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I’m going to publish more #ESG content over at Substack

Hi there,

I’ve started this newsletter over at Substack in the depths of the COVID-19 crisis. Every day I read reports about firms that are doing amazing things for their stakeholders.

Unfortunately, I’m also reading stories that indicate some firms – who just weeks ago raved about their ESG credentials – have made some really short-term decisions that will put their stakeholder relations back decades.

I’m passionate about cutting through the public relations spin many put on ESG related initiatives and assessing the real risk management problem faced by the corporate world – a lot of press releases, but not enough changes to how firms operate to deliver a positive social impact.

Please subscribe if you’re interested in hearing more from me on ESG matters.

Cheers,

Brennan

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What Are Some Different Operating Models That Will Emerge After COVID-19?

The rapid acceleration of COVID-19 into a global pandemic that has cost many lives and livelihoods won’t last forever. On the other side of the bridge, firms will either still be in business or have closed their doors permanently. The operating model that made sense pre-COVID will require changes to be competitive in the new normal. This post outlines some potential changes that firms might want to consider.

An operating model is a framework for how a business delivers value to its customers. A trend over the past few decades has been focusing on the core competencies of a business, and outsourcing capabilities to third parties where this is possible so that a firm has a lean operating model and can focus on what it does best and the areas where it adds the most value.

What the COVID-19 pandemic has highlighted is that there are risks from outsourcing and offshoring that require flexibility and quick thinking inside often complex contractual arrangements. For firms that have their locations offshore, the movement restrictions will have reduced the capability of these teams unless investment in people, processes and systems was made well before COVID-19 arrived.

A firm will need to design a new target operating model to reflect the higher risk aversion and control over your value chain that boards will demand from senior executives. ESG risk is more important now, and in the new normal, than it was at Davos earlier in the year.

Institutional investors will expect great improvements in responsible corporate behaviour and efficiency. Employees will expect a strong focus on a safe workplace and measured changes to employment as opposed to indiscriminate cost-cutting. Regulators will expect compliance projects to deliver, even if deferred, and more regulation in many areas is likely to emerge in the new normal.

This scenario paints a picture of an ever more complex operational environment in which to design your new target operating model. For firms that were already struggling with people, processes and systems before COVID-19, this crisis could end them. The uplift in capability required for your *entire* workforce to be able to work remotely for extended periods will be beyond the constrained resources of many firms.

This remote work drive ignores the fact that two-thirds of the economy *can’t* work from home because of the type of work they do – for example, construction or in-person service at a retail store. The higher level of social scrutiny will mean standard responses to crises will face serious social media and political backlash if firms implement them. Already, those who are missing out on help because of the “lines in the sand” drawn by politicians are a major social unrest risk factor.

Because the core focus of the target operating model design is about delivering value to customers, the products and services that a firm offers will be adjusted. If firms are more conservative, risk-averse, and less willing to spend on discretionary items, your product and service offering will need to offer value-for-money and easily plug-in to existing operating models to win new business. The appetite for multi-year or even multi-month implementation projects will not return unless there are clear drop-dead regulatory deadlines.

The top value streams that your firm delivers to customers will need to be enhanced to reflect the new normal. Firms need to remove friction or pain in their customer experience, which implies high-skill people quarterbacking implementations and focusing on automation of processes wherever possible to reduce the overall cost of delivery and run-cost in BAU.

Simplifying the operating model of a business unit wherever possible, will assist in sustainable cost outs. The organisation design workstream of a target operating model design will need to carefully build the right structure that enables value delivery with no excess FTE requirements but sufficient flexibility to respond to ebbs and flows in transaction volume. Firms will need to work with collaboratively with customers and employees to arrive at this new organisation design. An indiscriminate restructuring that doesn’t consider the end-to-end value stream delivered to the customer will result in poor outcomes for the firm.

The role of location and place in how the assembly of value streams occurs will need to change. If more people are working at home, less office space will be required. Thankfully, because of outsourcing and offshoring, many handoffs between different organisations are already managed remotely through email, video chat, collaboration tools, and conference calls. There will need to be an uplift in the tools available if your firm doesn’t have these because getting people to use their cellphone and desk at home without full reimbursement will become untenable in due course.

The onshoring of all elements of the value stream, wherever possible, is a scenario some boards may ask senior executives to plan for. This will involve evaluating the entire value stream to ensure that end-to-end domestic replication is feasible. Firms will review customers and suppliers equally – it may become uneconomic to do business with some customers.

