ESG transformation: opportunities and risk management

Financial services organisations are working hard to become net zero within the next few years, addressing environmental, social and corporate governance (ESG) expectations, managing their risk profile in consideration of climate change and complying with a fast-evolving regulatory framework.

Organisations may ask themselves:

  • 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 we maintain a sustainable and profitable business while becoming net zero and ESG compliant?

The opportunity to embrace a social purpose and increase profitability

Capitalism does not necessarily mean a trade-off between achieving social good and profit. According to the ?corporate shared value? theory, business can be leveraged to be the solution to social and environmental issues, rather than the problem.  

Many empirical analyses have provided evidence of how long-term profitability can be higher for firms that make social improvements their major business objective. Social improvements cover a vast range of topics and can be inspired by the United Nations? 17 'sustainable development goals?.

However, merely addressing ESG objectives and being a ?good citizen? doesn't necessarily translate into better business profitability. Companies need to transform their business purpose, corporate strategy, products / services and operating model, to evolve the business into new long term market opportunities through addressing the social need. 

Consequently, many financial services organisations have updated their mission statement and vision incorporating social and sustainability objectives, updating policies and frameworks, setting targets and check points. However, many are still in a situation of ?impasse? regarding funding the initiatives required to achieve the transformation, implementing changes and updating their culture, services, decision making and operating models.

Programs are required to be executed but without a rationale for change that includes improvements to the bottom line, they tend to stall. Embracing a new purpose, strategy and business model provides the opportunity to achieve the above as well as the incentive to fund transformative initiatives.

Time for action and risk management 

Many financial services organisations have updated their governance models to include sustainability functions and teams, new committees and 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 education, outside of and across the organisation, makes the availability of data and metrics inadequate.  This does not support organisations to ?walk the talk?.

When taking decisions and implementing actions, 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, actions are not performed and progress is slow.

One of the most important outcomes of risk management is to enable better decision making based on informed assessments of the risk / return trade off.  Quantification techniques have evolved over time, allowing for more informed decisions to be taken.

Stress testing is a good example of a similar evolution. Risk management's use of stress testing techniques enables the assessment of the risk of extreme events and can support strategic decisions.

Risk management can help organisations achieve sustainable business; it can also 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.  

It 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.