Should ESG be included in the Risk Agenda?
Panellists Satpal Singh and Mohd Abdul Hakim Mohamed Razip were the speakers for the first CRO networking group event for the year, a discussion which was moderated by Ramesh Pillai. In his introduction, Ramesh said that Bank Negara was already talking about climate change, and had requested a gap analysis on their relevant policy climate change document for companies regulated by them by the end of May2023; organisational capability for climate risk management will be needed to be “ready” by December 2024. However, for many, there was still confusion about whether ESG was mandatory or a ‘nice-to-have’ component on the risk agenda; companies were asking if it was necessary to do ESG if they were already managing climate risk. There appeared to be some lack of understanding on the relationship between ESG and climate change.
There was also a lack of clarity when it came to specifically implementing ESG. Ramesh advocated applying the World Economic Forum (WEF) concept of stakeholder activism as it was easy to grasp. “When implementing ESG, you are not implementing it because you want to hug a tree,” he said. “You’re implementing it because you want to create value for your company. ESG management is not just looking at the down side, but looking for the opportunities to be had.” With that in mind, and considering other factors including the regulatory and market environments, risk professionals need to urgently address the question of whether ESG should be included in the risk agenda, or not; and, if so, how.
Satpal, the Chief Governance & Risk Officer of PLUS Malaysia, said that he looks after risk management and resilience, compliance and integrity, and the programme management office – all of which are closely tied to risk management. PLUS, which runs the North-South Highway, is one of 30 highway concessionaires in Malaysia. Referring to the WEF’s Emerging Risks Report, he noted that the key risks over the next two years included extreme weather, livelihood crisis, infectious diseases and cybersecurity failure. Over the next five years, however, the risks veered towards climate action failure, extreme weather, human environmental damage, biodiversity loss and livelihood crisis.
“A lot of these risks are environmental, social and governance risks,” Satpal pointed out, emphasising the need to look at long-term value for shareholders and the organisation as a whole. The loss of resources will mean the whole planet is likely to be affected, thus impacting the main ‘place of business.’ With the depletion of natural resources, the production of goods and services will be curtailed. Stakeholder perspectives also needed to be considered. “When investing with other investors internationally in big projects, they expect you to have a certain programme in place that reflects environmental, social and corporate responsibility, and good governance,” he said.
While Malaysia still lagged behind internationally in ESG, it was fairly progressive regionally, he added, stating that moving in the ESG direction was timely, and that ESG risks should be incorporated in risk reports. Second speaker, Berjaya Sompo’s CRO, Mohd Abdul Hakim Mohamed Razip, gave an overview of the programmes developed by different institutions in the financial sector. “Climate change is covered under the environmental factor for Berjaya Sompo’s framework,” he said. “Climate change risk is divided into three areas: physical, transition and liability risks.” However, the ‘E’ and ‘S’ tend to be emphasised more; Berjaya Sompo did not wait for Bank Negara’s directive, he added.
Because the organisation wants to go beyond climate change and focus on ESG, it has established a project to set up a sustainability framework based on the UN’s sustainability agenda. He noted that a buzzword increasingly associated with climate change was ‘greenwashing’ – a term with negative connotations, and something that his company intended to avoid, by focusing on the proper implementation of its programmes. Ramesh remarked that climate change was only one of ten ESG pillars but it was currently emphasised and considered urgent because from the business perspective, it posed the greatest operational risk.
“If we don’t stop the slide, the earth will not be available for us to do business on,” Ramesh said, adding that risk professionals were not alone when it came to the lack of clarity on the issue, as even some directors were unclear about it as there was little guidance. He explained that Bank Negara, as a result of their international Supervisory associations, was committed to implementing climate change risk management as part of their regulatory initiatives, and was therefore pushing it through as a priority. There was a need to look at financial and social materiality, i.e., assess the impact we have on society, and society’s impact on us.
“Sustainability is a concept understood in ERM,” he continued. “It generally applies to commercial sustainability, but ESG sustainability is a different animal and, frankly, its scope is scary and can overwhelm risk professionals.” Sustainability and ERM were inextricably linked, he added. The discussion that followed saw the participants generally giving overviews of how ESG was being approached or managed in their respective companies, and the main challenges they faced in putting the appropriate plans and policies in place. Many firms are beginning to realise that ESG-related practices are already in existence; what is needed is appropriate integration with other systems.
Besides integration, the need to identify and manage ESG benefits to the business, was also a major challenge. While Bank Negara’s expectations could be managed, the scarcity of suitable talents tended to complicate this. One participant noted the lack of suitable applicants for the Sustainability Officer’s position in his organisation. Another mentioned that her company had discussed whether ESG could sustainably be integrated into products which could then be offered to customers, but there was uncertainty over whether the market was ready for this, and if it would be supported by the local culture and current attitudes.
Participants also brought up the growing sophistication of investors, which had become instrumental in driving their organisations’ move to incorporate ESG-friendly practices, and their efforts at involving the various lines of defence, as well as uncertainties as to which line could best do the job. While ESG was already a serious consideration within some organisations, many others were not as experienced. Even at board level, awareness of ESG and climate risk was very low, participants said, adding that they were constantly asked if there was a need to implement ESG risk management, if returns could justify investments, and if there would be a negative impact on the company’s bottom line.