Some suppliers may find themselves cut out of entire markets overseas because of COVID-19 with no foreseeable way back in as the era of globalisation ends. Governments should be aware of the risk to the economy if entire value chains collapse under the strain of changes made by firms unilaterally as a result of this crisis. The end of business travel for the foreseeable future means that large enterprise sales are unlikely to be cemented which further increases the pressure on firms to cut costs and automate as much of their value delivery as is realistic under the constraints they are operating within.

The post-COVID-19 target operating model will be very different from the digital transformation or cross-functional capability TOM that found favour over the past few years. If you thought that the increase in risk and compliance projects stemming from the GFC and higher levels of supra-national regulation, then you are in for a surprise. Expect an enormous focus on risk management in supply chains and increasingly invasive due-diligence from customers.

 For example, if I were advising a firm on due diligence of a potential supplier, a report of how they managed their response to COVID-19 in extreme detail would be a bare minimum expectation. This reporting will increase the timeframe for major supplier changes because firms will have to produce even more collateral and potential customers review it in detail to manage risk appropriately for any changes to components of an operating model.

The different target operating model designs that emerge after this crisis will have simplicity at their core. Wherever a value chain currently hits a border or complex manual handoff, the removal of these frictions will be a core focus of how capabilities combine to deliver value to customers. A higher level of governance, accountability, and assurance around controls and risk mitigants is by higher risk aversion at board-level.  

There is also a higher level of ESG risk sensitivity from stakeholders, particularly asset managers concerns about enormous asset price fluctuations. This sensitivity means that any firm embarking on a target operating model design for the new normal must ensure that a responsible operating model is an outcome. A responsible operating model gives boards assurance that ESG risk reduction is part of the target operating model from the start of the program. It will enable the delivery of the revised strategy for the post-COVID-19 world that is a lot more conservative and cautious than it was even a month ago.

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How Can Firms Restructure Responsibly During COVID-19?

How can firms restructure responsibly? In the COVID-19 era, many boards and senior executives have made enormous decisions about the short-term changes they need to make to their business to stay alive. Many have acted with integrity and considered their entire group of stakeholders, not just shareholders, and done the right thing for their customers and employees. Others have reverted to the crisis playbooks of yesteryear.

Just a few months ago, in January 2020, the rise of ESG investing reached a crescendo at the World Economic Forum in Davos, Switzerland. The global elite spoke lovingly about their sustainability initiatives and measures they were taking to reduce ESG risk inside their firms. Institutional investors, riding high on a decade long asset price rise, were very comfortable with the new direction.

Where are many of these voices now? The environmental, social and governance risks for firms emerging from the response to the COVID-19 health crisis are enormous. Because of the advice around social distancing, use of personal protective equipment, and working from home wherever possible, there are obvious worker health and safety risks. Some firms have responded well, others have acted as if the last 50 years didn’t happen.

The social risks from continuing to insist on retail tenants trading when there is already low foot traffic in shopping malls, for example, will be held to account once this is over. The inability of a firm to hibernate in a competitive and contract-driven world should have been clearer to policymakers. However, the speed of the response has led to grave policy errors that will extend the hurt throughout the economy and risk social problems because of the prioritisation of larger firms over small business and workers.

Restructuring your operations responsibly in a crisis can be done. It means working closely with all stakeholders wherever possible, and not making unilateral decisions without open communication and at least an attempt at consultation or engagement. The “panic stations” approach taken by some during this crisis has highlighted how everything they wrote in the front matter of their most recent annual report was complete nonsense.

What has been good to see is some firms choosing to draw down credit lines and leverage the support the banks are getting from central banks to tap their banking syndicate before doing highly dilutive equity raising in a time of high uncertainty. For firms that have a decent chance of doing well on the other side of the bridge, the extra medium-term debt in their capital structure is probably a better bet than an equity raise.

For small businesses, restructuring responsibly in a situation like COVID-19 can be almost impossible. To have the flexibility to do a responsible restructure, you already needed a strong balance sheet and decent cash flow history. Your banker will be aware of government guarantees, but you still need to be a good credit.

Many of the businesses most impacted by the collapse in sales simply were never and will never be good credits. Low margin, high volume businesses will only be good credits if they have some sort of collateral like owning the restaurant building or a distribution warehouse with a low loan-to-value ratio.

