ESG Has Now Evolved Into Risk Management. Is Your Organization Ready for the Change?
ESG (Environmental, Social, and Governance) has roots in Corporate Social Responsibility (CSR) and the environmental movement, but it today encompasses an organization’s impact on society and the environment, climate change threats, and changing attitudes about ESG concerns.
Development of ESG
Since the term “ESG” was first used in a 2005 report commissioned by the UN Secretary-General, it has served as a roadmap for organizations to better integrate environmental, social, and governance issues in asset management, securities brokerage services, and related research operations.
ESG has evolved from a feature that was merely desirable to one that is absolutely essential throughout the course of recent years. Currently, stakeholders and investors want greater transparency in the global business operations, and regulatory agencies develop disclosure frameworks and requirements.
ESG was initially used to measure the environmental and social effect of a firm; however, it has since expanded to include the identification and management of climate-related, social-related, and governance-related risks that a company confronts.
Risk Control in the Age of ESG
According to the World Economic Forum’s 2022 Global Risks Report, all of the top five global dangers that have been identified are connected to climate change. As global attention swings to climate challenges, climate risk is increasingly seen as a commercial risk.
It is now generally acknowledged that climate-related consequences on a corporation can be material and necessitate disclosure, largely as a result of the work of the Task Force on Climate-Related Financial Disclosures (TCFD). Taking this idea one step further, the concept of double materiality says that an organization’s effect on the climate or the environment can also be material. Also, climate change affects people as well as the environment, which brings the “E” and “S” of ESG closer together.
If not handled properly, ESG concerns can have negative effects on a company’s bottom line, public image, and legal standing. Every business faces unique challenges associated with its industry and operations, but all ESG risks can be broken down into three categories.
Environmental risks can include concerns linked to the global transition toward a greener future, such as climate change effect mitigation and adaptation methods. Environmental hazards can also include the physical dangers posed by a changing climate, such as drought, natural catastrophes, and agricultural disruption. Environmental risks can also include concerns related to the worldwide transition toward a greener future.
Social hazards can include issues with working conditions, safety, and the upholding of human rights, as well as initiatives to promote diversity, equity, and inclusion.
Governance risks include issues like anti-corruption procedures and adherence to applicable laws and regulations.
As ESG becomes a key issue of consumers and stakeholders, more instances of unethical business practices are emerging, and the companies involved are under increasing scrutiny. In addition, the number of businesses receiving greenwashing fines has increased.
Increasing dangers from external environmental variables are just as common as scandals and disputes involving an organization’s environmental or social impact.
Risk of Disclosure and Compliance
Based on recent global climate commitments, ESG disclosure requirements around the world are likely to become stricter. Companies will have to spend a lot of money on data collection and reporting, and they should expect to be looked at more closely by a wide range of stakeholders. Disclosure mistakes or failures could also put a company in legal and financial trouble. In 2023, firms should put a lot of effort into accurate data collection and reporting.
A corporation that fails to recognize, report, and address ESG risks may miss out on lucrative commercial and investment possibilities even if it has not yet felt their negative effects. As more institutional investors use ESG investing, these key risk assessments will be built into the core of due diligence and investment screening processes.
ESG and Environmental Resources Management Alignment
As businesses improve their ESG data collecting and reporting practices, risk management becomes an increasingly important aspect of their ESG initiatives. Businesses must first identify ESG risks that affect their operations and then plan and manage them to reduce their impact.
ESG risk considerations should be considered in corporate decision-making and enterprise risk management (ERM). Savvy firms are striving to fully link their risk management frameworks and decisions with ESG policies. Doing so can unleash ESG’s full potential, turning it from a side issue into a company’s core strategy.
Finding Important ESG Risks
An exhaustive list of ESG concerns is a good place for businesses to start when identifying substantial issues. While deciding how to respond to these concerns, businesses should think about how they might affect their employees, communities, investors, consumers, and the environment in general as they engage in each of their activities, produce each of their goods, and maintain each of their relationships.
Once these important issues have been found, they should be evaluated based on how they affect stakeholder decisions and their economic, environmental, and social effects. Before gathering information for a report, it’s important to make sure that the key points give a full picture of the organization’s ESG performance and impacts. Is each topic important and relevant to the company? Is there anything obvious that’s missing? Review material subjects to integrate stakeholder feedback once reports are issued.
A company’s internal and external stakeholders can be better understood, as well as the ESG risks that relate to the company’s operations, through conducting a materiality assessment. To understand how economic, social, and environmental impacts are seen along the whole value chain, substantial stakeholders involvement and copious data collection is required.
Moreover, materiality analysis should consider future versions of these ESG risks and opportunities to help firms forecast. The insights collected from these conversations and research can help an organization to figure out its non-financial impacts, rank which impacts are most important, and guide strategic thinking and communication.
The Benefits of ESG Risk Management for Business
The conclusion is unambiguous: ESG risk management is beneficial to the company and not just a compliance exercise. Organizations should think about the cost of inaction and what ignoring red flags and faulty practices can cost in the long term rather than protesting the cost of ESG.