This post discusses compliance risk and compliance risk management.

WHAT IS COMPLIANCE RISK?

Compliance risk is the threat posed to a company’s financial, organisational, or reputational standing resulting from violations of laws, regulations, codes of conduct, or corporate standards of practice. Compliance risk is an organisation’s potential exposure to legal penalties, financial forfeiture, and material loss resulting from its failure to act by industry laws and regulations, internal policies or prescribed best practices. Compliance risk is also known as integrity risk. 

Compliance risk is also known as integrity risk. Many compliance regulations are enacted to ensure that organisations operate fairly and ethically. As global regulations proliferate and stakeholder expectations increase, organisations are exposed to greater compliance risk than ever before. An organisation’s compliance with applicable laws and regulations can affect its revenue, leading to a loss of reputation, business opportunities and valuation.

TYPES OF COMPLIANCE RISK

An organisation may be implicated in compliance risks in several ways, including corrupt and illegal practices, privacy breaches, environmental concerns, process risks, and workplace health and safety.

IMPACTS OF COMPLIANCE RISK ON BUSINESS ORGANISATIONS

Compliance risk is the risk of impairment to the organisation’s business model, reputation and financial condition resulting from failure to meet laws and regulations, internal standards and policies, and the expectations of critical stakeholders such as customers, employees, and society. Compliance risks can expose a business to many consequences, including legal penalties, voided contracts, financial forfeiture, loss of business opportunities, material loss, and damaged reputation. 

While compliance risks mainly involve the need to comply with laws and regulations, they can also relate to the need to act in a way investors and customers expect, for example, by ensuring proper corporate governance. Organisations must improve their risk assessment process to incorporate compliance risk exposure to understand their risk exposures adequately. Compliance risk may impact an organisation in four significant ways: business, legal, financial, and reputational.

DIFFERENCES BETWEEN COMPLIANCE AND REGULATORY RISKS

Compliance and regulatory risks arise from laws and regulations that rely on penalties or sanctions to regulate the operations of a business. 

What is Regulatory Risk?

Regulatory risk is the potential for changes to laws, regulations, or interpretations to cause losses. Regulatory risk is the potential for new laws to cause compliance costs or cause disruptions to your business. Regulatory risk is the effect of a change in laws and regulations that could cause losses to an organisation. Regulatory risks could, for instance, (1) increase the costs of running a business – e.g. costs to achieve compliance, (2) change the competitive landscape – e.g. perhaps invalidating your business model, (3) make your business practices illegal – e.g. new law changing rules on marketing, and (4) reduce the attractiveness of an investment. New and emerging regulations can also greatly impact your strategic direction, business model and compliance system. Hence, it is essential to consider regulatory requirements when evaluating business risks.

What is the difference between Compliance and Regulatory Risks? 

Compliance risk is the potential that a business would violate a law or regulation. Compliance risk relates to a company violating a law or regulation. Compliance risk often results from insufficient control systems, lack of training, due diligence, and human error. Compliance risks can expose a business to severe consequences, including legal penalties, voided contracts, financial forfeiture, material loss, loss of business opportunities, and damaged reputation. While compliance risks mainly entail the need to comply with laws and regulations, they can also relate to the need to act in a way that investors and customers expect – e.g., by ensuring proper corporate governance. Improved regulatory compliance leads to strong corporate governance. It is, therefore, essential for a business organisation to have a good compliance risk management programme. Let us now proceed to discuss compliance risk management.

WHAT IS COMPLIANCE RISK MANAGEMENT?

Compliance risk management is the art of managing the risk of non-compliance. With limited budgets and resources, no company can consistently achieve perfect compliance with all regulatory burdens. Some mistake is bound to happen eventually. The goal is to reduce the operational risk of non-compliance down to levels acceptable to a company’s Board of Directors and regulators. An organisation’s failure to act according to industry standards, laws, or policies can lead to legal penalties. 

Regulatory compliance is the most compelling risk because the statutes enacting the requirements generally bring huge fines or can even lead to imprisonment for non-compliance. The industry standards are considered the next tier of compliance risk. With best-prescribed practices, these standards are not laws like regulations. Compliance with internal policies is the third tier of compliance risk. 

Compliance risk management is a part of the collective governance, risk management and compliance discipline. Non-compliance can lead to the loss of the reputation of the organisation and business opportunities. Compliance risks differ by industry and business type.

IMPORTANCE OF COMPLIANCE RISK MANAGEMENT

Besides punitive fees, penalties and a sense of professional obligation, there are several reasons why organisations need to avoid common compliance risks. A comprehensive compliance risk management strategy enables an organisation to understand and effectively address potential threats to its ability to conduct its business. Here are three paramount importance of compliance risk management: it helps to understand the risk of non-compliance, setting a firm’s risk tolerance, aligning compliance processes and risks, legal and liability concerns, data privacy, and protecting business reputation.

ESSENTIALS OF SOUND COMPLIANCE RISK MANAGEMENT

The five essential elements of a sound compliance risk management programme are:

1. Active board and senior management oversight,
2. Effective policies and procedures,
3. Compliance risk analysis and comprehensive controls,
4. Compliance monitoring and reporting, and
5. Testing.

COMPONENTS OF A SOUND COMPLIANCE RISK MANAGEMENT

Here are the five critical components for a successful compliance risk management programme: (1) Develop a compliance risk system, (2) Define risk tolerance, (3) Identify risk factors, (4) incorporate regulations, and (5) Continuously update.

TYPES OF RISK IN COMPLIANCE RISK MANAGEMENT

Businesses are susceptible to different types of compliance risks. Types of risk associated with compliance risk management include:

1. Regulatory and political uncertainty

2. Data protection

3. Conflicts of interest

4. Market risk

5. Conduct risk

6. Corruption

7. Process and products quality

COMPLIANCE RISK ASSESSMENT

A key concept of compliance risk management is the risk assessment process, which includes identifying and evaluating the potential risks that threaten an organisation’s ability to ensure it is compliant with laws and regulations. Risk assessment entails reviewing information sources, such as reports from the business’s management and regulatory bodies, and identifying data and information already available to the organisation. 

Compliance risk assessment helps a firm understand the full range of its risk exposure, including the likelihood that a risk event may occur, the reasons it may occur, and the potential severity of its impact. A practical risk assessment should begin with a detailed picture of the compliance landscape the company operates in. The two questions to answer are (1) where the company operates and (2) what regulations cover the sector and similar businesses. 

HOW TO ASSESS COMPLIANCE RISKS 

By looking at the different types of risk and categorising their effects into buckets, the company can take the analysis and approach further by assessing the level of compliance risk. This can be done by using resources and defining roles to (1) collect cross-functional input, (2) leverage data, (3) define responsibilities, and (4) Regular review.

STEPS TO ASSESSING COMPLIANCE RISKS

A practical risk assessment must also include a clear picture of the organisation’s operations. In other words, you need to know the “who, what, where, when, and how” of the day-to-day operations happening on the ground in the company. 

The five critical steps to assessing compliance risks include:

1. Understand the company’s current state of affairs.

2. Map the company’s potential risk contact points.

3. Assess the current controls to prevent, detect, and correct violations.

4. Determine and prioritise the compliance enhancement measures.

5. Update the business risk assessment periodically.

See the full video on Compliance Risk and Compliance Risk Management: https://youtu.be/E2ppg5MJ0uk