ESG Transformation: opportunities and risk management

This paper (part one of a series) discusses the opportunity provided by our transformed environment and the impact for risk management.

Climate risk, ESG and sustainability are at the top of the financial services agenda

The world is facing one of the most complex scenarios of all times; including a pandemic, geopolitical pressures, war, climate issues, the list goes on, but financial services organisations are being expected more than ever to provide answers and take actions to address these problems.

In particular, focusing the attention to sustainability, financial services organisations are working hard to become net neutral within the next few years, addressing broad ESG expectations in terms of the wider impacts to the ‘system’ they operate into (e.g., ‘nature positive’), managing their risk profile in consideration of climate changes and complying with a fast-evolving regulatory framework.

And if this was not enough, some of these objectives may also conflict with resilience priorities and with each other.

Some of the questions financial services organisations may ask themselves include:

  • How can we reduce our carbon footprint while maintaining operational resilience?
  • How can we rethink the supply chain without impacting our social objectives?
  • How can governance evolve to achieve the longer-term transformation required?
  • And most of all, how can we maintain a sustainable and profitable business while becoming net neutral and ESG compliant?

The opportunity to embrace a social purpose and increase profitability

Several economists over the last few years have embraced the idea that capitalism does not necessarily mean a trade-off between achieving social good and profit.

According to a well-known theory called ‘corporate shared value’ (originally formulated by two Harvard Business School professors, Michael Porter and Mark Kramer), business can actually be the solution to social and environmental issues, rather than the problem.

Many empirical analyses and case studies over the years have provided evidence of how long-term profitability can be higher for those firms that make social improvements their major business objective.  Social improvements cover a vast range of topics and can be inspired by the 17 ‘sustainable development goals’ of the United Nations; examples include products and services that would improve quality of living, education, affordable and clean energy, biodiversity.

Merely addressing ESG objectives and being a ‘good citizen’ doesn’t necessarily translate into better business profitability!  Companies need to transform their business purpose, as well as their corporate strategy, products / services and operating model, to evolve the business into new long term market opportunities through the lens of addressing a social need.  Intuitively, this is in fact the key to guarantee a competitive advantage and market success over time.

Many financial services organisations have recently updated their mission statement and vision incorporating social and sustainability objectives.  Many have also translated these into required updates to the principles contained in policies and frameworks, setting targets and check points.  However, many are still in a situation of ‘impasse’ when it comes to funding the initiatives required to implement the transformation, putting in place changes and updating culture, services, decision making and operating models.

A significant transformation is required to achieve sustainability without compromising on profitability.  Expensive programs are required to be executed but without a rationale for change that includes improvements to the bottom line, these initiatives tend to stall.  Embracing a new purpose, strategy and business model provides the opportunity to achieve the above as well as the actual incentive to fund transformative initiatives.

Time for action and risk management

With a clear purpose in mind, many financial services organisations have updated their governance models to include sustainability functions and teams, new committees and new responsibilities. However, clear direction and actions remain an issue.

How can organisations be steered and incentivised towards the required transformative journey?

The lack of common standards, definitions and in general education, outside of and across the organisation, makes the availability of data and metrics inadequate.  And this in turn does not support organisations to ‘walk the talk’.

So, let’s take a step back.  When taking decisions and putting actions in place, the consideration of a trade-off is normally required.  We always assess pros and cons, return and risk.  The ESG challenge is not only about disclosure but especially about assessing risk and return.  However, without data and metrics, this trade-off cannot be assessed, hence decisions are not taken and, consequently, actions are not performed.  This means progress is slow!

If we look at risk management for example, one of the most important outcomes of this practice is to enable better decision making based on informed assessments of the risk / return trade off.  Risk has always been assessed by financial services organisations but quantification techniques have evolved over time, allowing for more informed decisions to be taken.

Stress testing is a good example of a similar evolution.  Despite the requirement for stress testing starting as a regulatory one for forward looking assessment and disclosure, the proactive approach of risk management in using stress testing techniques means that its output can not only address the assessment of the risk of extreme events but also support strategic decisions.

Risk management can help accelerate the progress organisations make in achieving sustainable business.  Risk management can be the driving force to make the transformation, through the application of risk techniques and methodologies to estimate sustainability impacts and risk, therefore supporting (strategic) decision making.

Given the lack of available and consistent data, the assessment of risk may not necessarily be of directional value at the beginning, but with time (given data normally improves with use) we can expect big improvements for early movers when it comes to techniques and precision.

Parting thoughts

Running a sustainable business is not just about being a ‘good citizen’ but also about increasing value and profitability.  However, to achieve this, the transformation required to many businesses is epochal, all-encompassing and revolutionary.

Risk management has the opportunity to be one of the driving forces behind the required transformation; assessing ESG impacts and estimating sustainability risks will enable the journey to a sustainable business and improved profitability.

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About the author

With many years of experience in the international financial services industry, Alessandro has a wealth of experience in risk, regulation and compliance, gained through international roles, both as a consultant as well as a banker, including CRO roles in the UK and CH.

His experience ranges from strategy and governance, AI / ML risk applications, risk transformation, system implementations to compliance and regulatory assurance.


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