What is ESG in Risk Management?

Blog post Team CENTRL 2022-07-26

The need for long-term and resilient company strategies has never been more apparent. Recent global disruptions highlight the necessity of being responsive to unexpected shocks. The ripple effects are extensive from individuals to organizations to third parties and supply chains.

Environmental concerns are also at the forefront, and we expect this trend to continue. With the Biden administration’s re-alignment with the Paris climate accord, there has been a significant shift in the United States’ posture around climate change.

The worldwide focus on these concerns is a clear signal of more to come on the legislative and regulatory fronts, strengthening the emphasis on sustainability throughout the financial and non-financial sectors.

Such factors have led many to recognize transformation risks and the financial and commercial impacts of shifting to a greener economy. Companies and their vendor ecosystem will be challenged to react to new expectations in the coming years while also looking for upside opportunities.

What Is ESG’s Role in Risk Management?

The transition from corporate social responsibility (CSR) activities to environment, social, and governance (ESG) programs increases the demand for third-party risk management.

CSR programs had existed since the 1970s, when societal shifts such as the environmental movement prompted corporations to evaluate their influence on society. CSR initiatives were mainly focused on local communities and frequently overseen by marketing or human resources departments.

On the other hand, ESG is frequently managed by compliance and risk departments. It’s a broader approach. ESG recognizes overall societal impacts by the organization, its supply chain, and third-party partners.

Vendor risks and resilience are widely cited as the main challenges keeping business leaders awake at night. This, alongside the present context of many pressure points pushing the new vision, is why an increasing number of corporate executives are asking the following questions:

  • How will the current pandemic and supply chain disruptions affect the organization’s third-party resilience?
  • How could today’s issues jeopardize the organization’s worldwide third-party ecosystem’s financial health?
  • What influence will environmental, social, and corporate governance (ESG) challenges have on the organization’s third-party risk management (TPRM) in the future?
  • How will the organization prioritize metrics and regular monitoring to manage the changing landscape?

What Is the Benefit of ESG Risk Management?

While environmental, social, and corporate governance (ESG) may appear to be a fashionable new phrase, your organization has likely been addressing some of these risks for years. The difference now is the intensity with which ESG concerns are being addressed — and the manner.

The good news is that managing ESG risk does not have to be difficult, and there are several options available to assist. The benefits of action must exceed the costs of inaction, especially for medium-sized businesses that cannot afford to get caught up in an enormous ESG scandal.

In addition, many companies have discovered that having an ESG inside your enterprise risk management program provides a unique opportunity to be good corporate citizens while doing what is good for business.

Improved Sustainability

Companies aware of their environmental, social, and governance (ESG) risks will better allocate resources, make sensible investments, manage rising operational costs, improve talent retention, and comply with applicable laws. These actions contribute to increased efficiency and cost savings in the long run.

Better Regulatory Compliance

Regulatory compliance duties for ESG are increasing as stakeholder demands for responsibility from corporations expand. Integrating ESG factors into an enterprise risk management (ERM) plan should make sharing this data to appropriate regulatory authorities much more accessible, lowering the resource load and the need for legal intervention.

Attractiveness to Investors

Socially conscious investors, including institutional investors with vast sums of money at their disposal, consider ESG issues when making investing decisions. Moreover, traditional investors are also beginning to recognize the importance of solid ESG risk assessment to a business.

As a result, the better a company is at tracking and reporting its ESG performance, the more appealing it might be to a broader range of potential investors who recognize the value of socially responsible investments.

Employee Productivity

An “ESG-aware” organization can boost employee motivation, retention, and productivity by establishing a feeling of pride and purpose within the workers.

Furthermore, several facets of ESG risk management, like health and safety, work schedules, human rights, and diversity, directly impact employee well-being. If these concerns are handled properly, they can improve the work environment and increase productivity.

What ESG Risks Should Companies Consider?

Although the term ESG has been used extensively, it is typically recognized to comprise three aspects of ESG to assess: environmental risks, corporate governance issues, and social responsibility.

The amount of corporations producing sustainability reports and ESG performance data has increased over recent years. Organizations are striving to fulfill community demands for information on sustainable development and social responsibility policies inside their operations and across their supply chains.

Specific, consistent metrics and indicators for ESG performance are developed, although reporting has remained chiefly optional. However, regulatory authorities have begun to build reporting criteria and risk management frameworks.

Environmental Risks

The environmental component of ESG considers a company’s usage of natural resources and the climate risk of its operations and global supply chain practices. These problems might range from various environmental factors, including carbon footprint, harmful chemical use, waste management, and impacts on water pollution, biodiversity, and deforestation.

The growing need for renewable energy, more sustainable transportation networks, and green infrastructure remain essential priorities. In addition, calls for promises to achieve net-zero greenhouse gas emissions and carbon neutrality have increased pressure on global businesses.

Social Risks

The most scrutinized social elements by shareholders and stakeholders alike include signs of a company’s diversity and workforce management, as well as human rights problems in its supply chain.

The recent turmoil has compelled firms to heed calls for social justice and develop strategies to prevent unconscious prejudice and structural racism. The activities aided in the consolidation of continuing initiatives to include diversity, equity, and inclusion into corporate boardrooms and workplace cultures.

Governance Risks

Corporate governance has historically been defined as the rules and processes that control the operations of the board of directors and the practices that enable transparent decision making, legitimate financial reporting, and the protection of employee and shareholder rights.

New corporate governance initiatives have evolved within the context of ESG concerns. For example, executive compensation has garnered attention, and criteria for board management of regulatory compliance, legal, and reputational threats have evolved.

Supplier ESG Risks

Let us not forget that managing ESG risk isn’t just important for your organization, it’s also key to manage this risk with your suppliers and third-party partners.

We’ve already seen big businesses (not funds) being compelled to integrate their supply chains into their environmental standards by the EU.

We predict that, by the end of 2022, these large global companies will have made genuine business allocation/relationship decisions based on environmental sustainability (some have already begun).

For this reason, we advise that your portfolio companies have some kind of ESG risk representation in their portfolios because it is quickly becoming “customer risk.”

How Should ESG Risk Be Measured?

ESG performance is becoming an increasingly significant factor in corporate pricing. Companies employ ESG criteria to evaluate their non-financial performance in a business context where sustainability and ethical effect are crucial to survival.

Several ESG grading systems have arisen to consistently measure a company’s ESG position. ESG ratings, akin to corporate credit ratings, score organizations on ESG factors and a sustainability scale.

A numerical score is calculated based on yearly sustainability reports, media coverage, investment research, management data, and ESG risk exposure.

How Vendor360 Can Help You Manage ESG Risks

Managing third-party risk while complying with industry standards is a complex process. Using spreadsheets or other techniques to keep track of third-party suppliers and the risks they bring to your organization can prove to be challenging.

Vendor360 is a cutting-edge, consolidated third-party risk management tool that streamlines the selection and onboarding of new partners. It can help you assess your downstream liability and mitigate ESG and supply chain attack risks while giving you a complete picture of your third-party risk posture.

You can acquire vendor data quickly, automate assessments, and maintain complete control over the supplier risk assessment process. It also manages vendor due diligence and compares good vendor controls to common vendor risk trends using inherent risk analysis.

Vendor360 will keep track of review progress, set deadlines, and verify questionnaire progress throughout your third-party portfolio. An appealing user interface, considerable automation, and analytics dashboards will streamline your vendor risk management processes.

Schedule a demo today to learn more about Vendor360.

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