Completely independent of what policymakers may think, the banks still have their internal business rules around risk. Even though there has been some easing of regulation, that doesn’t mean the banks will suddenly make enormous amounts of credit available. The bank CEOs have been clear about this – they will eventually be picking winners and losers. Banks have the best transaction and risk data to consider whether the business they’re considering extending credit to will be able to make a good go of it on the other side of this pandemic.

An example of the difficult position small businesses find themselves in is that three main areas of risk – payroll, lease obligations and trade creditors – can’t all just be put on pause without consequences. A move towards cash on delivery and repayment of any deferred lease liability could mean that more businesses are untenable because of the higher working capital requirement alone.

This situation means that responsible restructuring will only be feasible for the strongest SMEs. They will need to innovate by creating new product and service lines that comply with changing consumer preferences. Their payroll will need to reflect the new normal, and if that means layoffs, paying out full entitlements or claiming wage subsidies to help employees through this is the right thing to do.

The rapid decision-making in a crisis can sometimes stop the risk of going out of business, but there are lasting consequences to any mistakes made during the process. Of particular concern are the audit and assurance risks around many of the decisions made. There will be an accounting for errors made by firms. In essence, banks will closely monitor the use of funds obtained by credit, governments will audit subsidies, employment regulators will audit layoffs, and tax offices will review tax returns and reimbursements.

The consequence of an irresponsible attitude towards restructuring during this crisis is that many businesses will not be able to reopen on the other side of the bridge. This scenario is different from the economic reality. In essence, some firms are simply not viable, and their directors have closed doors because that is the right thing to do in their particular situation.

Where I see a lot of risks is that because so many people have been negatively affected by this economic crisis, there will be a lot of judgement and community expectations around what “the right thing to do” really was during COVID-19. ESG risks must still be identified and managed appropriately during this crisis, just like the rule of law isn’t on hold. Boards and senior executives should consider how they’ve approached their response so far. If you can improve outcomes for stakeholders before the crisis is over, make an in-flight adjustment now. It’s better to alleviate pain than be the subject of investigative reporting or regulatory consequences once this is over.

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COVID-19, ESG Risk And Business Resiliency

Impacts of COVID-19

The impacts of COVID-19 on many businesses around the world have been enormous. The firms that have invested in preparedness and have the operating model to make work-from-home realistic for its people have been able to proceed as if everyone was just embracing flexible working. The firms that have under-invested in preparedness and not managed risk appropriately have had to scramble to change their operating model to support remote work.

For firms in industries profoundly affected by government shutdowns, their revenue could have plummeted to zero already. For others, particularly in discretionary spending areas, they have already seen the negative impact on their cash flow and balance sheet. Many companies have had no choice but to shut down operations and layoff employees. Many boards and senior executives have cut pay and bonuses in solidarity and because they can’t appear unaffected by the seriousness of the problem.

One of the fascinating things to watch as this crisis has unfolded is the difference in response from some firms. Some firms are replaying their Global Financial Crisis playbook – shut down, layoff staff, slash costs and scramble to preserve cash. Other firms are taking a more responsible approach and considering how to balance recognising the precariousness of their position and the impact on their customers, employees, suppliers, and community of their decision-making.

A firm’s operating model is the framework for how they deliver value to their customers. The people, processes and systems they combine into capabilities that enable value streams for customers don’t exist inside a vacuum. They are a living entity that needs continuous improvement and efficiency gains to maintain a competitive position.

The impact of COVID-19 on many firms has highlighted the weaknesses of their operating model. The rise of outsourcing and focus on core capabilities only has left many firms in an invidious position. In essence, they have so many contractual commitments outsourcing functions or capabilities left, right, and centre that it truly is impossible to hibernate their firm for even a month because of the contractual consequences.

There are no easy choices during a crisis, but boards and senior executives and responsible for identifying and managing risks which includes tail risks. If their operating model is fragile, the buck stops with them. While the enormity of the revenue losses due to government shutdowns was extreme, the ability of a business to function with everyone working from home is a bare minimum of business continuity planning.

The rapid decisions to layoff workers or raise equity finance massively diluting existing shareholders will present ESG risks for some firms. There will be consequences as this crisis is more severe than the GFC or the Great Depression and the resiliency of business to sudden shocks will become a critical assessment criterion for enterprise value over the next decade.

