ESG risks: definition and risk management strategies
Failing to live up to the expectations of investors, customers and wider society is something that businesses today must work to avoid. Certainly, in the contemporary business landscape, ESG (Environmental, Social, and Governance) risks and performance are increasingly becoming a focal point for companies. Understanding and managing these risks is crucial for sustainable business continuity and long-term success.
What are ESG Risks: definition and examples
Since the term ESG was first used in a 2005 UN report, its three principles have become important to an organization’s long-term success. What is the meaning of ESG risk? ESG itself refers to a set of metrics used to assess an organization’s environmental and social impact and how it is governed. While not the only tool available, there is something to be said for adopting management systems to manage risks and improve performance in order to deliver on ESG demands and commitments. When coupled with certification to standards like ISO 9001 (quality), ISO 14001 (environment) or ISO 45001 (occupational health and safety), companies can also demonstrate and communicate their performance in the various ESG dimensions.
ESG risks have potential negative impacts on an organization’s financial performance, business continuity and reputation that may arise from its environmental, social, or governance practices. These risks can vary widely depending on the industry and specific business activities. Analysis of the resultant data could inform decision-making for companies, stakeholders and investors alike. Following are some ESG risk examples.
Environmental Risks
Environmental risks refers to the potential for environmental damage that can affect a company's operations and financial performance. Examples include climate change impacts, resource depletion, waste, pollution, and deforestation.
On the financial front, banks and financial houses have their own ESG performance to consider and consequently they do not want to be seen investing in businesses that are having a harmful impact on the environment. This could prevent the business from expanding as it wishes and may see conditions aimed at reducing environmental impact imposed on loan offers. Increasing regulations may see businesses forced to carry out costly remedial actions to mitigate their environmental impact.
Aside from financial restrictions, a business may see its products or services boycotted by customers or subjected to limited market access. Many organizations that have underperformed in environmental protection, but which have attempted to promote themselves as responsible have been accused of ‘greenwashing’. There is a reputational risk attached to this but there could also be fines or sanctions for using false and misleading advertising.
Social Risks
Social risks are related to the rights and well-being of workers, communities, and consumers. They include issues like labor rights violations, health and safety hazards, and impacts on local communities.
Most developed countries now have legislation around equality by gender, race or religion and failure to meet these regulations is a social risk that could result in fines and penalties for contravention. For businesses involved in food, health and similar sectors, poor performance can mean a risk to both finances through fines and compensation awards and to reputation as well. An area that is taking on more significance in recent times is that of Diversity, Equity and Inclusion (DEI) in the workplace. This is something that many businesses have tended to ignore, relying instead on equality laws and regulations. Many studies point to positive benefits from having a DEI policy and there is also an ISO management system standard (ISO 30415) that organizations can apply to guide a structured approach to integrating DEI principles into how they operate and do business.
Governance Risks
Governance risks pertain to the internal systems, controls, and procedures that govern corporate conduct and decision-making. Examples include quality, anti-bribery and corruption, information security, privacy management, and board diversity and structure.
Quality management systems based on ISO 9001 were one of the earliest in the ISO family but several more have been added to deal with particular aspects, for example, ISO 37001 and ISO 22301 covering anti-bribery management and business continuity respectively.
ESG Risk Mitigation Strategies
To mitigate ESG risks, companies can adopt various strategies such as conducting thorough ESG risk assessments and integrating ESG considerations into decision making processes and company procedures. Engaging with stakeholders to better understand their concerns and expectations is also important.
For companies that have adopted certification of management systems, implementing policies and practices and monitoring and reporting is done as part of the planning and auditing processes for individual management system standards or as part of an integrated management systems approach.
Why is ESG Important for Risk Management?
Because companies are increasingly obliged to set out their ESG policies and positions it is important to consider how those commitments are being measured and judged. Most companies will issue an annual ESG report that customers and other important stakeholders may study to ensure they are supporting an organization with values attuned to their own and which investors will use to support their investment opportunities.
Those companies that go down the management system certification route will have the opportunity to consider ESG ambitions from the initial planning phase of the PDCA cycle . The check phase will provide the opportunity to determine how successful policies and processes have been in meeting their commitments and then allow them to act accordingly. This approach also helps address potential risks proactively and build resilience against ESG related shocks, as well as comply with regulatory requirements.
Equally important, incorporating ESG into risk management is not just about avoiding negative outcomes; it's also about seizing opportunities to create value and drive innovation. Companies that effectively manage their ESG risks are well positioned to thrive in a rapidly evolving global business environment.
