In our second Risk Officer Sustainability Forum (ROSF) roundtable, we had a lively discussion and debate on the risks and challenges posed by emerging sustainability regulation and how to manage these.
We recognised the complexity of complying with the volume of regulation, not all of which is currently aligned, and which comes from both international and domestic sources. For companies operating internationally, there are differences in the requirements at a national level which must be reconciled at group level. Anecdotally, even within a single country and for a single topic such as investments, it is difficult to keep the list of regulations to a single page.
Trying to maintain a gap analysis of current practice against emerging regulation was described as “an overwhelmingly difficult task” in many organisations.
On top of the emerging regulation, we debated that voluntary affiliations and accreditations - such as becoming a signatory to a UN aligned ‘Principles’ framework or a Net Zero alliance - added an additional layer of complexity. The expectation of other stakeholders such as traditional and ESG rating agencies and society itself will also move over time, possibly faster than we can take action to respond.
While the impact of failing to meet new regulations as they come into force are likely to be imposed gradually, reputational damage could be quicker and more impactful, particularly in an age of heightened attention to sustainability, activism and social media. Within the foreseeable future, failure to keep up with changes may lead to commercial loss, as business partners, customers or suppliers impose minimum ESG requirements through their value chain.
In order to mitigate these risks, it is important to articulate the sustainability strategy at board level, so we are clear how to prioritise efforts in the sustainability space align to corporate purpose and the social impact that the board wants its company to create. This is a topic we expect to return to in future, and won’t discuss it further in detail here.
While we expect that much activity in the sustainability space may become a hygiene factor for business, there is likely to be a real commercial opportunity in how the sustainability strategy is embedded into a business and this could create real commercial opportunity for those able to grasp it. While we recognised that compulsory disclosure arising from the Task Force on Climate-related Financial Disclosures (TCFD) could ultimately drive change, this backward-looking approach is unlikely to lead to a coherent, embedded strategy overall.
Risk Officers should keep a watchful eye on how their board is engaging with sustainability and whether the business is developing at a slower or faster speed. If the board is pushing the business faster than it can respond, then the outward communication may not match inward development, leading to allegations of ‘greenwashing’ or similar. If the board is slow to understand the need for change, then investment in projects to move the company forward may be curtailed, and sustainable initiatives not advanced. In general, the more informed a board, the faster an organisation is likely to act to move its agenda along. Risk Officers can facilitate this education by clearly articulating the threat, perhaps supported by deep dives and scenario analysis.
Third party and supply chain risks are not new features of regulation, however the emerging focus on ESG increases our reputational risk exposure overall. We discussed the concept of ‘reputational leverage’ where we expose our reputation to the sustainability actions of others, and asked ourselves whether we are doing enough to understand the risks within third parties. These could be through outsourcing, through supply chain or through our core business, where companies that we choose to invest in, lend to or underwrite carry a reputational risk, such as coal-related projects.
The way we interact with external suppliers may change our risk landscape over time – for example if we flock to companies with the best ESG position we will create a concentration of dependence on a few suppliers in due course. Alternatively, if we choose a patient approach of encouraging our suppliers to improve over time we may be challenged by stakeholders, if they do not achieve their plans.
While regulators are keen that companies use metrics to report on their progress, there are still ambiguities in the way in which third parties should be included in our sustainability metrics, not least because the methodology for allocating emissions and other sustainability scores remain to be standardised. Non-carbon related sustainability issues, such as diversity, are more likely to be a matter for initial and ongoing diligence, and we will therefore rely on the willingness of these parties to publish their own progress with whatever metrics they use, which raise questions of verifiability and consistency.
Its not just third parties where data is a challenge and therefore poses a risk. Data and metrics are used to support decision making, and our current metrics are generally geared towards short-term decision making for profit and capital purposes. There are not yet sufficient robust metrics to fully assess longer-term sustainability decisions, and there is therefore a risk that boards will find it easy to dismiss longer-term decisions based on unfamiliar and incomplete metrics in favour of the familiar.
Verifiable metrics for understanding the benefits of sustainability decisions are in short supply, and so we will need to rely on internal metrics to drive change – which again come with their own risks. As risk professionals we will need to be especially alert to the potentially unintended consequences that may arise from including sustainably metrics within remuneration schemes.
Participants at our roundtable felt that although we had had a very lively debate, we could have easly spent considerably more time discussing the issues that are merely touched upon here. As ROSF evolves, we will delve deeper into a number of these themes.
Alex Duncan is Chief Risk Officer at Just. The second ROSF roundtable was held on 23 September 2021.