[Ed. note: You can read Part 1 of this series here, along with Part 2].
The words “opportunities and risks” are almost overused in ESG, but most talk seems to focus on risk. Let’s drill down into what “risk” really means, how ESG professionals typically misuse the concept and thoughts on/dangers of putting dollar values on risk and risk reduction. Many ESG risk values are mythical, wishful thinking and not particularly credible.
Consider what the World Business Council for Sustainable Development (WBCSD) found in a 2018 study:
- Although companies have sustainability professionals working to address ESG-related risks and issues, they struggle to get these into risk management discussions.
- Little collaboration exists between a company’s risk and sustainability practitioners.
- ESG risks managed and disclosed by internal sustainability staff are considered less significant than conventional risks, leading to a bias against ESG-related risks.
This comes down to two main problems:
Garbage economics are frequently used in generating outsized ESG risk values. Traditional property and casualty loss values are determined using the replacement cost of an actual quantifiable loss or actuarial science based on years (if not decades) of relevant historical data. Sustainability arguments frequently include avoiding a loss that may not be potentially real, and sometimes rely on highly contingent (or flat out questionable) numbers, including placing a value on externalities. These are attempts to quantify value of avoiding a potential intangible loss, i.e., “If we avoid a negative reputational event based on ESG, the ROI on the investment that resulted in that potential avoided loss is X.” Examples often relate to predictions of boycotts, lost revenues, and even carbon taxation. Confusing, isn’t it? And not credible. Some organizations may be okay with undefined values of avoiding contingent risks as a management tool. But in my experience, that is an exception rather than the rule. ESG practitioners should determine how their own organizations regard risk avoidance valuations before going too far.
ESG staff tend to apply different risk tolerance determinations than those developed by the company’s risk management department and on which management, executive and the board relies. Corporate risk management departments work in concert with insurance brokers, underwriters, actuaries, and company executives and board members to vet risk tolerance levels and loss determinations combined with risk management solutions. This applies to property and casualty exposures and establishing deductibles or self-insured retentions. Attempts at ESG risk determinations that are not aligned with the company’s existing risk management framework will fall flat.
Framing ESG primarily as a risk issue is in most cases not the strongest approach, especially if you don’t coordinate with your risk management function to ensure appropriate values and benchmarks for ESG are used. A better path is to demonstrate opportunities, the subject of the next installment of this series. In the meantime, PracticalESG.com member resources on ESG risk management, values and reduction, and communicating the value of ESG are available in the Guidebooks section. If you aren’t a member, sign up now and take advantage of our no-risk “100-Day Promise” – during the first 100 days as an activated member, you may cancel for any reason and receive a full refund.
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