Possible Changes To Operating Models

Some of the parts of an operating model are people, processes, systems, locations, and suppliers. I will deal with each in turn.

People are an essential part of any business. Even a highly automated technology business requires highly skilled people who can work together collaboratively to deliver value to customers. Critical considerations for this area of an operating model include:

  • Health and wellbeing – how are we supporting our people through this crisis?
  • Cross-functional capability – how cross-skilled are our people?
  • Digital literacy – can our people work from home productively?
  • Succession planning – has it been done and does it extend down through the business?
  • Minimum FTE requirement – how many people do we need to deliver value?
  • Keep the lights on – what is the actual “business continuity plan” critical number of FTE?

Processes are how the organisation transforms things from raw inputs into valuable outputs for either internal or external customers. The need for manual intervention in a process creates friction and increases risk, particularly in this situation. Critical considerations for the operations include:

  • The known manual process breaks – how do we automate them today?
  • Maker-checker tasks – how do we ensure controls are in place when remote working?
  • Client handoffs – how do we help them improve their processes?
  • Reporting – are there any non-standard reports that should have better governance?
  • Redundant processes – what do we not *have* to do that we’re wasting time doing?
  • Work allocation – how are we responding to peaks and troughs in transaction volume appropriately?

Systems are the technology and applications that power the processes and are increasingly an enormous proportion of a value stream’s commercial value. They are also complicated and costly, as many firms are still struggling with legacy systems. How do you sort out longlasting problems during a crisis?

  • End-user experience – can everyone work from home? If not, why not? Where’s the gear?
  • Video conferencing – what can we leverage? Please no free services for an enterprise
  • Cybersecurity – what controls do we have in place around remote working?
  • Change – is there a change freeze? What about vendors?
  • Test – what ready-for-business checks aren’t already automated
  • Real-time analytics and dashboards – where are they? If they aren’t, why aren’t they available?
  • Capability – do we have the right systems to enable value to be delivered? If not, why not?

Locations include offices, factories, retail stores, or distribution warehouses. They now definitely include people’s homes!

  • Office space – how much are we going to need if we reduce FTE and more people work from home?
  • Factories – how is our offshoring strategy going with border closures?
  • Retail stores – what is the margin contribution of a physical store vs same sales online?
  • Distribution warehouses – how efficient are we? What optionality is there for growth?

Suppliers are critical parts of your value chain. For many firms whose target operating model included a lot of outsourcing, external suppliers are responsible for many capabilities. The interlocks between a firm and its suppliers are critical to managing risk. Key considerations include:

  • ESG risk – how are they treating *their* customers, employees, suppliers and community during this crisis?
  • Controversy – has the supplier caused any controversy during COVID-19 with their actions or words?
  • Capability – has the supplier been able to deliver what it has to?
  • Business continuity plan – if the supplier invoked their BCP, how did they communicate and had they previously tested this with you?
  • Continuous improvement – are they partnering with your teams to enable efficiency wherever possible?
  • Above and beyond – have they been a partner or a contractual counterparty throughout COVID-19?

The Post COVID-19 New Normal

There will be many changes in how firms operate because of COVID-19. I believe that a higher focus on remote working, efficiency, automation, simple product and service lines with lower complexity to deliver and focus on value-for-money will emerge on the other side of the bridge.

Many firms will be working on these changes already with some sort of crisis response team. The smart ones will be using the crisis to implement accelerated transformation wherever possible to take advantage of lower internal resistance to change and politics. They will emerge much stronger once this health crisis is under control.

The new normal will be similar to what best practice was before the crisis – your target operating model design has to incorporate delivering excellent outcomes for your stakeholders. You have to consider risk management and plan for the tail risks.

The relentless drive for cost control and efficiency can sometimes forget that over-optimising and leaving no slack in the system means a firm is unable to respond fast in a crisis. A lean operating model doesn’t mean zero slack. You still need to be prepared for emergencies and have substantial risk mitigants in place for the risks your particular business faces.

Once this COVID-19 pandemic has died down, the level of risk aversion will increase at board level. Directors will hold senior executives to account for their mistakes in managing the firm’s COVID-19 response and give a due endorsement of their successes where that is warranted. The post-COVID-19 new normal will lead to serious consideration of offshoring, outsourcing of critical functions, and the genuine demand for office space.

