Risk managers need to up game on sustainability risks

As reporting requirements and corporate exposures to climate change and social upheaval increase, risk managers will need to engage more with environmental, social and governance (ESG) risks, according to a number of risk management bodies. Despite growing awareness of ESG-related risks among investors and at a board level, risk managers in many organisations have yet to engage with ERG risks. However, ESG risks are increasingly relevant to corporate success and require the skills and coordination of risk managers, experts argue. ESG, also known as sustainability or corporate social responsibility (CSR), is an integral part of enterprise risk management (ERM), according to Sarah Gordon, expert and trainer at the Institute of Risk Management. “Depending on the industry, ESG-related risks are some of the biggest risks an organisation faces. For example, in the oil and gas industry, one supermajor cites sustainability risk as being responsible for 80% of delays and failures,” she said. Awareness of the business impact of ESG risk has been rising, according to Typhaine Beaupérin, chief executive officer of Ferma, which recently hosted a webinar on the topic. “Our last European Risk Manager Survey 2018 indicated that 71% of respondents have a regular or occasional collaboration with ESG specialists. This result was confirmed by a similar polling question during the webinar (70%),” she said. In October 2018, the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and the World Business Council for Sustainable Development (WBCSD) jointly produced guidance on ESG risk management. Building on COSO’s ERM framework, the guidance is intended to provide a framework for organisations, and their risk and sustainability managers, to identify, assess and report on ESG-related threats. Launching the guidance last year, COSO chairman Paul Sobel said: “The prevalence of ESG-related risks globally is increasing, and there is a growing demand from stakeholders for ESG-related insight. Using the common language of ERM, this guidance helps to meet the needs of risk management and sustainability practitioners for integrating ESG-related risks into ERM.” Growing interest in ESG-related risk can, in part, be explained by regulatory developments, according to Ms Beaupérin. Reporting requirements have been increasing for a range of ESG risks, most notably modern slavery, the gender pay gap and climate change. The EU recently agreed new ESG risk disclosure requirements for banks and insurers as part of its Action Plan on Sustainable Finance. As of 2018, the EU’s non-financial and diversity reporting rules require large companies to publish regular reports on the social and environmental impacts of their activities. “There is an ongoing trend at EU level to ask for more accountability and disclosure on ESG elements,” said Ms Beaupérin. “Companies are now required to produce an annual extra-financial statement (NFR Directive) and will be more and more pushed to also rate their environmental impact. As part of the EU Sustainable Finance action plan, the recently adopted taxonomy regulation will indeed establish the criteria that will deem an economic activity as sustainable,” she said. There is also a business need to manage ESG-related risks because they are becoming increasingly visible and civil society is highly sensitive to these issues, explained Ms Beaupérin. “Whether you talk about polluting spills, weather-related supply chain disruptions, worker fatalities or child labour, these examples are now quickly translating to financial with impacts on market prices, equity loss, contract breach,” she said. There has been a “radical shift in the perception” of ESG-related risks, according to Rodney Irwin, WBCSD’s managing director. Speaking on Ferma’s ESG-related risk management webinar, he noted a shift towards ESG risks in the World Economic Forum’s annual Global Risks Report. Extreme weather, natural disasters and failures in climate change adaptation have come to dominate the rankings. WBCSD said the number of ESG-related corporate incidents is increasing. In addition, climate change is now impacting business, according to Mr Irwin. For example, record low water levels on the river Rhine in 2018 caused a number of petrochemical facilities to cut production and issue profit warnings. US utility company PG&E filed for voluntary bankruptcy protection in January due to its exposures to last year’s devastating wildfires in California. Corporates are increasingly aware of the impact of ESG-related risk, whether it is extreme weather events, increased regulation or changing consumer opinion, according to John Ludlow, chief executive of UK risk and insurance management association Airmic. Energy and extractive industries, for example, are already under pressure from local communities, regulators, investors and consumers over climate change, as are the shipping and airline sectors. The clothing, technology and food sectors have also been criticised in the past for working conditions and modern slavery in their supply chains. The power of societal groups enabled by social media is driving ESG risk and requires risk managers to consider a wider range of stakeholder groups, explained Mr Ludlow. Relationships with stakeholders are increasingly important to the success of the corporate brand and strategy, he said. “Organisations need to map transactional stakeholders and understand their growing dependencies, but also go much wider to include NGOs, regulators, consumer groups and the media. These stakeholders are becoming increasingly important. Ignore them at your peril,” warned Mr Ludlow. Despite growing awareness of ESG-related risks, there is a disconnect between sustainability and risk management in many organisations. While many companies have CSR departments and board members responsible for sustainability, their activities are not always aligned with the risk management function. A WBCSD survey found that while 89% of risk and sustainability practitioners agreed that sustainability risks could lead to a significant impact on business, more than 70% felt risk management practices were not adequately addressing sustainability issues. WBCSD analysis found that 35% of companies did not disclose any sustainability risks identified in their sustainability reports in 2016. A poll of Ferma webinar participants found that only 6% had ESG risk as a responsibility. Some 45% played a role in ESG risk and 23% are planning to do so. Just 18% said they work closely with ESG specialists in their organisation and 24% have no relationship with an ESG specialist. Half (52%) said they work with an ESG specialist on an occasional basis. According to Ms Gordon, the perceived disconnect between sustainability issues and risk management reflects a lack of awareness and differences in language used by sustainability and risk managers. “Sustainability managers may not be aware of the power of ERM and how it can be a conduit or accelerator for getting your voice heard. Conversely, risk managers may not be aware of the importance of sustainability risks, or don’t have enough knowledge of ESG risks. These risks can be difficult to quantify and sometimes people shy away from them,” she said. According to Ms Beaupérin, the biggest challenge in aligning ERM and sustainability is measuring and quantifying the material impacts of ESG elements. Some 40% of Ferma’s webinar audience identified this as the top challenge. “This is a complex process for organisations as it requires the availability of internal data about the company’s activities that should be reliable and of good quality. Data analysis will need resources and expertise that are not necessarily present,” said Ms Beaupérin. Risk managers need to work closely with their CSR and corporate communication colleagues to identify risks and get “ahead of the curve”, according to Mr Ludlow. “Risk managers need to work with the CSR and corporate communications functions to manage and map out shareholders, understand their needs and better interact with them. Some stakeholder groups could bring a company down or block its endeavours,” he said. Mr Irwin also urged risk managers to “pick up the phone” and call colleagues in the sustainability department to help organisations address ESG-related risks. “There is nothing stopping you from picking up the phone and finding out who in your organisation is responsible for sustainability, downloading the COSO ESG guidance and our diagnostic tools,” he said.

Risk managers need to up game on sustainability risks

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