What is risk and risk factors?

Contents

• 1 Definition
• 2 Usage
  • 2.1 Role in Risk Quantification
  • 2.2 Risk Factor Disclosure
• 3 Risk Factor Classification
  • 3.1 Conceptual Classification
  • 3.2 Risk Factors of Issuers / Guarantors
  • 3.3 Risk Factors in Securities
• 4 Issues and Challenges
• 5 See Also
• 6 References

Definition

Risk Factor (also Risk Driver) is a general term denoting an attribute, Characteristic, variable or other concrete determinant that influences the Risk Profile of a system, entity, financial asset etc. Risk factors may be causes of risk or merely correlated with risk. Their identification is an essential aspect of formal Risk Management

Usage

Risk factors play an essential role during Risk Analysis, the identification phase of any risk management activity. While this activity is typically internal to an organization / firm, risk factors may have to be disclosed in the context of commercial operations of regulated entities

Role in Risk Quantification

In the context of quantitative Risk Measurement, risk factors are associated with (represented) determinant variables. Some indicative examples:

• Medical risk factors
• Macroeconomic Factors affecting Credit Risk and used in Stress Testing
• Disaster Risk Factor

Risk Factor Disclosure

In the context of regulated financial services and in particular the offering of financial products there are concrete requirements around the formulation and communication of risk factors associated with such products[1]

Risk Factor Classification

There is an enormous variety of possible risk factors depending on context (the Risk Type) being considered.

Conceptual Classification

The following list offers an overall (generic) classification scheme of Risk Factors:

• Quantitative versus Qualitative Risk Factors, indicating the degree to which factors can be associated with concrete data
• Static versus dynamic factors, that is factors that change in time (with different possible timescales)
• Idiosyncratic (specific) versus common (systemic) factors, that is factors that apply across multiple systems
• Fundamental (lower level) factors versus composite (higher level factors)

Risk Factors of Issuers / Guarantors

Risk factors which are specific and material to the issuers/guarantors could, for example, be divided into the following categories:

• Risks related to the issuer's financial situation;
• Risks related to the issuer's business activities and industry;
• Legal and regulatory risk;
• Internal control risk; and
• Environmental, social and governance risks.

Risk Factors in Securities

• Risks related to the nature of the securities;
• Risks related to the underlying;
• Risks related to the guarantor and the guarantee; and
• Risks related to the offer to the public and/or admission of the securities to trading on a regulated market.

Issues and Challenges

• The conflation between risk factors and the Risk itself
• The conflation between correlation and causation
• The ability of the totality of identified risk factors to explain the risk being considered (Unexplained Variance))
• The influence of different risk factors on outcomes may be overlapping and difficult to disentangle (correlation / dependency between factors)
• The impact of a risk factor on the risk profile may not be monotonic
• Certain risk factors may be very difficult to quantify / model. Qualitative factors are in general those that are difficult to quantify due to the complexity, emerging risk nature

See Also

• Risk versus Risk Factor
• Root Cause Analysis

References

1. ↑ ESMA Guidelines on risk factors under the Prospectus Regulation, March 2019

Ranking or prioritizing hazards is one way to help determine which risk is the most serious and thus which to control first. Priority is usually established by taking into account the employee exposure and the potential for incident, injury or illness. By assigning a priority to the risks, you are creating a ranking or an action list.

There is no one simple or single way to determine the level of risk. Nor will a single technique apply in all situations. The organization has to determine which technique will work best for each situation. Ranking hazards requires the knowledge of the workplace activities, urgency of situations, and most importantly, objective judgement.

For simple or less complex situations, an assessment can literally be a discussion or brainstorming session based on knowledge and experience. In some cases, checklists or a probability matrix can be helpful. For more complex situations, a team of knowledgeable personnel who are familiar with the work is usually necessary.

As an example, consider this simple risk matrix. Table 1 shows the relationship between probability and severity.

Severity ratings in this example represent:

• High: major fracture, poisoning, significant loss of blood, serious head injury, or fatal disease
• Medium: sprain, strain, localized burn, dermatitis, asthma, injury requiring days off work
• Low: an injury that requires first aid only; short-term pain, irritation, or dizziness

Probability ratings in this example represent:

• High: likely to be experienced once or twice a year by an individual
• Medium: may be experienced once every five years by an individual
• Low: may occur once during a working lifetime

The cells in Table 1 correspond to a risk level, as shown in Table 2.

These risk ratings correspond to recommended actions such as:

• Immediately dangerous: stop the process and implement controls
• High risk: investigate the process and implement controls immediately
• Medium risk: keep the process going; however, a control plan must be developed and should be implemented as soon as possible
• Low risk: keep the process going, but monitor regularly. A control plan should also be investigated
• Very low risk: keep monitoring the process

Let's use an example: When painting a room, a step stool must be used to reach higher areas. The individual will not be standing higher than 1 metre (3 feet) at any time. The assessment team reviewed the situation and agrees that working from a step stool at 1 m is likely to:

• Cause a short-term injury such as a strain or sprain if the individual falls. A severe sprain may require days off work. This outcome is similar to a medium severity rating.
• Occur once in a working lifetime as painting is an uncommon activity for this organization. This criterion is similar to a low probability rating.

When compared to the risk matrix chart (Table 1), these values correspond to a low risk.

The workplace decides to implement risk control measures, including the use of a stool with a large top that will allow the individual to maintain stability when standing on the stool. They also determined that while the floor surface is flat, they provided training to the individual on the importance of making sure the stool's legs always rest on the flat surface. The training also included steps to avoid excess reaching while painting.

What is meant by risk factors?

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