How to fight the black swan
Critical risk assessment factors in ESG principles
Human-induced climate change is causing dangerous and widespread disruption in nature and affecting the lives of billions of people around the world, despite efforts to reduce the risks. People and ecosystems least able to cope are being hardest hit. That tough environmental assessment comes from the latest Intergovernmental Panel on Climate Change (IPCC) report which has just been released. Then as the world watches the dramatic conflict unfold in Ukraine, there comes with these tragic events, a myriad of heightened social risks that includes population upheaval, poverty, and increased geopolitical danger, probably not as pronounced since the start of the Second World War.
Then locally, South Africa because of ongoing corruption, poor leadership and often a lip-service approach to governance, is teetering on the brink of becoming a failed state according to the latest Institute of Risk Management 2022 Risk Report. It is high time for the risk community to start thinking bigger and more tactically than many are right now. There is a famous Chinese curse which says, “May he live in interesting times.” Truer words have not been said. These are times of great danger and uncertainty and high time that more effort is put into properly assessing and planning ESG-related risks. These are the constant dangers that present themselves in the environmental, social, and governance-related space.
Managing the problem though is a minefield because ESG risks are difficult to quantify as they are inevitably big and amorphous. And just when you think you have assessed the problem and put a plan in place, another black swan paddles into view. The best way to manage ESG risks is for organisations to start living and practicing the principles. These are well articulated in King IV which says quite plainly value creation growth, preservation, performance, and prospects are linked to risk governance.
The link between value creation and risk is often lost in translation and is unlikely to be Included in a risk register because it is implicit in the strategic objective of a business. However, considering that the risks relate to value creation, this should be within the scope of the duties of the Chief Risk Officer. It should also be evident to a company that effective execution of ESG enhances sustainability. That begs the question what the risks are to the ineffective execution of ESG, and what the impact will be if there is failure. Viability is always the first order of strategy.
The risk function can provide research and insights relating to businesses in similar industries which may have been threatened to the extent of survival. Experience, mistakes, and successes need to be studied and evaluated and that understanding then provides feasibility and capability for forward planning. Then risk velocity needs to be factored in. This is the speed at which a risk can suddenly emerge and become dangerous or at least significant to the organisation and those operating in its orbit. The use of child labour and “sweat shops” may have escaped notice a few years ago, but social media and heightened awareness has led to immediate cancellation of product lines and production contracts when these circumstances are discovered. The impact on brand value is substantial.
Risk velocity should be constantly evaluated. And if the risk potentially has a knock-on or even a contagion effect, all stakeholders in that industry can act both collegially and independently. In the same way that COVID has had wide ranging effects on supply chains, climate change can have similar impact and disruption. In most cases insurance is available for damage occurring at direct suppliers, but climate change events can disrupt productive capacity and infrastructure at multiple tiers in the business that support the delivery of resources and equipment.
ESG risk assessment also has a direct impact on brand value. Should circumstances develop that damage the brand, this can have the multiple effect of both removing the brand premium as well as reducing the expectation of future earnings from the business. Companies are now operating in a different and dangerous paradigm where change is an ever-accelerating constant. Understanding and evaluating ESG risk will go a long way to providing some certainty, The cost of a failure of integrity or ethics is the clear difference in the market value of the business.
