Setting the stage for his Tea Talk presentation on ESG and ERM recently, Friday Concepts Group Managing Director Ramesh Pillai said that organisations worldwide were now focusing more concertedly on ESG and their ESG practices because there were no other options. “Historically, corporate social responsibility, CSR, was the initiative championed by activists, employees and consumers,” he said. “Carbon footprints and ethical supply chains were scrutinised but this was not considered a core business objective, nor was it officially regulated.” However, all this has changed.
ESG and sustainability are hot topics for boards, and a requirement increasingly sought by investors, employees, regulators and customers. “Stakeholders have come to realise that environmental, social and governance issues – ESG – are critical to the reputation of businesses, and their financial performance,” Ramesh said. “Today’s shareholders want to know more than just what you can earn for them. They also want to know how it is earned. Even if you do not have investors who care about ESG, you can bet that many of your valued customers and staff do.”
How then should an organisation roll out and maintain an effective ESG programme as a natural part of daily operations and not just another shareholder marketing programme or compliance activity? One approach is to integrate ESG into the firm’s ERM programme. There is a correlation between ESG sustainability and ERM sustainability; understanding and dealing with it can improve long-term organisational sustainability. ESG is changing the business world as stakeholders increasingly expect companies to make their operations more sustainable.
Stakeholders want to know how organisations are affecting the environment, how they treat their clients, employees and community, and if they conduct their businesses ethically. These environmental, socio-economic and governance variables which are likely to affect the financial situation or operating performance of a company, are collectively referred to as ESG. “While all ESG variables are incredibly diverse, they all have one thing in common: they can have a significant impact on an organisation’s long term sustainability and profitability,” Ramesh said.
Overlooking these risks could potentially incur large financial penalties and cause the business to lose the support of customers, investors, and stakeholders. However, ESG issues and their relative relevance vary by company, industry and sector. Each organisation must identify, manage and reduce its unique material ESG risks. Risk managers should ensure that their environmental, social and governance standards are fully integrated into the organisation’s operational plans and strategies. Collaboration with key stakeholders is essential for risk mitigation and strong disclosure strategy.
Risk managers should also apply traditional risk fundamentals to ESG risk management. Ramesh said that putting appropriate controls in place, for example, and ensuring accuracy and transparency in all communications, will place companies in a much better position to act on their values, respond quickly to threats and prepare for regulatory intervention. “Organisations which do this will also stand a far better chance of increasing their ESG ratings…which provide a means of measurement for investors requesting insights into a company’s sustainability credentials,” he explained.
Generally, the higher the ESG matrix score, the more likely the business can withstand long term risk, embrace innovation and take a forward looking approach to value creation. This is in line with the 2030 Agenda for Sustainable Development. “The definition of sustainable development, according to the UN, is development that meets the needs of the present without compromising the ability of future generations to meet their own needs,” Ramesh said, adding that confusion had arisen because what constitutes a sustainable and resilient path has not been clearly defined.
It has led to uncertainty over whether applying ERM automatically covers ESG sustainability issues. He explained that the 2030 Agenda had its roots in the 1987 Brundtland Commission Report. “In that year, the UN Brundtland Commission defined sustainability,” he said. “Today, there are almost 140 developing countries in the world seeking ways of meeting their development needs. It’s gathered a life of its own and is pushing forward a lot of ERM concepts as well.” The confusion which has arisen is not necessarily a bad thing.
“The fact that there is confusion means that people are cognisant of…enterprise risk management and they understand that ERM is also about sustainability,” he said. Introducing the IERP’s interpretation of sustainability as a proactive approach that ensures the long term viability, resilience and integrity of the business by optimising – not reducing or minimising – resources, reducing environmental, energy or social impacts, and managing resources while not compromising profitability, he said it meant thinking broadly about impacts and issues.
“You need to engage and partner with stakeholders, make connections and integrate sustainability within and across the business,” he stressed. “Think broadly about values and not about profits.” While ESG looks at sustainability from a narrower perspective, ERM looks at sustainability from a much broader one. There were many business benefits to placing greater focus on ESG risk management, and building it into the wider general management framework. Advantages include enhanced sustainability.
“With a clearer view of ESG and ESG risks, businesses can better allocate their resources, combat rising operating expenses, improve their employee retention, and remain compliant with regulations,” Ramesh pointed out. “These combined can help to create greater efficiencies and cost savings in the long term while providing a stronger foundation of resilience in the face of uncertainty.” It also helps achieve more proactive regulatory compliance as businesses are expected to report on all ESG issues.
If ESG risk management is incorporated into ERM strategy, disclosing this information to the relevant government bodies will be much more straightforward, helping to reduce legal intervention. It is also likely to increase profitability as any business which is responsive to mitigating risks and concerns that might impact its bottom line or reputation is in a much better position to be profitable. Additionally, ESG-conscious organisations are more likely to be considered a safer investment by those exploring sustainable funds.
“They are more enticing to investors,” he said. “Socially conscious investors are now keen to incorporate ESG values such as responding to climate change, into their portfolios together with the more traditional factors of risk and profitability. Organisations that manage their ESG risks well, are the most likely to be able to attract these top investors.” Not only is ESG investing gaining traction due to generating competitive returns, it also helps investors to feel good about their investments. Finally, an ESG focus can attract and retain talented employees.