COVID-19 isn’t a crisis like many others – the sudden shock to economic activity has caused many to challenge their assumptions about a suitable response. A focus on delivering value not just to customers but to a broad group of stakeholders, while maintaining their trust and support, is not an easy task. But boards and senior executives will need to simplify and optimise their operating model because the level of competition for winning new business after this crisis subsides will be enormous because of the output gap in the economy. Only the most robust and most responsible will prosper.

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Lessons From The Global Financial Crisis Already Forgotten In COVID-19 Response

The policy response from governments and central banks to the COVID-19 pandemic has been swift. Central banks are loosening monetary policy to an extent never seen before, expanding their balance sheets through buying bonds and making more instruments eligible for repo borrowing. Governments are deploying wage subsidies, direct cash assistance to industries, easing of regulations and spending like there is no tomorrow on healthcare. However, many of the lessons from the GFC have fallen by the wayside.

The biggest lesson of the GFC was that community acceptance of support in a crisis depends on a fair distribution of the benefits of that support. Because policymakers messed up the GFC response, saving the financial system but not getting buy-in from the community, a wave of populism rose over the following decade. It took different forms in different countries, but the underlying sense of cynicism and lack of control drove severe changes to how ordinary people perceive and react to bailouts.

I’m making a very simplistic assessment of complex economic history here. Still, based on the massive policy gaps emerging around the world, particularly around gig economy workers and small businesses, there doesn’t seem to be a lot of depth to the details of the response so far. When you start digging into the terms and conditions of different support packages, the difficulty of accessing them means that governments are perhaps unintentionally picking winners and losers in a government-decided economic shutdown.

In the United States, limiting executive compensation to not higher than last year’s executive compensation was one of the limitations placed on the support of large corporations. What does the community think of this? For sure, when your revenue goes to zero, tough decisions will need to be made.

However, a more appropriate approach has been boards and senior executives taking at least 30% pay cuts themselves before proceeding with layoffs or redundancies. It’s not clear if the ESG risk concerns that have arisen over the last decade emerged at some COVID-19 crisis high-level management meetings.

One insight into the importance of lobbyists is the number of industry-specific supports provided around the world. Explicit support includes direct cash payments, wage subsidies, sweetheart loans, and tax breaks or deferrals. Implicit support, which is far harder to calculate the value of, includes easing of regulations, suspension of regulatory activity, postponement of enforcement mechanisms and relaxation of rules previously implemented to avoid the very financial instability that occurred in the GFC.

Overall, there is a lot of risks that temporary support measures in a crisis do not have clear exit criteria. Even if there are time limits in legislation or regulations, they can be extended. And if the collapse of economic activity continues for the rest of 2020 as the world tries to arrest the COVID-19 pandemic health crisis and save lives, the pressure on politicians and policymakers to make these temporary support measures the “new normal” will be immense.

For example, how is universal free childcare going to be unwound? Already, some childcare centres will need to close even with the 50% fee plus JobKeeper supports because of the number of kids withdrawn from their centres. If the policy goal was to keep childcare in operation, how is the logical end game not nationalisation of childcare? If the taxpayer pays for everything anyway, how do officials ensure value-for-money and no rent-seeking? What assurances will the government receive from the sector? What happens to all of the child care subsidy arrangements frozen in time?

As you can see, there are no easy answers. There are very complex policy problems to resolve on the other side of the bridge. A comprehensive review and audit of the money paid out, and implicit support given will be required. The sharing of the economic pain outside of the private sector will be called for if unemployment rises beyond 10%. It will be untenable to have a large group of workers receiving their fortnightly salary uninterrupted while many face unemployment, reduced hours, and suspension of worker’s rights.

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Operating Models And Cost Cutting In A Pandemic

The spread of COVID-19 and its impact on business means that many firms will be looking at cutting costs. One of the issues with indiscriminately cutting costs is that throughout an organisation, particularly a big and complex one, lots of processes happen every day and they’re not always clean and automated. A lot of documentation, controls and risk mitigation can help you manage your operations, but institutional knowledge kept inside people’s heads is what gets lost during massive layoffs.

Understanding your current operating model pre-pandemic is critical before making any rash decisions. What are the top value streams you deliver to your customers? Are there any that are redundant during these shutdowns? Is hibernation of a business unit or factory location even realistic under such high uncertainty? An operating model can equally apply to a team, a business unit, a division or an entire business group.

