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What risk needs to know about ESG intelligence

What risk needs to know about ESG intelligence

With ESG considerations becoming a central element of corporate operations, risk management professionals need to be able to identify, manage and mitigate associated risks, quantifying existing liabilities and incorporating new elements into their ERM frameworks.

ESG in brief

Once confined to the realm of impact investing, environmental, social and governance (ESG) performance is now a topic for board meetings, employee interviews, consumer marketing campaigns, and supply chain analysis. It should also be a tenet of ERM policy statements.

Non-financial environmental, social and governance issues are impacting every aspect of business operations, with the recognition that corporations have a central role to play in combatting climate change, preserving the environment, and benefitting society as a whole, while still generating profits.

This is easier said than done, however. Many of the challenges faced by organisations attempting to improve ESG performance are rooted in the breadth of issues covered by the unassuming acronym, along with the speed at which those issues are evolving.

  • Environmental concerns encompass greenhouse gas emissions, sustainability goals, water usage, renewable energy take-up, recycling schemes, wildlife conservation, and the impact of business operations on the planet.
  • Social factors include health and safety, diversity and inclusion, employee wellbeing, charitable contributions, and local community support schemes.
  • Governance refers to policy decisions, transparency in reporting, executive remuneration, and board independence among many other factors.

To further complicate matters, the prioritisation of any given issue depends on the sector, purpose, location and size of the organisation.

Chief risk officers (CROs), risk managers and operational risk teams need oversight of their organisation’s ESG risk exposure in order to manage and mitigate the risks associated with all of the issues falling under the ESG umbrella.

This includes understanding how ESG fits into existing risk assessments and frameworks, and whether risk management needs to fundamentally alter the way they have been operating in order to account for ESG risk.

Viewing ESG from a risk perspective

Incorporating ESG intelligence into business risk strategies requires analysis of those issues from a risk perspective – identifying where controls need to be implemented, tracking the velocity at which ESG risks emerge, and calculating the business’s vulnerability to them. Key risk indicators (KRIs) should then be updated to include ESG factors.

At present, there exist a number of frameworks for assessing ESG factors and quantifying ESG performance. The different taxonomies offer various methods for breaking down the wide array of topics covered under the ESG banner, some of which can clarify understanding of an organisation’s operational risk profile.

The Sustainability Accounting Standards Board (SASB) Standards and Global Reporting Initiative (GRI) are among the most high-profile frameworks offering classification of ESG issues. As of September 2020, five major standard setters including SASB and GRI have been collaborating to create a corporate reporting system combining financial accounting and sustainability disclosure. These standards provide guidance on identifying relevant topics, and ensure comparable, consistent reporting, useful in identifying associated risks, and embedding ESG classifications in existing ERM strategies.

These standards enable ESG issues to be linked to KRIs, giving the risk management function the tools and constructs to understand ESG as part of overall risk assessment. Many ESG factors will already exist within current risk mapping, perhaps under different names, and will present no additional challenge.

Meanwhile,

a gap analysis between existing ERM frameworks and external ESG standards allows for the addition of any missing factors. This gives CROs and risk managers the opportunity to integrate overlooked elements of ESG into their strategic risk profile.

ESG risk intelligence

Accurately assessing risk includes the ability to measure an organisation’s ESG liability. Specific risks associated with ESG factors include:

  • Financial risk: Investors shunning companies that fail to make adequate ESG disclosures; consumers preferring competitors with more positive environmental and social credentials.
  • Reputational risk: Loss of credibility due to negative reporting on environmental failures; executive pay scandals; failing to act on in response to popular movements.
  • Compliance risk: Fines and other penalties for failure to comply with ESG-related regulation.
  • Operational risk: Inability to attract talent due to poor employee treatment; challenges to operating in a community because of inadequate CSR policies.

Not only are the risks connected to ESG many and varied, they are heightened by the fact that the issues tend to develop quickly, and are susceptible to changing stakeholder expectations and priorities.

These in turn are influenced by external factors beyond the organisation’s control, such as competitor behaviours, political decisions or NGO campaigns.

The reconfiguring of the traditional shareholder capitalism model into a broader stakeholder-centric ethic, closely aligned to ESG issues, requires risk managers to better understand the perceptions of all stakeholder groups. To do this, they need up-to-date intelligence on their own ESG liabilities; real time tracking of stakeholder sentiment; and consistent benchmarking on ESG topics.

Using targeted threat monitoring tools and risk mapping, a risk intelligence solution allows CROs to surface and quantify identifiable ESG risks, and make informed decisions on how to mitigate them.

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