Risk professionals were finding it difficult to push the ESG agenda primarily because of the lack of clarity of what they should do, and because of unclear regulations. There was, however, a growing buzz about it, although this was currently unsupported by appropriate action. Stating that climate change was not new to banks, especially, a participant remarked that banks already had policies which supported this as anything affecting the banking business usually had a knock-on effect on other businesses which depended on the financing and credit that banks provide. He said that in his organisation, ESG was parked under the risk function as it had the most relevant skill sets.
His organisation had developed a scorecard that enabled companies to be rated for ESG when they applied for funding or credit. A great deal of data has been collected but the bank has not yet determined how this will be used. From the perspective of the airport business, the threat of climate change is very real because it directly affects operations, a participant from the industry said. However, this still needs to be balanced with economic sustainability because the business is still vulnerable in the wake of the pandemic. Although they will proceed with caution, he said his company was not putting ESG and climate change under the risk function for the moment, but will not shy away from responsibility either.
Some companies are already looking to the UN SDGs and targets for guidance where ESG is concerned, said a participant from the insurance industry. Her organisation, she said, had already committed to reducing exposure in carbon assets and was working with others to achieve this. While using the SDGs and targets as a guide reduced pressure to some extent, the company still had a fiduciary duty to ensure that its funds were performing well, despite statistics which show that global ESG products generally underperformed. Nevertheless, the company had also launched an ESG fund and was currently doing a gap assessment.
She said that Bank Negara has higher expectations of organisations with international links, as they may have greater access to knowledge and other resources. Besides this, the tone from the top was very strong; board awareness of ESG was high. Benchmarking was already being done, with Scope 1 and Scope 2 being measured at group level, with the board pushing for Scope 3 to be done as well. Employee awareness was also a focus; the organisation ensured employees understood ESG and how they could contribute to it. Additionally, by setting up a takaful foundation in 2014 to provide insurance cover for the B40 sector, the organisation has also covered the social aspect to some extent.
“The topic is, should ESG be included in the Risk agenda,” said Ramesh, bringing the discussion back on track. “ESG is all about disclosure. It is not just about actions. The systems part is the one thing that is often underestimated. You cannot utilise normal risk management system for ESG disclosure purposes. Another different, dedicated system is needed.” Emphasising that ESG does need to be part of the risk agenda, he pointed out the necessity of determining who will be responsible for doing this, and for its coordination. “Responsibility needs to be a first-line responsibility,” he said. “Whoever coordinates it cannot give independent views on it. It cannot be done by the risk function, technically speaking.”
The tone at the top was also important, he stressed, but so was the “echo from the bottom, and the reflection in the middle – because the people at the top can say what they like; nobody will take notice of them!” It is unfortunate but true that not many people understand what ESG is. “ESG is not imperialism,” Ramesh explained, linking it back again to the UN SDGs. “The SDGs say that all the aims of the SDGs are international but the control is national, and the national agenda depends on the local conditions or environment. ESG is twofold: how we impact society and how society impacts us. ESG is not just about risk, it is about opportunities.Companies can market themselves as ESG-compliant.”
Remarking that people may not understand ESG fully but they all want it, he said that if customers wanted it, they had to be considered seriously. Addressing the possibility of higher costs with ESG, he said that investor dollars would be looking at it, and if companies did not follow what stakeholders wanted, the company ran the risk of substantially losing out, eventually. Flagging some of the grey areas that dog the issue, he said that some companies cannot hit stipulated targets regardless of their efforts, and situations are not always cut and dry. ESG risk management is simply good risk management and has the potential to create long-term value.
Organisations must thus identify the factors that will prevent them from doing this; they need localised data to determine probabilities but this may not always be available. This could also lead to another conundrum: the risk is that companies may start to turn away profitable business because of the misguided belief that all probabilities can always be statistically calculated. He cautioned care from the risk perspective, urging participants to “Balance what can be done from different perspectives, with what is acceptable within local culture, and the profit which can be derived from doing business.” Participants also observed that ‘green’ bonds can be used to price certain instruments.
Also discussed was the increase in evidence of cases of greenwashing. Ramesh remarked that companies may slide into this practice because of market pressures. “These organisations may have been trying to bring everyone on board to improve the market,” he said. “Unfortunately, this has not happened.” This greenwashing has led to possible mass downgrades which could affect yield curves. Local companies and markets were being assessed by western standards and values, which may be skewed by other perspectives of ESG. Locally, however, companies have to follow government policies which may not always be similarly aligned.
Currently, there were no unified cohesive initiatives for companies to follow ESG practices. Incentives need not necessarily be financial; there were other types which could be as effective. “ESG is an international agenda which everyone has agreed to but we don’t know if the targets are the right targets so we will have to go along with it as it is a government target,” he said. “We have no choice unless the government changes its target.” He suggested that companies have their own 12-month, three-year and five-year plans so that they can keep track of how they are addressing their particular ESG risks. An aim to bear in mind was the ultimate 2050 target.
Most Malaysian companies were not sure how to do Scope 3, he remarked, adding that the most advanced companies were usually the ones with overseas parent companies, like MNCs, whose expertise they could access. “If you’re looking at it, and wondering how to do it, you’re probably the norm,” he concluded. “You don’t have to hire the top person to head sustainability. It can be someone at lower levels who understands how things work, to drive processes. Others at higher levels can learn as they go along. Part of ESG is learning. It’s about commitment, and this gets bigger as it goes along…it’s how it’s nurtured.”