Does ESG Expose Additional Risks and Opportunities?

If you work with a publicly-traded company or otherwise follow financial news, you’re undoubtedly familiar with ESG, which can best be described as a “set of standards” for evaluating a company’s track record on an array of Environmental, Social, and Governance issues.

Over the last decade or so, ESG has become a significant concern for mostly external stakeholders, especially investors. The most recent biennial Report on US Sustainable and Impact Investing Trends from the US SIF Foundation indicates that the amount of “sustainable” assets under professional management jumped an eye-popping 42% from $12 trillion to $17.1 trillion between 2018 and 2020.

Larry Fink, CEO of multinational investment firm BlackRock, illustrates this commitment by stating:

A company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process.”

It’s not just investors taking an interest in ESG; society at large is increasingly concerned with topics like climate change, income inequality, and more. Unlike how businesses operated in past decades, everyday people have a plethora of tools available to bring attention to their concern on certain issues or behaviors.

As of late last year, the Governance & Accountability Institute released a report stating 92% of S&P 500 and 70% of Russell 1000 companies produce at least some sort of ESG disclosure annually.

For a large number of these companies, ESG ends up being a pat on the back. Disclosures are typically approached from an investor disclosure perspective that ultimately are filed away.

But there can be so much more to ESG than just a pretty report for investors…

Issues and actions outlined in ESG disclosure reports do not occur in a vacuum. In some cases, these issues can have dramatic impacts on a company’s finances, its ability to operate, and most significantly, its reputation. A couple of good examples of ESG-related impacts include the Wells Fargo scandal where fake accounts were created to meet quotas (e.g., social/governance) or the recall of millions of Volkswagen cars in 2015 for faulty emissions systems (e.g., environmental).

With more intense hurricanes, wildfires and other calamities, many ESG-related risks, once considered “black swans,” are becoming more common and can manifest quickly.

This fact brings to mind an article I wrote back in the summer of 2018 on how the emerging GDPR regulations from the European Union exposed interdependencies of risk, specifically data in this case. In preparing for GDPR, many companies came to realize the extent of risks around data in that it doesn’t just sit on the company’s servers, but bounces between devices on different networks.

In the case of ESG, consider a Gallup survey from last year where 7 in 10 workers claim to be at least somewhat concerned about an employer’s environmental record and 3 in 10 would consider leaving to work at a more “sustainable” company. This ESG-related issue is most certainly relevant or interdependent with talent risk, which is especially acute for many companies right now.

A company could experience tremendous impacts if top-talent were to leave a company for this reason.

In spite of connections like this and countless other examples, many companies mistakenly keep ESG & ERM separate.  

For many companies, ESG-related activities are kept separate from the risk function. Many companies handle its ESG disclosures in the finance area while the risk area has little input and limited awareness into what goes into these disclosures nor any idea of issues the ESG or “sustainability” officer has identified.

According to a survey by Gartner from late 2021, few ERM professionals consider improved ESG governance and reporting as a top challenge for this year. But on the flip side, last year’s Center for Excellence in ERM Summit at St. John’s University discussed how this disconnect between ESG & ERM is a red flag for many investors.

Instead of each of these areas operating in their own silo, the summit and subsequent whitepaper explains how ESG & ERM should work together to reduce risk to the company’s strategy while increasing the company’s long-term viability. A corporate Board member attending the St. John’s Summit said the event “…emphasized the importance of having the ESG conversation at the board and with the executive team, while also pointing out that ESG must be tied to the strategy and business model.”

This board member went on to state emphatically,

You may be thinking “fantastic, another project,” especially if ESG hasn’t been a necessity or priority at your company.

However, as the St. John’s whitepaper explains, you don’t have to “boil the ocean” (no pun intended). Instead, simply having a conversation around these topics and identifying ESG issues or dimensions that align with your corporate strategy is a good place to start.

I want to remind or reiterate one important point that often gets lost – ESG doesn’t always mean risks in the negative sense. As COSO explains in this whitepaper, management can also identify or otherwise examine ESG-related trends that lead to new opportunities.

While it isn’t necessarily something you have to do, especially if your company is privately-owned, you could take advantage of opportunities that yield ongoing benefits like reduced costs, increased resilience and improved reputation. This may make any costs worth the investment, especially if pursuing an opportunity doesn’t require a big financial commitment.

As an example, let’s look at the Dollar Shave Club.

When my husband first joined, his monthly razor shipments would arrive in this huge cardboard envelope the size of a file folder. It seemed like an incredibly wasteful way to send a pack of 4 razor blades. Apparently, someone said something, or Dollar Shave Club realized they were using way more natural resources than necessary, so the packaging was changed to a much smaller cardboard box with minimal plastic. This seemingly simple change had the double impact of saving the company on raw material and shipping while bolstering its reputation of being aware of people’s concern about the environment.

Many companies have not considered how interconnected ESG & ERM can be. But as interest in ESG from investors, vendors, suppliers, employees, and general society continues to grow, companies would be wise to understand how these type issues can impact their strategic goals, whether negatively or positively.

Does your company factor ESG into risk assessments? How does your company spot and act on any opportunities related to ESG issues?

The ESG issue is a more urgent matter for publicly traded companies, but it should be a concern for companies regardless, especially considering the reach of social media and 24-hour news cycles these days.

To share your thoughts or experiences on this topic, please leave a comment below or join the conversation on LinkedIn.

And if you prefer, you may email me privately at comments@strategicdecisionsolutions.com.

Blending ESG & ERM may seem like a daunting task, especially if these two areas don’t coordinate or collaborate already. However, as these issues gain more prominence globally, so will the need to better understand risks and opportunities around them. If your company is struggling to do this effectively, please don’t hesitate to contact me by email or through my online calendar to begin discussing your challenge today.

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