The core components of any operating model are the people, processes, and systems that combine to enable capabilities that let a business unit deliver value to its customers.

The way a business makes money is by selling the value its capabilities create to customers at a higher price than it costs to deliver that value stream. If any of the three core components are not optimised, there is a risk that competitors will be able to deliver more value for less than you can. Thus, there is a competitive impulse that requires continuous improvement of your operating model.

The capabilities that an operating model enables to deliver value do not exist in a vacuum. Governance of the operating model has to have control and regulatory compliance built into how capabilities are designed and implemented.

The point is that if you want to cut costs during a pandemic, there’s an awful lot of upfront work and analysis that should already be accessible to boards and senior leaders. Your business continuity plan should have different scenarios of “bare minimum” capabilities required. When you suddenly have no revenue, there’s not much point keeping the lights on unless you have a fortress balance sheet and can cope with a few months of zero income.

The operating margin that your business earns drives these decisions. It should not surprise anyone that lower margin industries were the first to shut their doors and layoff staff. If you own a bar that has a turnover of $1,000,000 and a net income of $100,000, then you have monthly costs of $75,000. By definition, you can’t survive longer than six weeks ((100/75)*4.33).

The big policy response question is that if the government has shut you down in the name of public health, is a wage subsidy and the possibility of a select loan going to compensate you for your losses fully? No, it’s not! Business owners and their newly unemployed or stood down workers are partially reimbursed shock absorbers for this health crisis.

Why would a business owner borrow more money from the bank, if they even let them, when there is so much uncertainty? If they have leased premises, and their landlord is obstinate, they aren’t guaranteed to have a rent waiver while the government has closed their doors. That liability is still accruing.

Making changes to safe harbour rules doesn’t change rational behaviour in this situation – when you’re in a hole, you stop digging! Many business owners aren’t even bothering to get JobKeeper because they can use it as an opportunity to make layoffs in the heat of the crisis gambling that Fair Work will never catch up to them.

On the other side of the bridge, your target operating model is going to have to change. It will need to focus on value streams that offer real value to customers and is in line with shifts in consumer preferences in a Great Depression 2.0 environment. It will need to be highly automated and efficient because the competitive pressures on the other side of the bridge will be enormous because of the size of the output gap.

The offshore business processing centres will face pressure to open onshore offices and hire local workers. This risk was already an issue in highly regulated industries, but this trend will spread across the entire economy. The multi-jurisdictional value chain is going to be out of pattern for a while.

This crisis will drive significant changes in the standard corporate playbook. The transformation of your business during and after COVID-19 will require enormous changes in how you do business.

Cost-cutting isn’t just about laying workers off. That’s something anyone with a calculator can figure out. It doesn’t solve your broader business problem – why was your operating model so fragile in the first place? What is your firm’s purpose? Why do you exist? What is your strategy, and how do you design a target operating model that enables the delivery of real value to your customers while keeping a demanding group of stakeholders onside and on your team?

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What Is The Exit Strategy From COVID-19 Shutdowns?

What is the exit strategy from COVID-19 shutdowns? New Zealand and Australia are conducting a real-time policy experiment to manage the health crisis. They have taken different levels of action to reduce the spread of the virus and limit the impact on the public health system.

The extent of community transmission and the development of a vaccine are two key variables to consider in this analysis. The cost-benefit of the lockdown will have made sense if these drastic measures avoid a significant loss of life. That seems to be a consensus view – get the lockdown done and then let non-essential firms start back up in a controlled fashion.

There is no doubt that both governments have a lot of serious analysis and modelling standing behind much of their decisionmaking. However, this will be a political decision for the respective leaders of each country. One of the disappointing things on social media is a complete inability of many even to consider the truth that tradeoffs exist when it comes to crisis response measures.  That’s what we elect politicians to do on behalf of society.

The pain of this health crisis primarily falls on those affected by COVID-19 and their families. People die or have ongoing severe health complications because of COVID-19. Then, it falls on those negatively impacted by government public health measures.

There are apparent policy gaps in all of the financial support packages developed and deployed so far. For example, the behavioural response of some employers eligible for wage subsidy payments has been not to bother and just close their business down. Other employers have decided not to comply with employment law during a crisis, putting them at even higher risk of being successful on the other side of the bridge.

