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​Internal Audit and Emerging Risks: From Hilltops to Desktops

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As a profession, internal auditors have cultivated a long and respected legacy as purveyors of hindsight. Almost all of us are adept at looking at last year's data and telling management where past mistakes were made. While hindsight is a necessary part of internal auditing, 20/20 hindsight is one of our least valuable skills. Often, our clients are already aware of past mistakes.​

With the advent of operational auditing and, ultimately, the introduction of consulting/advice into our portfolio of services, we also became purveyors of insight. Insight is generally seen as more valuable than hindsight to our beleaguered stakeholders, but it too suffers from limitations in an era when risks emerge at warp speed. Today's insight may well be tomorrow's hindsight. 

There will always be a need for hindsight and insight, but foresight is the ultimate source of value. Stakeholders seek to navigate the future more than revisit the past or dwell in the present. It is time for internal auditors to focus our telescopes ahead. We need to concentrate on the risks of tomorrow if we are to not only protect but enhance value for our organizations.

Yet, stakeholders are generally unimpressed with our acumen at detecting emerging risks. In a 2016 KPMG survey of chief financial officers and audit committee chairs, only 10 percent agreed that their internal audit function adequately identified and responded to emerging risks that threatened their companies.

Over the past year, I have turned often to weather analogies when addressing challenges and opportunities for the internal audit profession. In many ways, identifying future risks is like predicting the weather. When our parents and grandparents were young, there was no such thing as weather radar. If they were curious or concerned about potential changes in weather, they simply peered out their windows or stood on a hill and scanned the horizon for potential storms. Of course, their weather predictions were often wrong. Climbing to the hilltop may have expanded their view, but weather patterns are far too complex to know if the clouds you see contain damaging winds, or if they are even coming your way. 

That's why modern meteorologists have turned to more advanced methods. They monitor approaching storms with Doppler radar. They use digital satellite images to record cloud patterns around the world, and they plug the data into supercomputers, applying advanced statistical equations and algorithms to create more accurate forecast models. Of course, we all know that even meteorologists sometimes get it wrong, but their degree of reliability has increased dramatically with the advent of new tools and technology.

From hilltops to desktops, we all need to get smarter about risks, and there's a lot we can learn from meteorologists. They don't just observe the weather and make guesses about what the future might hold. They use every resource at their disposal to identify potential trouble spots and patterns before the storm materializes or inflicts significant damage. 

Internal auditors and meteorologists have much in common. But our scope is much broader than predicting the weather. It encompasses virtually every type of risk, from the impact of changing market conditions or pandemics to financial and compliance issues. And that means our focus must extend far beyond the immediate future.

It would be great if there were technologies like Doppler radar to identify emerging risks. Someday, such tools might exist, but until then, we need to create our own virtual radar for detecting and monitoring emerging/approaching risks. That requires us to become more analytical in our approach.

As KPMG Partner Michael Hill has noted, "Emerging risks can arise from many sources — economic or demographic shifts, changes in the competitor landscape, technology advances, or customer preferences." So, there is a lot for us to watch for when it comes to emerging risks. The horizon is so vast that the job will simply be too great for a chief audit executive alone. It will take the proverbial internal audit "village" to monitor emerging risks for a typical company. Just as the department's resources are assembled when annual internal audit plans are formulated, so too should the various experts be deployed to identify and monitor emerging risks. For example, the staff with the greatest IT expertise should monitor the horizon for emerging technology risks. 

Fred Stuckel, vice president of enterprise risk management and audit at Express Scripts, shared the process his company uses to identify emerging risks in a recent video posted by North Carolina State Poole College of Management's Enterprise Risk Management Initiative. Stuckel noted that within Express Scripts, he and his team "spend a lot of time on the internet and on social media." They "peruse through international newspapers that are converted from foreign language to English, to get different perspectives of what the impact of any kind of change might be to the United States or to the global market."

There is no silver bullet for identifying emerging risks. Like all risk assessment, there is a degree of art in addition to science. However, if internal audit isn't looking in the right direction, there is a greater likelihood of missing emerging risks. But just as storms in the Northern Hemisphere often emerge from the West, there are directions from which potential risks facing your company are likely to emerge. These include:

  • Economic forecasts (macroeconomic as well as those facing your industry).
  • Known strategic business risks facing your company.
  • New corporate initiatives being planned.
  • Legislative and regulatory outlook facing your industry.
  • Geopolitical developments and political risks in regions where your company operates.
  • Disruptive threats or opportunities facing your industry.
  • Performance of your primary competitors.
  • Risks emerging as headlines via traditional or social media.

Identifying emerging risks should be a collaborative process with management. After all, management is likely to have already identified many emerging risks​ that threaten the organization. We should position ourselves as a partner, not a competitor trying to on​e-up management, when it comes to emerging risk acumen. After fully vetting our inventory of emerging risks, we should be prepared to share our perspectives with the audit committee. Our conversation must include our own plans for monitoring and responding to these risks as the organization's internal auditors.

We have entered an era in which crises have become commonplace, and after each new crisis, the same questions arise: "Why didn't we see it coming?" "Where were the internal auditors?" The world's best internal audit functions are well-prepared to answer these questions, and they do so in part by focusing on the future, by maintaining agility, and by proactively identifying and addressing emerging risks.

Hindsight is one of our least essential skills. It's time to turn our telescopes in the other direction.

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