Unlock Growth by Integrating SustainabilityDirector, Global Risk Center for Marsh & McLennan Companies
Last December’s COP21 climate summit was all about unifying around pledges to limit global temperatures; this year’s summit, now underway, is about how to put those goals into action.
Government policies and actions will have a large role to play in driving the shift to a low-carbon economy; however, market forces are also driving new responses for businesses to respond to the risks and opportunities presented by the evolving business environment.
The World Economic Forum’s Global Risks Report 2016 highlights six of the top 10 global risks over the next decade that are related to natural resources and the environment. Other critical risks, such as social instability and unemployment, can be exacerbated by environmental or natural catastrophes. Together, the forces of a changing physical environment present businesses with a wide array of strategic and operational risks, including supply-chain disruptions caused by decreased availability of key resources, the loss of customers or vendors and changing policy and regulatory regimes aimed at reducing the risk of climate change.
Corporate risk profiles are changing under these environmentally-driven pressures and three associated trends: The growth of responsible investing has led investors and credit rating agencies to focus on companies’ exposure to climate change impacts, growing requirements for disclosure on sustainable practices and shifting customer preferences cascading through B2B and B2C supply chains. Across a wide range of industry sectors, sustainability and transparency around the product is no longer a tiebreaker after cost, quality and delivery; they have become table stakes. As the CFO of a food products supplier observed, “If it is important to the customer, then it is important throughout the supply chain.”
Despite the significant implications and measureable financial impacts of sustainability-related risks and opportunities, in many companies, sustainability often has weak links to the corporate financial, risk and strategy agendas. Companies must identify, assess and respond to the strategic and operational risks and opportunities presented by this changing business environment. Those that do not may find themselves losing ground in an increasingly competitive global marketplace.
Research into the risk and sustainability gap by Marsh & McLennan Companies, the Association for Financial Professional and GreenBiz Group identified three key actions for both sustainability leaders and risk and finance leaders to help companies make progress: integrate sustainability into strategic planning and enterprise risk management (ERM) planning processes, embed sustainability into financial modeling and risk assessment processes and create a common set of terminology.
Corporate sustainability efforts often have weak links to the corporate financial, risk and strategy agendas.
Embed Sustainability into Existing Operational and Strategic Planning
To support growth and achieve a competitive advantage, sustainability must be integrated into the strategic and financial planning process.
Sustainability executives should secure leadership support and become allies with those who have a seat at the strategy and executive table. In addition, sustainability leaders should participate in cross-functional bodies that cut across silos, such as a loan committee that includes marketing, finance and product development representatives.
Building relationships with the strategic planning team or internal audit can also help drive ownership of the concept through the organization. At one organization, the internal audit group has helped align sustainability and enterprise risk-management processes and support external reporting. Perhaps more importantly, the group has guided the sustainability team in shaping conversations across the business and executive team.
At many companies, such integration of sustainability and planning is already taking place as a means to manage strategic and operational risk. For example, one company chose to ensure a high level of LEED certification in constructing a new plant in China. This created a “sustainability win” and also provided a competitive advantage, as customers approved of this approach. It also ensured greater operational resiliency by reducing energy costs, reducing wastewater and generating other operational efficiencies that position the company for success in the face of fluctuating water costs or the future introduction of a carbon price. As the CFO said, “We are investing $90 million, and we don’t want to do this twice.”
Leading companies are also factoring externalities into corporate scenario planning or three-year strategic planning processes. A global clothing manufacturer incorporated information on water stress and scarcity into strategic planning and had discussions about emerging market growth plans and factory leasing and siting. Discussions on a ten-year lease for a factory were enriched by questions of whether there would be sufficient water to support operations, and the analysis helped the company identify potential issues in business continuity.
Finance and enterprise risk leaders are also recognizing that sustainability-related initiatives offer opportunities to secure new or expanded conversations with capital markets. For example, one manufacturer’s $60 million expansion of a facility was financed by a new market tax credit program that attracted four different impact investors focused on community development. The organization’s finance team worked closely with the sustainability group to promote the project, including working on a video segment on the green impact of the expansion.
Embed Sustainability Risks into Risk Assessment Processes and Financial Modeling
Many companies have not effectively integrated sustainability risks into ongoing risk assessment processes. One barrier is that the horizons for many sustainability risks (three to five years) far exceed those used in most corporate risk assessments (six to 18 months). That creates challenges in quantifying sustainability risks in meaningful financial terms for the company. Given the different risk horizons, sustainability issues can be considered “immaterial.”
Yet companies are making progress. For example, many now apply an internal carbon price to project evaluations as part of the risk assessment and capital allocation process. One organization categorizes and embeds sustainability risks (such as climate change impacts or transitions in energy supply) into its risk taxonomy and enterprise risk management categories (financial, strategy, or reputation) as an accelerant and driver of other key risks. This approach enables the enterprise risk management and sustainability teams to identify overlaps between many corporate-identified exogenous risks and so-called “sustainability risks.” In this way, a sustainability focus has become an element of risk mitigation and contributes to achieving organizational strategies.
At another company, the sustainability executive became part of the ERM committee. In that role, the individual has been able to integrate sustainability discussions into an ERM process that is strongly focused on the economic and financial risks to the company by working closely with the treasury, finance, and legal leaders of the annual ERM review.
Create a Common Language Relating to Risk and Resilience
The framing and communication of sustainability risks has a huge impact on bridging the gap to the finance and enterprise risk management programs. Corporate sustainability goals and programs need to be communicated in the language of the business and, in terms of the core corporate metrics, consistent with those required from any strategic or operational business plans. Those might include a risk-adjusted return number, a range of the potential cost-saving, or revenue or earnings increase, with a clear identification of the assumptions and a clear understanding of the risks that create uncertainty in outcomes.
Establishing a common core language relating to risk and resilience clarifies the issues that are deeply tied to business operations. For example, a conversation about issues such as “how to increase the resilience of the supply chain” is more likely to gain traction in a company than a discussion about “a sustainable agriculture strategy.”
It is clear that sustainability issues will continue to affect businesses as extreme weather events, resource depletion and other related impacts present financial risks. Shareholders, investors, regulators and customers are demanding greater disclosure on the risks to a corporations’ long-term sustainability.
Finance and enterprise risk leaders must help their corporations financially assess and integrate sustainability-related initiatives to enable enterprise risk mitigation and capture competitive advantages. For their part, sustainability leaders must look to better integrate their efforts into corporate strategic and operational planning, financial modeling and enterprise risk management to help the corporation respond to evolving risks.
Those companies that can effectively identify, assess, respond to and manage the strategic and operational risks and opportunities presented by the changing business environment will be best positioned for long-term growth.