Aligning Sustainability and Risk Management

This post first appeared on Risk Management Magazine. Read the original article.

FF Sustainability and ERM

In September 2019, the Business Roundtable, a nonprofit association made up of CEOs from major American companies, issued a statement that the primary focus of business is no longer to drive shareholder value, but to work in the interests of all stakeholders, including employees and communities. This marks the latest development in a broad trend of rethinking the purpose of business and can be seen as the coming of age for the corporate sustainability movement. Sustainability—often called corporate social responsibility or CSR—is a movement that considers how businesses can act in the interests of society and the environment, rather than regarding its impacts as “negative externalities.” While the movement’s early focus was philanthropic, sustainability frameworks today aim to hit the sweet spot between business priorities and societal needs.

One of the most striking trends in sustainability over the past few years has been corporate demand for help aligning sustainability and enterprise risk management (ERM) frameworks. Many have begun to realize that companies that have a well-developed ERM process are far better at managing sustainability issues.

While risk management and sustainability practitioners may have reason to be skeptical of each other, the current approach fosters institutional blindness and narrow thinking. If one were to read a corporation’s annual report and then peruse its sustainability report, it might seem that they were about different companies. Risk disclosures can be biased toward focusing on the issues the company can directly mitigate; sustainability disclosures can come off as marketing exercises that feature happy children and questionable data. The current divide is in no one’s interest, and global changes are forcing both parties and organizational management to rethink their approach.

Assessing Materiality

Until recently, sustainability practitioners tended to dismiss risk-led approaches as regressive. Early corporate social responsibility efforts focused on philanthropy divorced from the core business, which evolved into compliance-driven risk-reduction work focused on the supply chain. Both approaches were eclipsed by concepts of “shared value,” which hold that companies should pursue sustainability initiatives that simultaneously create business value and address societal concerns. Growth and innovation—not risk reduction—are the goals of this approach to sustainability. Inspired by the chance to build a more just, equitable world, corporate sustainability leaders want to alert senior leaders to sustainability’s transformational opportunities, not focus exclusively on narrow risk-reduction efforts in energy use, recycling, and health and safety.

For their part, some risk management professionals regard sustainability as vague and grandiose. ERM categorizes business risks and then measures their impact and likelihood before and after mitigation efforts. Sustainability’s focus on “material priorities” does not slot easily into these frameworks.

Given the breadth of societal and environmental impacts of business, sustainability frameworks aim to help companies prioritize and identify where to focus their efforts. This prioritization process is known as a “materiality assessment” and works by considering business drivers and stakeholder priorities, then focusing on where the two are most aligned. In the health care sector, for example, material priorities might include access to health and affordability of medicines, while in the oil and gas sector, climate change will be a key material issue.

Materiality assessments consider the overall relevance of issues to a business and to society according to a variety of qualitative and quantitative approaches. While they do seek to determine an issue’s impact on the business—distinct from the issue’s impact on stakeholders—they do not translate these issues into plausible events or evaluate their likelihood. These limitations can make it difficult to differentiate between strategic sustainability opportunities and fundamental compliance issues. Indeed, assigning internal ownership of such issues as climate change or economic inequality may lie somewhere between challenging and impossible. The effects of these risks are broad and unpredictable, with mitigation responsibilities crossing several departments. No company can address these risks solely through its own actions so many consider it far easier to leave them off the list.

A Path Forward

In the World Economic Forum’s 2019 list of global risks, the primary items cited are not economic or geopolitical. Mounting investor interest in climate change is driving broader consideration of the financial consequences attending systemic environmental and social risks, which have eclipsed governance issues as a focus for activist investors over the past several years. Similarly, the new chief executive officer of the Sustainability Accounting Standards Board recently declared that “sustainability isn’t new; it is the new face of risk.”

The World Business Council for Sustainable Development and the Committee of Sponsoring Organizations of the Treadway Commission (COSO) have published a wealth of innovative thinking on how best to practically align sustainability and risk concepts. These approaches can help integrate sustainability into core business decisions, driving a more robust, differentiated understanding of risk. This should help focus the proper consideration of a company’s impact on its environment and on the potential consequences for the company’s reputation—itself an ever-tighter feedback loop.

If priority sustainability issues can be evaluated using risk management tools, then goals, actions and programs will become much more rigorous and robust. For example, BSR, a global nonprofit focused on social responsibility for businesses, has helped companies conduct gap analysis between the materiality “long list” and the risk taxonomy to ensure that there is a clear understanding of where there is overlap. It has also evaluated priority risk material issues using ERM criteria, notably analysis of likelihood and reputational risk. Using these tools has sparked notably productive discussions between companies’ risk and sustainability functions that have driven clearer approaches to strategic priorities and gained traction with senior leadership. BSR has also tried to bridge the gap in organizations by bringing risk, sustainability and other functional teams together in scenario-planning workshops to drive creative thinking about the longer-term future.

These approaches do not mean reverting to a narrow concept of sustainability as risk reduction. Rather, it means that sustainability practitioners must become much clearer as to what constitutes a true business risk, as opposed to a reputational concern or strategic sustainability opportunity. Clarity will help ensure more robust implementation plans, goals and issue accountability. As one BSR member put it: “Sustainability needs to be part of the ERM process, and we need to clearly distinguish between what is a business risk and what is not. We need to act decisively on material sustainability risks, but people will get tired if we claim all sustainability issues are also business risks.”

Risk teams will also maintain a core focus on short-term, quantifiable risks. However, better alignment can provide language and concepts to evaluate emerging concerns and better anticipate large societal shifts that have too often been dismissed as unpredictable “black swans.”

As businesses prepare for the new decade, they must plan for the consequences of climate change, the onset of disruptive technologies and new business models, and demands for transparency from stakeholders including both investors and employees. A new collaborative approach between sustainability functions and ERM can drive stronger, more sustainable strategies to make business more resilient for the changes to come.

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