Perhaps we became overconfident after the success of the first two of the Risk Officers Sustainability Forum (ROSF) roundtables?
Having talked about models for the risk officer’s involvement in sustainability, and how to deal with the tidewater of emerging regulation, we assumed that putting the risks of sustainability into practice would be an interesting but straightforward proposition. How wrong we were!
Our ambition was to look at this through the lens of underwriting, lending and investment in a single meeting. It quickly became apparent that one overarching consideration was common to all our efforts and perhaps poses the biggest challenge as risk officers. You’ll have to read on to find out what that is, and I hope that the following observations help set the scene.
We were attracted to the idea that the purpose of our sustainability efforts is to build a better world, not a perfect world, and that risk officers we may need to be the arbiters of what is “good enough for now”. We need to balance the seemingly conflicting priorities of fiduciary duty to our investors, conduct towards our customers and expectations of other stakeholders in a way that both moves the sustainability agenda forward and protects our companies from other risks over the short and longer term.
We questioned whether our companies should be encouraging the sustainable transition or enforcing it, and if we try to enforce the transition by withdrawing from certain clients, where will they turn? Is there a greater chance of influencing good behaviour through shareholder voting than through divestment, or will the risk of remaining invested but being associated with a “bad” client outweigh the opportunity of future transition? If we withdraw from mining, do we slow down the transition by impeding the extraction of precious metals needed for battery technology to support a switch to green transport? These are decisions where a clear articulation of the risks and benefits of each approach requires careful consideration.
We recognised that the opportunities and hence the risks that different sectors face are also very different. A general insurer will be able to transition its investment far faster than a life insurer, lenders may have criteria imposed on them by their funders, while an asset manager may have limits imposed on them by their clients’ preferences, which might or might not be explicit and may be oriented to sustainability to a greater or lesser extent than the firm. How do we accommodate those disparate interests?
A general insurer has a different challenge in its underwriting portfolio, where it will need to build people and planet, and not just profit, into its responsible underwriting framework. Both that sector and the banking sector have more opportunities to support the broader climate transition sooner than life insurers or pension funds may have, given that they can be underwriting and financing opportunities earlier in their lifecycle than others in our sectors might.
Differentiated pricing is seen as a tool across all sectors, with more favourable terms available to those clients with better sustainability credentials, or incentives given for articulating and/or achieving plans with a sustainable connection. Examples of these can be seen in the ‘green bond’ market and in the bank lending market, with our companies having the opportunity to benefit from these new products both as issuers and investors. The challenge with pricing differentials could be that the overall risk profile may not have shifted downwards and there could be bottom line impacts.
The familiar risk tools such as risk modelling and key risk metrics both suffer from relatively immature data to reliably inform them fully at this stage, although we recognise that things are improving. However, there is still a risk that too much pressure is put on us to publish or make decisions on numbers and models underpinned by inadequate data or assumptions, and again the risk officer may well be required to provide a clear articulation of the pros and cons here. Scenario analysis, particularly but not solely for climate risk, will help uncover the drivers of the transition and help to inform our colleagues and influence the culture towards sustainability risk. We’d like to find a way to bring sustainability into risk appetite and acknowledge that this is generally a work in progress with no-one suggesting they’ve found the perfect approach.
All sectors recognise the need for greater capabilities and understanding in sustainability and there is a commensurate risk in not being able to buy or build these skills. Forming a view of the current and future sustainability of each company or client in our portfolio to support our decision making is a challenge that we will have to take gradually over a protracted timescale. This implies risks in our decision-making processes now. While a lot of the current focus of decision making has been on the ‘E’, other areas may come to the fore in the short or medium term, leading to future skill stretches.
In addition to the risk of making the wrong call, we recognised the emerging and perhaps greater risk of having our reputations damaged as a result of being associated with – or not being associated with – a certain position. Clarity on the positions that we are taking allows our informed stakeholders to make informed judgements. It also exposes us to attack by those that have different views or agendas, whatever side of the sustainability agenda they come from. We’re used to seeing groups agitating for faster change in the environmental and social agenda, but I was struck by the high-profile criticism recently levied at Unilever for giving too much consideration to sustainability. We can see the benefit of joining coalitions of like-minded companies to provide weight to our respective interests.
The one overarching consideration that we came back to was how to manage the moral dilemma that seems to be embedded into many of the choices that we must make. That dilemma arises because many of the decisions that we must make have winners and losers. We might appear to forego shareholder return to invest in a lower yielding greener asset. Our refusal to participate in an environmentally unfriendly project may lead to its cancellation and lost job opportunities. Staking out a clear position in excluded investments could attract criticism of going too far… or not far enough. Pursuing greater diversity in the workplace may involve approaching our talent decisions in a way hiring managers are not used to and with an eye on longer term benefits. There are endless examples!
Despite the challenges in managing the transition to more sustainable businesses, there seems to be a consensus amongst us that is better to seek a long-term sustainable return through building sustainable companies that will transcend generational and other social interests rather than focus on short term profit-making at the expense of people or planet. Our boards therefore have the unenviable task of determining how each decision help to build a better, fairer world overall without disadvantaging one or more of our stakeholders disproportionately? As risk officers, we can stake out strong leadership positions within our firms to help our colleagues and our Boards navigate the dilemmas and moral challenges of sustainability agenda.
Alex Duncan is Chief Risk Officer at Just. The third ROSF roundtable, hosted by the Risk Coalition, was held on 20 January 2022.