Whilst companies are currently focusing on the extensive actual and possible impacts of Covid-19 on their business and broader stakeholders, there will soon come a time for reflection and assessment of the suitability and strength of systems, policies and strategies in place. With significant potential for corporates to emerge from the extreme pressure of the current crisis greater and more resilient, some of the principal areas for examination may arguably be in the environmental, social and governance (“ESG”) sphere.
It is widely held that ESG factors have the potential to materially influence the long-term performance of a business and the stakeholder value it creates. In its recent ‘Corporate Sustainability Reporting’ position paper, Norges Bank Investment Management stated that “companies’ exposure to and management of sustainability risks and opportunities can affect their value creation.(1)”
It follows that robust ESG risk management should be recognised as the driving force for any serious commitments to long-term business sustainability and strong ESG performance.
Scott Mather, CIO U.S. Core Strategies at PIMCO notes “we believe integrating ESG risk analysis helps us make more informed investment decisions.(2)”
Institutional investors across the board assess ESG risk management as part of their investment criteria, with a number of organisations using either external or proprietary ratings systems to better understand how corporates are managing risks.
This involves identifying the effects of sustainability topics on internal and external stakeholder value, determining the resilience of companies to adapt to ESG-related changes and structural shifts and measuring the potential impact of sustainability issues on a company’s long-term business model.
Sir Jon Thompson, CEO of the Financial Reporting Council stated: “Not only do boards of UK companies have a responsibility to report their impact on the environment and the risks of climate change to their business, but investors expect them to operate sustainably.(3)”
ESG considerations are progressively gaining a progressively larger share of corporate boardroom discussions so what questions can directors ask to ensure adequate consideration is given to ESG-related risks within their companies?
Has the business established a formal ESG governance framework?
This might include a Board-level sustainability committee as well as an executive ESG risk committee. Key consideration should be given to whether the board and management have the necessary ESG skills, knowledge and experience. Collaboration between sustainability teams, risk management and stakeholder-facing roles must be strong. It is also beneficial for risk management teams throughout the business to have an adequate level of expertise in this sphere and they should be suitably resourced. Overall sustainability governance structures can be underpinned by sustainability advocates throughout the organisation who are tasked with driving the ESG agenda forward.
Does the company properly manage ESG-related risks; are sustainability risks integrated into the overall corporate risk management framework?
A systematic and holistic approach to identifying, assessing, managing and responding to ESG-related risks should be included across all business operations, supported by a suitable ESG framework and related set of policies. By working with management to identify sustainability risks, the board can then agree on appropriate initiatives as part of the overall business strategy to manage ESG impacts as well as suitable indicators to measure performance and targets to put in place. An important consideration in risk assessment is whether scenario analysis is used by the company as a tool to better understand the potential impact of ESG risks on the business model?
Are ESG risks in the supply chain being assessed and managed?
These can affect corporate reputations, but also have a significant bearing on the successful management of operations. Mapping the supply chain and engaging with direct suppliers to encourage subsequent engagement with companies further down the chain can be beneficial. Supply chain relationships should be strengthened through transparent communications, engagement, feedback and the provision of effective grievance mechanisms. Crisis scenario analysis and stress testing can be conducted to assess risks in the procurement sphere. Rewards for responsible business practices within the chain can be considered alongside systems to deter from and penalise irresponsible practices. Companies should look to adopt policies that go beyond legal compliance to ensure an ethical, efficient and responsible supply chain.
What sustainability opportunities can be captured by the organisation?
ESG performance and management should not only be considered in the context of risk mitigation – there are also numerous opportunities that can be harnessed. These can include increased access to capital, strengthened employee attraction and retention, competitive advantage through innovation and ability to generate growth, retained ‘social licence to operate’, cost savings through efficiencies, reputational benefits, better decision-making as a result of more diverse teams, as well as opportunities from broader ESG-related shifts (such as increased demand for resources as a result of growing populations and reduced exposure to future regulation). Investors often look at companies which can specifically benefit from ESG-related opportunities. Franklin Templeton, for example, “identifies and assesses companies poised to thrive in the transition to a lower carbon future (4)” as part of its investment process.
Is the company reporting adequately and transparently on sustainability risk management and resilience, with due consideration paid to disclosure requirements of all stakeholders?
Michael R. Bloomberg, Chair of the Taskforce on Climate-related Financial Disclosures (“TCFD”) states that: “Increasing transparency makes markets more efficient, and economies more stable and resilient.(5)” Sustainability risk management should form the backbone of reporting on ESG-related topics. There is specific focus in the investor sphere on environmental risk analysis, with the BlackRock Investment Stewardship team expecting companies “with which [it has] already engaged on TCFD-aligned reporting to disclose sufficient detail across the four pillars of the TCFD framework and provide a timeframe within which the company will report fully in line with the eleven recommendations.(6)” This is not to say that companies should purely focus on environmental risks; reporting of ESG / non-financial risks should be based on the concept of materiality and should provide stakeholders with a comprehensive understanding of how ESG risks are integrated into the business’ overall risk assessment, management and mitigation process. All stakeholder communication surrounding the ways in which the company creates long-term value should include ESG risks and opportunities. The company needs to clearly demonstrate its ESG risk mitigation strategy to all external audiences.
Is the company engaging appropriately with its stakeholders on sustainability risks?
Feedback from stakeholders is a crucial tool in ongoing ESG risk management and can include investor engagement, employee feedback, shareholder activism, community consultations and day-to-day requests for information. In addition to ensuring transparent reporting on ESG-related issues, a company should actively engage on sustainability risk management. Barbara Novick, co-founder and Vice Chairman of BlackRock said: “We have the capacity to engage companies year-round in meaningful discussions on the specific steps they should be taking to manage long-term risks and opportunities, including increasingly material sustainability issues.(6)”
It seems logical that material ESG factors should be fully integrated into a company’s risk management framework as a central component of the business’ ability to create long-term stakeholder value. With a comprehensive understanding of ESG risks and opportunities, a company can ensure it has the systems, policies and structures in place to mitigate risk and harness opportunities, thereby underpinning its overall approach to sustainability.
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1. www.nbim.no/en/the-fund/responsible-investment/our-voting-records/position-papers/corporate-sustainability-reporting/
2. blog.pimco.com/en/2019/05/esg-investment-management-responsibility-research-results
3. www.frc.org.uk/news/february-2020-(1)/frc-assesses-company-and-auditor-responses-to-clim
4. www.franklintempleton.co.uk/investor/article?contentPath=html/ftthinks/common/responsible-investing/discovering-value-in-climate-change-investing.html
5. www.fsb-tcfd.org/
6. www.blackrock.com/corporate/newsroom/press-releases/article/corporate-one/press-releases/stewardship-priorities