Why sustainability should be a key enterprise risk management consideration
The COVID-19 pandemic has highlighted the diverse web of interconnected factors that can impact a business, demonstrating more clearly than ever that siloed thinking is not the way forward – especially when it comes to addressing risk.
“Traditional risk management looks at financial risks, and companies used to look at risks in silos like financial risks, health and safety risks and so on, but now we have seen that one crisis or one risk can create a domino effect; so we've seen that the pandemic is a health crisis that created a humanitarian crisis, a monetary crisis, and an economic crisis. It has shown businesses that the time of siloed thinking is long over,” says Dr Allinnettes Adigue, head the ASEAN Regional Hub for GRI (Global Reporting Initiative), the independent, international organisation that provides the world’s most widely used standards for sustainability reporting – the GRI Standards.
“The pandemic has shown the vulnerability of supply chains, the lack of resilience also the interdependencies and interconnections of our world,” agrees Constant Van Aerschot, director of the WBCSD (World Business Council for Sustainable Development) Asia Pacific. “If somewhere a link in the chain is broken, that means the whole chain is broken. What we have seen is that those companies with intact value chains have in fact benefitted from the pandemic. Some have made record profits, because they were able to deliver where their competitors could not. Those with intact value chains are typically more advanced in ESG because they will engage more with stakeholders.”
Adigue agrees that there have been winners and losers from the pandemic – with sustainability-focused organisations coming out on top. “A study by BlackRock released in the middle of last year found a correlation between those companies that performed well during the pandemic and those that were listed in the Dow Jones Sustainability Indices (DJSI) - meaning they have committed to corporate sustainability. It has shown how positively that strategy has impacted them in a crisis,” she says.
The importance of ESG
These findings show that ESG is emerging as a factor with enormous impact across an entire organisation, not just within one silo. Increasingly, it is becoming a key consideration for risk managers. This has been evidenced in numerous recent events – for example, the bankruptcy case filed by PG&E, the Pacific Gas and Electric Company in the US, which is a fortune 500 company, was a result of the sweeping US wildfires that damaged a lot of its physical assets.
“It was an environmental cost event; because of climate change we're having massive wildfires and as a result, it damaged the physical assets of the company, which impacted the solvency of the company - and because of that they had to file bankruptcy,” says Adigue.
“It also brought up a discussion on policy issues and regulatory risk, because it's now being recognised that climate disasters will increasingly add financial stress to utility sector stakeholders. So now companies have to factor in the costs of climate change and this cost may be transferred to the cost for customers. This illustrates the concatenated risk – how one crisis or one risk can create and may affect numerous stakeholders.”
Similarly, Van Aerschot highlights the way in which extreme weather events and climate change now need to be considered in companies’ risk mitigation strategies.
“EDF, the utility company in France, is facing drought, which means less water - which means they cannot cool down their nuclear power plant. That's a natural risk that will impact the nuclear industry. Another example is ArcelorMittal, a global steel manufacturer . They have embarked in mangrove restoration around the Great Lake in the US because if they don't have water, they cannot use their manufacturing plant that is located on the shore of the lake to make steel. If the water table goes down, they have to stop production. So including natural capital and natural disruptions into risk management is critical for a company.”
Risk as opportunity
A recent webinar titled Aligning Sustainability and Risk Management, organised by GRI and featuring Van Aerschot and Adigue, explored the ways in which sustainability is shaping the role of risk managers, increasing their relevance to the organisational transformation process.
The WBCSD defines a sustainability risk as an uncertain social or environmental event or condition that if it occurs, can cause a significant impact on the company, but that on the flip side includes opportunities that may be available to an organisation because of changing social or environmental factors.
In Van Aerschot’s view, the role of chief risk officer should be renamed ‘chief risk and opportunity officer’ - because of the opportunities that are inherent in risk.
“For example, there is the opportunity to make sure you can overcome any supply chain disruptions,” he says. “The question is whether risk officers actually change the way they do risk management - do they include ESG in their risk assessment? We found that there is a misalignment between the risk filings at the stock exchanges, the chief sustainability officer, and the materiality risk assessment. There is no alignment or little alignment, and on one hand, you have the natural capital, the social capital, the ESG world, that captures those risks in a way that the traditional risk manager does not. The changing business landscape includes the necessity to speak to stakeholders and supply chain, and this means that chief risk officers need to change the way they look at risk.”
Adigue agrees that some companies that have reported sustainability issues in their sustainability reports are not identifying these in their risk findings. “Companies are missing the value that a sustainability report would bring to their risk management,” she says.
To help businesses achieve a more joined-up approach, WBCSD has created a diagnostic tool that helps companies understand how well ESG-related risks are currently integrated into their ERM processes and structures.
“It looks at whether the ESG risks align with the enterprise risk management filing at the stock exchange – so there are resources there to support new ways of addressing risk,” says Van Aerschot. He adds that ESG risks call for a dynamic approach to risk assessment. “You have several interconnected risks that together forms a cluster that can lead to an aggregated impact that is more severe than the most severe individual risk. So the traditional way of looking at single events in a 2x2 matrix (impact versus probability of occurrence) no longer applies for ESG. A dynamic risk assessment approach can change the conversation in the boardroom.
A new approach
For many risk officers, sustainability is a new consideration – but there’s no doubt it will increasingly fall within their remit. In the recent webinar, the speakers highlighted that fact that while the chief risk officer role used to be more common in financial institutions, more and more non-financial companies are appointing risk officers - and the role of chief risk officer is growing beyond managing downside risk and regulatory compliance, and increasingly includes sustainability risk management – that is, the environmental, economic and social factors that could impact or could pose risk to the company.
In addition to the chief risk officer role, the board level risk committee has an important role to play. Again, communication is key.
“At board level, the question is how competent the board is on sustainability issues, whether those issues have been discussed, and whether there is a dialogue between the risk officer, the chief sustainability officer and the board level risk committee,” says Van Aerschot. “That's a governance question: how do you organise the risk function within your company, and who speaks to who?”
The new, expanded role of the chief risk officer encapsulates reputation, ethics, compliance, corporate responsibilities, sustainability and possibly even audit and investor relations. And in addition to having a board level risk committee, many companies are now creating board-level sustainability and ESG committees.
“Because everything is interconnected, it's probably just a matter of time before the board committees are merged,” notes Adigue.
“Because companies are now we are becoming aware of sustainability, we're seeing an internal revolution for companies,” she continues. “Different leadership positions in the company could drive sustainability in the organisation - so what we're seeing is that it's not just the role of the chief sustainability officer, not just the role of the CEO or not even the risk officer: everyone in the company has a role to play. Now we're seeing companies reorganising their structure and examining how they do things, with the goal of doing things better. Siloed thinking is a disease of organisations, and because of sustainability, we're seeing more cooperation within the organisation. They're aware that everything is interconnected.”
