Extreme weather events, data fraud and other risks related to environmental, social and governance issues are among the largest threats now facing business. But savvy organizations are implementing plans that not only mitigate these risks but also improve resilience and profitability.
Friday, July 26, 2019
By Robert B. Hirth and Rodney Irwin
In today's world, it's becoming impossible to ignore the rapid shifts taking place in relation to the environment, society and corporate governance. Business models are evolving, as are the wide array of factors that can help or hinder a company's performance and success.
For instance, 10 years ago, the top global risks in terms of impact and likelihood included only one risk related to environmental, social and governance (ESG) factors. But today, ESG-related risks account for nearly all of the world's top risks in terms of impact and likelihood, according to the World Economic Forum's Global Risks Report. Some of these risks include extreme weather events, water crises, cyber-attacks and data fraud or theft.
Before the 1990s, 80 percent of a company's market value was found in tangible assets such as plants, property and equipment. Now, up to 80 percent is represented by intangibles - brand, ideas, relationships, skills and resources. All of this includes a company's ability to adapt to and respond to new and emerging risks related to ESG.
Given these rapid and significant changes, the market is also shifting to reward the companies who understand how to measure, manage and mitigate these risks, and is even more receptive to businesses that are finding new, unprecedented opportunities in an evolving competitive landscape.
Many of these opportunities are aligned with emerging global frameworks like the UN Global Goals (a $12 trillion opportunity) and the Paris Agreement, which are poised to bring new technology and innovation in the transition to a low-carbon economy.
Perhaps the word “sustainability” is itself becoming increasingly counterproductive - especially when it evokes images of charitable or philanthropic businesses. Though these images may be pleasing, they're not helping ESG risks and opportunities gain traction as mainstream and material business priorities.
How can we change that?
New ESG-Related Risks and Opportunities
As we move to 2020, paying attention to new ESG-related risks and opportunities while creating longer-term value isn't the stuff of trendy, millennial-focused brands. Rather, it's a key building block of running a fully future-proofed company that's focused on resilience and long-term profitability.
For instance, banks such as ING and BNP Paribas and corporate giants like Olam, Danone and Phillips are implementing sustainable finance projects that demonstrate how better performance on ESG metrics can yield decreased loan prices and interest rates. This is a trend that's only just beginning.
What's more, companies that focus their efforts on strategically aligned sustainability risks and opportunities - to the exclusion of others - enjoy significantly enhanced performance on a variety of key financial metrics, including return on sales, sales growth, return on assets and return on equity. They also benefit from improved risk-adjusted shareholder returns.
In other words, focusing on ESG isn't about pursuing sustainability for its own sake. Instead, it's about paying attention to emerging risks and opportunities that could potentially impact business models and objectives.
Role of Global Framework Setters
It's not just forward-thinking business leaders who are paying attention to new ways of doing good business: The Committee of Sponsoring Organizations of the Treadway Commission (COSO) - the go-to framework for enterprise risk and opportunity management - is taking ESG issues seriously, too.
To ensure companies are able to operate, survive and thrive in the rapidly changing global risk landscape, the COSO board and its members have partnered with organizations like the World Business Council for Sustainable Development (WBCSD) and the Sustainability Accounting Standards Board (SASB). Firms need to not only measure, manage and mitigate their ESG-related risk exposures but also disclose relevant, reliable ESG data to key stakeholders (especially financial actors), and COSO and its WBCSD and SASB partners help them meet these objectives.
It's in the best interest of companies and their investors to more fully understand the relationships between their business models, the economy, the environment and society - because understanding these relationships should ultimately lead to better corporate decision-making with favorable outcomes for all stakeholders.
Evolution of Sustainability
Historically, “sustainable” companies have been categorized as those who go beyond legal minimum compliance to reduce their environmental footprint, take care of their employees and implement philanthropic projects alongside their day-to-day operations.
These companies are labeled the “good guys” because - even though their sustainability efforts may be perceived as costing more and don't necessarily relate to their daily business activities - they are committed to “doing the right thing.”
While this categorization offers a pleasant picture of what it means to be “sustainable,” it's a stereotype that may be getting in the way of ensuring that the strongest, most long-lasting, value-creating and consistently lucrative business practices permeate into the mainstream.
A truly sustainable business doesn't spend superfluous amounts of time or money on activities unrelated to its core business objectives. Rather, a sustainable business is informed, smart and dynamic.
Its senior management understands the company's impacts and dependencies on nature and society, and uses this information to make appropriate investment and resource allocation decisions that result in resilience and long-term profitability - thus preserving and creating value.
A sustainable company makes its decisions only after considering all available, material and pertinent information. Stated simply, a sustainable business is just another term for a well-run business.
The next frontier of sustainability isn't about “doing the right thing” - it's about properly managing risks and opportunities for a stronger, more resilient and more profitable business over the long term.
What company wouldn't opt in for that?
Robert B. Hirth is Senior Managing Director at Protiviti, Chairman Emeritus of COSO, and Co-Vice Chair of SASB. Rodney Irwin is Managing Director of WBCSD's Redefining Value and Education programs.