The decisions made in the heat of the moment have long-term consequences for many. The enormous increase in central bank support for the financial system in the interests of stability will take a decade or more to unwind. Remember, the US Federal Reserve had only wound down quantitative easing in a big way last year due to strong US economic performance. Now their balance sheet expansion is more than the Global Financial Crisis response in less than a month.

The problem for the government is that the horse has bolted on the economic consequences of the public health crisis. Many directors will have looked at the uncertainty and defaulted straight back to the GFC playbook – redundancies, conserve cash, slash cuts indiscriminately wherever possible. Many bankers will have looked at the support packages their banks have prepared and wondered how their credit policies and experience jibes with a panicked SME support approach.

I look forward to seeing more detailed exit strategy plans for both New Zealand and Australia. Already there have been far more people unemployed than either government expected, and severe issues with the support packages put in place. The focus on the top end of town will prove difficult politically, mainly if there are any further bailouts or special arrangements.

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Why ESG Risk Management Will Be More Important After COVID-19

Firms show their true colours in a crisis. Boards and senior executives are either prepared or unprepared. They can quickly assemble an appropriate response, or resort to replaying their Global Financial Crisis playbook. ESG risk was reaching its peak at Davos in January just two months ago. Still, some of the firms who were lauding their progress on managing ESG risk had gone back on how they said they’d conduct themselves before the quarter even finished.

The speed of the spread of COVID-19 and the widespread economic fallout around the world makes comparisons to the GFC and even the Great Depression unsuitable. This situation is far worse because of the sudden lockdowns and loss of revenue, leading to mass layoffs around the world. On the other side of this bridge, ESG risk management will be even more critical.

Why would that be the case? Well, think about the Royal Commission into financial services that highlighted enormous conduct issues. Then observe the dilemma that the banks find themselves in – they know they have to be responsible corporate citizens, but their loan books are facing an awful lot of uncertainty right now.

The central bank and regulators are supporting them for now. Still, there are so many different stakeholders to manage it will be a difficult task to get the balance right in such a highly uncertain situation. And what about the insurers? How do they do right by their customers in this scenario? It’s doubtful they could afford to waive pandemic exclusions on business interruption insurance, for example.

What about the superannuation funds and their trustees? Are their operating models – relying on 3rd party administrators and systems for core administration capabilities – able to respond fast to a massive regulatory shift with early access to super? When they thought about responsible investment principles, how rigorous was their assessment of their own DR/BCP capability, and what risk mitigation around handoffs between the funds and their administrators exists?

This crisis will also test asset manager operating models that heavily rely on outsourcing critical functions to 3rd parties. A lot of these particular concerns fall under the governance risks area. The need for independent governance and strong accountability of management to the board will be paramount when company boards are conducting post-pandemic reviews.

An ESG risk post-pandemic review will need to cover:

  • The timeline of the firm’s response
  • Environmental risks
  • Social risks
  • Governance risks
  • An assessment of stakeholder perceptions before, during and after the pandemic
  • A remediation programme of work to uplift any areas of weakness before the next crisis strikes

Boards and senior executives operate under resource constraints. Thinking carefully about all of the projects that a firm is currently undertaking and cancelling some to free up pandemic response resources is a natural response. However, the business needs to be ready for the other side of the bridge. ESG risk uplift projects will become quite pressing if any controversies occur during the crisis.

The lessons of the global financial crisis include the reality that community expectations drive your firm’s social license to operate. Quite simply, pure shareholder value decisions or creditor protection decisions that negatively impact other stakeholders are unlikely to go unnoticed by the public and the media. This fact means that even during the high-pressure environment of crisis decision making, senior executives need to challenge and consider a broad range of stakeholders interests. The heavily regulated environment firms are operating in mean that keeping regulators and politicians happy is perhaps more critical than keeping shareholders happy. We are now capitalism-adjacent.

ESG risk management is an extension of risk management in general. Most of the ESG risks will sit on a risk register already and have mitigants in place. There may be uplift projects already in flight. The mistake will be cancelling any of them if you want to be able to operate with the confidence of stakeholders on the other side of the bridge.

Simplifying your operating model and focusing on delivering the right outcomes to stakeholders as part of the business-as-usual cadence of your firm will help reduce ESG risk. Of course, if revenue has gone to nothing, then the most responsible decision for many boards will be to wind down the business and radically reduce its product and service offering to reflect its new reality.

