Holistic risk management starts with ESG

Traditionally, businesses managed risks by assigning unit leaders to manage potential threats within their respective fields. With time, the function evolved and an integrated approach to risk management was adopted in the form of ‘Enterprise Risk Management (ERM)’ to protect businesses from a multitude of unanticipated risk’y’ events that could potentially erode the bottom line.

Fast forward to the present day and risk management is experiencing another evolution – ESG risk. Growing investor concerns, public backlash, conscious consumers and employees, and a vast number of ESG regulations – are all driving the need to focus on managing ESG risk better.

Yet again, history seems to be repeating itself with most businesses continuing to follow a siloed approach when it comes to managing risk in ESG and not integrating it with the overall risk management function.

Businesses stand to gain from a unified approach to managing risk – and this includes ESG risk. A recent report by BSR states that robust enterprise strategies necessitate an ERM approach that incorporates ESG risks such as climate change.

What are ESG risks? They are concerned with the environmental, social, and corporate governance risks that enterprises may face. Some of these risks include climate change, human rights violations, bribery practices and regulations.

To understand how this unification can benefit an enterprise’s triple bottom line, let us take a closer look at some of the fundamentals of ESG risk.

An evolving field, risks related to environmental, social, and corporate governance are increasingly becoming a challenge. Especially when it comes to identifying and eliminating these risks. Timely identification allows businesses to come up with mitigation strategies and there are substantial benefits to be gained from it:

• Stock market impact: Mitigating ESG risks allow enterprises to focus on long-term profitability. While there are short-term costs involved in adopting ESG practices and mitigating ESG risks, the profits outweigh the investments. Case in point, Cheema-Fox conducted a study to understand the initial stock market reaction to the Covid-19 crisis and found that enterprises scoring high on the crisis response measure based on ESG sentiment garnered 1.4 – 2.7% higher stock return. Furthermore, the ESG and Financial Performance report by NYU Stern found a positive correlation between ESG and enterprise operational efficiencies, stock market performance, and reduced capital cost.
• Financial impact: In the third quarter of 2021, Reuters reported that global sustainable funds hit a record high of $3.9 trillion, more than doubling in less than 12 months. The transition to a net-zero economy, as data suggests, is a favorable opportunity for enterprises to meet financial expectations while fulfilling environmental responsibility. Findings from MSCI studies also arrived at a similar conclusion where they surmised that businesses with high ESG scores experienced lower capital and equity cost and debt compared to companies with poor ESG scores.
• Recruitment impact: Career decisions today are more ‘purpose based’ and millennials are increasingly looking for employers who care about their communities. WTWCO stated that 58% of employees consider an enterprise’s social and environmental efforts when choosing an employer. Enterprises with a strong legacy of ‘giving back’ to their employees, stand to increase their social impact, retain talent, and gain higher stock returns. Case in point, A London Business School study found enterprises in Fortune’s “100 Best Companies to Work For” list, generated 2.3 – 3.8% higher stock returns annually than their peers in the long run.

For businesses looking at integrating ESG risk into their ERM, here are a few fundamentals to begin with:

• Know who’s in charge: The first step while integrating ESG into ERM is to assign accountability. It could either be allocated to teams managing operational risk or non-financial risk. Doing so will enable risk thresholds to be defined clearly and monitored, implementation of appropriate tools and processes, and most importantly, complete risk visibility for management and board to make more informed decisions.
• Focus on risk data and risk mitigation strategies:  The fundamentals of ESG risk management are not different from traditional risk where data gets collected from multiple sources. This data needs to be filtered so you can isolate irrelevant information. The more accurate your ESG risk data, the better will the analysis and reporting.
• Cover every exit: To be forewarned is to be forearmed. Leverage ERM identification processes, such as asset categorization, and insights from ESG risk analysis to come up with robust preemptive plans that also serve as a great way to build investor confidence.
•  Identify your audience: Understand who your business’ key stakeholders are – is it the regulators, investors, board or end consumers? This will help determine the framework to be adopted to address your audience’s informational needs.
• Don’t fix what’s not broken:  Reinventing the entire ERM process can be time-consuming and is bound to cause friction. Instead, companies should take advantage of existing ERM mechanisms to spot, analyze and mitigate ESG risks.
• Develop an all-encompassing ESG perspective: ESG is a broad and evolving concept. Just factoring environmental concerns is not enough. Businesses also need to account for seemingly passive risks such as social, ESG finance, governance and more to avoid any potential impact stemming from these areas.
• Keep it simple:  When starting with something new, the rule is to keep it simple. This allows you to focus on the core objectives and execute them successfully. Only when you gain complete visibility into an organization’s risk, is when you can build on it and adopt more complex methodologies. The primary objective should be to get the basics right and build a strong foundation first.

Incorporating ESG into ERM is the next frontier of risk management which will allow enterprises to enhance brand value, leverage investment opportunities, and make more profits. Eventually, in the not-so-distant future, businesses with the most robust sustainable processes will not only survive but also thrive.

For more insights on mitigating ESG risks and incorporating them into the ERM, download this eBook on “Aligning ESG with ERM: The path to holistic risk management.”