Identify, Assess, and Adapt: How Directors Can Proactively Oversee ESG Risks

A slew of headlines from the past year identify a critical business reality: Environmental, social, and governance (ESG) risks have financial consequences.

PG&E Corp.’s bankruptcy earlier this year, for example, was dubbed “the first climate-change bankruptcy” by The Wall Street Journal. In 2018, for the first time ever, more CEOs in the United States were fired because of “ethical lapses”  than over financial concerns. And in 2017 alone, up to $941 billion of revenue from global public companies still depended on commodities linked to deforestation.

What does all this mean? First, ESG issues are increasingly having a material impact on the corporate balance sheet. Second, there is no longer any place to hide: In the current era of increased shareholder and stakeholder attention to these issues, companies and their boards will face the consequences of unaddressed ESG risks, some of which can materialize quite suddenly.

Given this new reality, boards have a choice. They can react to ESG crises as they arise, or they can work proactively with management to keep companies resilient in the face of these risks.

Ceres’ newest report, “Running the Risk: How Corporate Boards Can Oversee Environmental, Social and Governance Issues,” provides boards with a roadmap to transition from a reactive to a proactive approach to ESG risks. Built from interviews with over two dozen corporate directors, “Running the Risk” provides boards with actionable recommendations, leading practices, and questions to ask management.

As the report highlights, directors need to focus on three core areas when integrating ESG issues into their risk oversight role:

• Risk identification: ESG issues pose traditional business risks, potentially impacting a company’s operations, supply chain, workforce, and reputation. Boards need to ensure that these issues are factored into enterprise risk management processes, including sourcing information about relevant risks from shareholders, stakeholders, and external experts. As an example, AstraZeneca combined its safety, health and environment, compliance, and sustainability departments into one Global Sustainability team to better surface how ESG risks impact multiple areas of the business.

• Risk assessment: Identified ESG impacts are often incorrectly deemed immaterial or are thought of as only occurring over the long term. Boards need to engage management on how ESG risks are assessed, which could include using a materiality lens to consider whether and when the issues surfaced could significantly impact the company’s performance. Additionally, scenario analyses can be used to understand the impacts of various ESG risks on the company and the organization’s ability to address them. A positive example is Nestle’s 2018 materiality assessment, which included ESG risks alongside other financial risks.

• Action to mitigate or adapt to risks: Once ESG issues are appropriately identified and assessed, the board plays an important role in working with management to keep the company resilient. Options include using internal prices on ESG factors to drive business decision-making about capital allocations, diversifying risks through mergers and acquisitions, using insurance to offset risks, and having proactive policy engagement to address risks in a more systemic way. For example, PepsiCo reports that it considers environmental sustainability criteria for assessing capital expenditure requests over $5 million.

Risks are risks, whether they arise from climate change or currency fluctuations. Boards that take proactive steps to identify, assess, and adapt will create resilient, long-term value for their shareholders and stakeholders, and they won’t run the risk of being caught well behind the starting line in a crisis.