Understand ESG risks and their importance

This article is sponsored by ESG service

Businesses face new risks as investors, consumers, employees and partners demand greater corporate accountability, transparency and sustainability. Stakeholders want to know how organizations affect the environment, how they treat their employees, customers and communities, and whether they conduct business ethically.

These environmental, socio-economic and governance variables, which can affect a company’s financial situation or operational performance, are collectively referred to as ESG (Environment, Social, Governance) risks. Although ESG variables are diverse, they all have one thing in common: they can have a significant impact on a company’s long-term sustainability and profitability.

A company that neglects these risks could potentially incur heavy financial penalties and also lose the support of investors, customers and stakeholders. However, not all ESG issues are created equal and their relative relevance varies by company, industry and sector. This means that each organization must identify, manage and reduce its own significant ESG risks.

Why are ESG risks important?

ESG risks exist outside of a standard financial audit, but they are just as important to a company. Every company, regardless of size or industry, faces a variety of ESG concerns, some of which can lead to financial or reputational damage.

Negative ESG situations are becoming increasingly costly and harmful. The Bank of America (BofA) Global Research Team recently estimated more than $600 billion in market capitalization for S&P 500 companies has been lost to “ESG controversies” in the past seven years alone. Examples include:

  • Pacific Gas & Electric recently agreed to pay more than $55 million to avoid criminal prosecution for two major wildfires started by aging Northern California power lines owned by the company.
  • Poor governance led to the recall of millions of Volkswagen cars after the company admitted tampering with emissions tests. It cost VW $35 billion in fines, penalties, financial settlements and redemption fees.

Although small and medium-sized companies are not subject to the same level of stakeholder scrutiny or regulatory requirements as larger companies, they are nonetheless vulnerable to ESG incidents. More importantly, small businesses may not be able to recover without help from big investors.

If not addressed quickly and appropriately, ESG controversies can have significant negative impacts on business performance and survival. And while the cost of adaptation and mitigation can run into billions of dollars, it’s still a bargain compared to the cost of doing nothing. Therefore, it is essential for businesses to recognize and mitigate the different types of risks that pose a threat to their business.

Types of environmental risks

Environmental risks have become a major concern for investors and consumers as attention to climate change, greenhouse gas (GHG) emissions, resource use and biodiversity protection has increased. increase. Environmental risk refers to how an organization affects the environment and includes things like:

  • Impact of climate change
  • GHG emissions
  • Safety and use of water
  • Waste prevention and recycling
  • Pollution Prevention Control
  • Deforestation
  • Protection of healthy ecosystems
  • Impact on biodiversity
  • Protection of marine resources
  • Transition to a circular economy
  • Environmental management practices

Energy- and resource-intensive companies need to be particularly aware of environmental risks and regulations in order to develop long-term sustainable growth strategies.

Types of social risks

Social risks range from employee treatment and boycotts to labor violations and product recalls. These issues are diverse, qualitative and often simultaneously affect all of the company’s stakeholders, from employees and customers to suppliers and local authorities. Maintaining healthy, positive, fair and ethical relationships with these stakeholders is critical to the long-term success of a business, especially if that business’s success is built on public trust. Types of social risks include:

  • Diversity, Equity and Inclusion
  • Equal pay
  • Working conditions and safety
  • Respect for human rights
  • Workforce training and development
  • Data Privacy
  • Community involvement
  • Ethical Work Practices of Vendors/Vendors

Social issues tend to impact all stakeholders in the business. A company’s ability to avoid damaging its relationships and reputation can be important in securing long-term competitive advantages.

Types of governance risk

While most investors have a sense of good governance practices, there is no one-size-fits-all approach. It can be difficult to identify where and how best practices can affect business performance. Types of governance risk include:

  • Business Integrity and Ethics
  • Anti-competitive behavior and practices
  • Compliance with ESG regulations (including emerging regulations)
  • ESG information
  • Transparent communication
  • Complaint procedures and systems
  • Prevention of corruption/fraud
  • Executive compensation
  • Board structure and diversity
  • Bribery and Corruption
  • Policies and Standards
  • Tax compliance

Companies must navigate industry-specific compliance and regulations, consider the role of the board of directors when overseeing risk management policies, develop strong risk management systems and internal controls, determine what disclosures must be made to the public and investors, and to provide advice for sound decision-making and efficient allocation of resources.

Physical and transition risks

Organizations can also be exposed to so-called physical and transition risks.

Physical risks are those related to the physical impacts of climate change. These include acute risks such as increased frequency and severity of extreme weather events such as wildfires, floods and hurricanes. Chronic risk events occur over time and include changes in weather patterns, temperature increases and sea level rise.

Transition risks arise specifically from the transition to a low-carbon economy. These considerations include increased cost of raw materials, increased costs due to changes or disruptions in the supply chain, introduction of carbon taxes and increased pricing of GHG emissions, expanded emissions reporting requirements, exposure to lawsuits, and the cost of low-emission technologies.

Due to the complex and interconnected nature of all ESG risks, impacts can be far-reaching, making ongoing risk management and reporting critically important.

ESG risk management

Climate change is a major risk that could destabilize the global financial system. Therefore, better data and new information are needed to better identify and manage these risks.

ESG frameworks have been established to help companies assess and disclose their sensitivity to a range of ESG risks. There are many ESG frameworksbut among the most recognized are the recommendations of the SASB standards of the Value Reporting Foundation, the Global Reporting Initiative (GRI) and the Task Force on Climate-related Financial Disclosures (TCFD).

ESG frameworks help companies move away from compliance-driven mindsets and adopt proactive risk reduction strategies. Some general risk management guidelines to keep in mind include:

  • Companies can successfully identify and assess ESG risks
  • Senior management takes responsibility for ESG integration and risk mitigation
  • Companies have the appropriate skills, knowledge and expertise to manage risk
  • There is regulatory compliance and preparedness
  • ESG risks are considered when establishing, implementing and maintaining reporting practices

Appropriate mitigation of ESG risks makes companies less volatile and boosts investor confidence. Companies are rewarded with access to credit and debt markets, positive brand equity, reinvestments and long-term sustainable growth.

ESG data is essential to help companies engage in effective risk management and enables organizations to plan for compliance, improve voluntary disclosures, and create risk mitigation roadmaps to address issues. preventive threats.

Valerie J. Wallis