Business leaders are increasingly aware that environmental, social and governance (ESG) practices need to be part of an organization’s broader strategy, particularly as risks can impact long-term financial health, resilience and continuity. Yet only 35 per cent of Canadian ESG professionals believe their organization has a comprehensive ESG strategy, according to a recent KPMG survey.
“Understanding the full spectrum of an organization’s ESG risk exposure is a vital component of developing an integrated business strategy,” says Prathmesh Raichura, partner in Risk Consulting and ESG at KPMG in Canada. “Addressing your exposure can not only help mitigate vulnerabilities, it can also highlight opportunities for corporate innovation, enhance stakeholder relations and enable a competitive edge.”
There is growing consensus among business leaders, investors, governments and regulators that sustainability risk is also financial risk. In March, the Office of the Superintendent of Financial Institutions (OSFI) released its Climate Risk Management guidelines for federally-regulated financial institutions. When the guidelines come into effect, Canadian banks and insurers will be required to consider climate-related risks and opportunities in their capital planning, liquidity and solvency assessment processes.
This will also likely have a downstream effect on organizations looking to raise capital or obtain financing at preferred rates.
“OSFI’s announcement is a signal of what’s to come for other sectors – that climate risk needs to be accounted for across all aspects of the organization and embedded into the traditional risk management process,” says Andrew Ross, a director in KPMG’s ESG practice.
He adds that while climate is often atop many corporate and regulator sustainability agendas, an expanded ESG focus requires an organization to include complementary social and governance risks and opportunities in their strategies.
A company’s strategy needs to consider this expanded scope, including physical and transitional risks, says Teanne von der Porten, an executive director in KPMG’s ESG practice. This means understanding and addressing reputational threats associated with not meeting investor, customer and community expectations.
She points to Canada’s proposed Fighting Against Forced Labour and Child Labour in Supply Chains Act. “It will require public and private sector entities doing business in, or with, Canada to disclose steps taken to address forced labour and child labour risks throughout their supply chain. This will bring Canadian legislation in line with what we’ve seen in the U.S., Australia and Europe.”
Ms. von der Porten says a comprehensive ESG strategy needs to factor in business continuity planning and resilience in the face of increasingly complex and interconnected ESG challenges.
Transforming ESG risk into opportunity
The market, consumers and regulators are increasingly demanding that organizations take a comprehensive approach to managing ESG risks. But there are other reasons to embed ESG principles into core business operations, says Mr. Ross.
“As a result of the global shift toward a sustainable economy, the way our entire economic system is structured and operates today will look completely different in 10 years – and again 15 years after that,” he explains. “Companies that commit to this transition will likely be favoured by investors and attract investment. Organizations that are too slow to adapt may eventually lose their market position and access to skilled talent to competitors that have fully embraced this ESG-centric mindset.”
Mr. Ross says leading retail companies have systematically evaluated their supply chain across product lines. They have identified carbon-intensive products and processes, and developed a strategy to engage key suppliers and develop or re-design products with lower carbon footprints.
“This has led to more efficient supply chains and reduced production costs, including those associated with carbon pricing systems, which often flow through suppliers to the retailer. We’ve also started to see more retailers undertake a climate risk assessment of their supply chain to identify potential hot spots where distribution centres, warehouses and key supplier sites may be at risk from physical climate impacts.”
Understanding and managing ESG risk exposure
Many leaders are aware of the importance of having strong ESG governance, oversight and accountability at the board and executive level as well as straight through to a company’s operations.
How can leaders assess their ESG risk exposure?
As a first step, Ms. von der Porten recommends determining where the organization is most vulnerable, then prioritizing those risks that pose the greatest threat to value creation.
“Leaders can also gather important information about their company’s current performance by benchmarking against peers and stakeholder expectations,” she says. “Engaging with the community, suppliers, customers, employees, lenders and ratings agencies will be crucial in helping a company determine its ESG ambitions.”
She says business can use this feedback to develop performance targets, key performance indicators and action plans.
“Once you understand the ESG risk exposure within your business, that’s when you can identify the opportunities that will set your business apart and position it for long-term success,” says Ms. von der Porten.