meaning you can face a crisis situation before you are even aware of the cause. Illustrated by the speed at which ill-judged communications go viral.

Boundaries and association is primarily defined by geography and occupation, making regulation relatively straightforward.

People associate across the world in line with their interests cutting across national boundaries. New loyalties are being established. Illustrated by people’s identification with Wiki leaks.


PublishersDennis Chesley Global Risk Consulting Leader PwC US

Miles Everson US Advisory Financial Services Leader PwC US

Juan Pujadas Vice Chairman, Global Advisory Services PricewaterhouseCoopers International Limited

Executive Editors Robert G. Eccles Professor of Management Practice Harvard Business School

Christopher Michaelson Director, Strategy and Risk Institute, PwC Global Advisory Associate Professor, University of St. Thomas Opus College of Business

Managing Editor Rania Adwan +1 (646) 471 5116 [email protected] PwC US

Production Editor Shannon Schreibman +1 (646) 471 1102 [email protected] PwC US

Special thanks to the following parties for their production and editorial assistance: John Ashworth, Chris Barbee, Sarah Breen, Lisa Cockette, Michael Golen, Ashley Hislop, Angela Lang, Sarah McQuaid, Roxana Opris, Malcolm Preston, Alastair Rimmer, Suzanne Snowden and Guatam Verma

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The Design Group PwC UK 21384

Resilience: Winning with risk

Rehab Abdelhafez+20 (0) 2 27597812 [email protected] Egypt

Martin Caddick+44 (0) 20 7804 [email protected] UK

Mena Cammett+1 (703) 918 [email protected] US

Carlos Castillo+1 (703) 918 3127 [email protected] US

Lauren Cook+1 (646) 471 [email protected] US

Richard Gledhill+44 (0) 20 7804 [email protected] UK

Dan Hamza-Goodacre+44 (0) 20 7804 [email protected] UK

Lee Howell+41 (0) 22 869 [email protected] World Economic Forum

David Jansen+1 (646) 471 [email protected] US

Neil Kaufman+1 (646) 471 [email protected] US

Lit Ping Low+44 (0) 20 7804 [email protected] UK

William Macmillan+1 (646) 471 [email protected] US

Erwann Michel-Kerjan+1 (215) 573 [email protected] Wharton risk management and decision processes center, University of Pennsylvania - Wharton School

Shami Nissan +44 (0) 20 7213 [email protected] UK

Marissa O. Michel+1 (703) 918 [email protected] US

Bruce Oliver+1 (703) 918 [email protected] US

Oz Ozturk+41 (58) 792 9037 [email protected] Switzerland

Neal Pollard+1 (703) 918 [email protected] US

Authors