This can enhance employee motivation and productivity by instilling a sense of purpose. It may be viewed as an organisation ‘giving back,’ and be met with enthusiasm by employees. Many aspects of ESG risk management directly impact employee welfare, such as health and safety, working hours, and diversity and inclusion, all of which can improve the employee experience and lead to greater output. These are not just ESG issues but ERM issues as well. ERM is also about agility, and business intelligence tools such as robust data and analytics are crucial to achieving this.
ESG risk management is just regular risk management; integrating ESG factors into corporate decision making is therefore just good risk management. Moreover, any company that neglects ESG issues is definitely at increased risk of experiencing an ESG-related incident or controversy. “ESG risk is regular business risk and ESG risk management should be part of a company’s standard risk reduction practices,” Ramesh advised. “Most companies are managing some of these risks even in the absence of a formally defined ESG programme.”
The difference today is the urgency of the calls to address these issues, and the approaches which are more structured and regulated, with more disclosures required. Companies are under more pressure to set clear targets, reduce risk, measure their progress, and report in a transparent manner. But the benefit of action outweighs the cost of inaction. Many companies have already found that implementing an ESG programme is also an opportunity to be a good corporate citizen while making money, and creating long term value.
Organisations aiming to synergise between the overlaps of ESG sustainability and ERM sustainability may use ERM structures and processes to do so as ERM has more mature practices and strong industry consensus on best practices. “ERM has been around longer than ESG practices, underpinned by established framework and standards including ISO 31000 and supported by a mature ecosystem of ERM professionals and advisors,” Ramesh said. “ESG programmes can be easily layered into ERM processes, providing an immediate roadmap to operationalise ESG throughout an organisation.”
Companies should leverage on all organisational support that ERM currently has. “You don’t have to reinvent the wheel,” he pointed out. “You just leverage on all the ERM organisational support because the practices are very similar to a large extent.” This improves efficiency, increases savings and has numerous demonstrated benefits. Aligning and integrating ESG with ERM programmes helps reduce duplication. By pooling resources and avoiding duplication processes, ESG managers will make their ESG programmes more sustainable within their organisations.
ERM and ESG are both functional areas that can sometimes struggle to secure adequate funding, especially when organisations are looking for ways to trim expenses. “These two areas are competing with each other,” Ramesh said. “Don’t compete; combine them. By combining ERM and ESG processes, managers will increase the likelihood of receiving and protecting the funds they need. Do not compete; collaborate.” Many organisations assume ESG is a cost without financial benefit but this is not true.
“Analysis of over 2,200 studies on financial performance found a strong positive correlation between ESG investments and financial returns – not guaranteed, but there was a correlation,” Ramesh said. “Specifically, increased ESG investments were associated with superior returns in over 90% of the studies reviewed, over a specific time frame. ERM faces a similar dynamic. Organisations that excel at ERM tend to outperform their peers in traditional financial metrics…organisations rated more mature from an ERM perspective enjoyed up to 25% higher market valuations.”
ERM provides tools and approaches to better understand the outcomes and impacts of strategic decisions and managing risks. These tools can help managers to better identify and demonstrate benefits from the ESG programmes. An ESG programme can start by considering an organisation’s business activities, and areas where it has or can have particular impacts on ESG values and priorities. Metrics are then identified and monitored to track progress towards impact goals and support ESG reporting to interested parties.
The challenge, however, with taking an entirely objective based approach to ESG is that programmes can sometimes take on an aspirational quality. “One way to combat this is to reframe ESG objectives as part of the risk register or ERM exercise,” Ramesh explained. “An organisation starts with the assumption that the ESG objectives must be met. Then ERM tools are used to identify and document the consequences of missing the ESG objectives along with ways to proactively ensure the objectives are met. ESG can invigorate and accelerate ERM programmes…ESG can help improve ERM as well.”
The two practices reinforce each other in a cycle that creates more value for the organisation overall than either practice has on its own. Urging risk professionals to stop distinguishing between ESG and ERM sustainability, he said they could be synergised and managed together. Using ESG to move organisational culture from a compliance focus to an objective-centric approach was good strategy, as ESG and ERM sustainability overlap significantly, and ESG issues are naturally objective-centric. If an organisation does not have a formalised ERM programme at all, ESG can be the catalyst for one.
“ESG benefits from the structure, processes and tools of ERM, and ERM benefits from a high priority use case that helps demonstrate its value to staff, leadership and the board of directors,” Ramesh said. “Sustainability is the new frontier for business, driven by two dynamic frameworks: ESG and ERM.” Incorporating ESG insights into risk management strategy, allows ERM to guard against potential pitfalls while uncovering opportunities for innovation and growth critical to creating long term value.
Emphasising that ESG risk management was part of ERM, he said that ERM sustainability looks at the bigger picture whereas ESG sustainability looks at the sustainability picture but within three specific criteria: environmental impact, social responsibility and governance. To manage ESG sustainability therefore, ERM sustainability needs to be managed as well.