Being responsible in a crisis like COVID-19 doesn’t mean martyring your balance sheet with no hope of reaching the other side of the bridge. It does mean doing the right thing by your employees, your customers, your suppliers, your stakeholders and the broader community.

A key consideration for boards and senior executives during this time is what your responsible operating model looks like after this crisis. A standard target operating model programme that does not incorporate ESG risk reduction into the design and implementation of the TOM won’t deliver the outcomes you need to differentiate your firm from its competitors on the other side of the bridge.

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COVID-19 And ESG Risk Management

ESG risk hasn’t disappeared because of the COVID-19 pandemic. Unfortunately, some firms have reverted to their Global Financial Crisis playbook and accidentally opened up a swathe of avenues for criticism. Environmental, social, and governance risks are particularly acute in a crisis.

Many firms have done a fantastic job of looking after their stakeholders during this crisis. Unfortunately, others have not been behaving as the good corporate citizens that exist in their marketing and their annual report commentary.

The rise of ESG issues over the past decade was reaching its crescendo at the World Economic Forum in Davos just two months ago. There is no reason why firms who care about these issues will revert to old habits if they have embraced managing these risks inside their business in line with community expectations.

If anything, this current crisis will heighten the level of scrutiny on everything a company does. Every press release, every employment decision, every change to a product or service – they will all be under the microscope.  

The level of panic and fear in the community around COVID-19 and its health and economic fallout means that boards and senior executives need to think carefully about how their actions will be perceived and interpreted by the community.

Environment Risk

Environment risks include climate change, the natural environment, pollution, waste, and environmental opportunities for firms to create a positive impact on environmental outcomes.

Because of the COVID-19 pandemic, and the rise of working from home, there is a massive opportunity for firms to reconsider their office space footprint. If remote working is the new normal, customers can still receive value.

Firms can use a different mix of activities that rely less on office space, such as video calling. A lower office space footprint will reduce the firm’s overall environmental footprint as long as business travel remains cancelled or not possible.

New ways of working across a firm’s end-to-end value chain will need to consider what other firms in your value chain are doing at the same time to reduce their environmental footprint.  

Social Risk

Social risks include the wellbeing and development of workers, health & safety, supply chain issues, product design, controversies and positive social impact initiatives.

The natural response of many firms has been to immediately furlough workers to reduce costs. If revenue has gone to zero, then cutting costs is obvious. However, some firms have made responsible decisions – paid sick leave for staff needing to self-isolate due to COVID-19, paying wages where they can for the duration of a lockdown, and continuing to pay health insurance premiums.

Some firms are even partnering with organisations in other industries needing lots of staff quickly to offer opportunities to their furloughed workers. Health and safety actions are even more critical during this time. The provision of PPE is essential – if it can’t occur, then boards and senior executives should think very carefully about whether it is responsible to open at all without providing this to staff.

The way that some firms have chosen to treat staff is already causing controversy. On the other side of the bridge, they will face unfair dismissal claims and litigation from suppliers treated poorly. Other firms have endeavoured to pay their invoices faster and settle trade creditors and contractors where possible before closing their operations temporarily.

Governance Risk

Governance risks include corporate governance issues such as board composition, executive remuneration, shareholding composition and accounting standards used in financial reporting. Organisational behaviour issues such as tax policy, ethics, anti-competitive actions and financial stability are risks here.

Sharing the pain is a smart decision many boards and senior executives have already taken. Pay cuts and no bonuses are the bare minimum act of corporate social responsibility if you are standing down thousands of employees.

Firm-wide pay cuts to protect jobs instead of redundancies can also work here. How many boards have turned over completely since the GFC? For most, this will be their first major crisis and letting senior managers deal with the crisis and focusing on governance as opposed to micro-managing will be a challenge for some.

Board composition needs to be a blend of different experience and perspectives – how many will have thought through the productivity implications for their workforce if school kids are at home during this crisis? Managers being genuine about workplace flexibility where possible will be a differentiator on the other side of the bridge.

Executive remuneration in the coming years will be even more sensitive than after the Global Financial Crisis. You see, many people never thought anything changed after the GFC. If Australia is facing its highest levels of unemployment since the Great Depression, even the at-risk potential numbers when it comes to executive remuneration could be a target for regulators.

Considerations For Boards And Senior Executives

Boards and senior executives will be under a lot of pressure right now. Many have invoked their business continuity plan or had to manage crises non-stop since this pandemic escalated in severity worldwide. A key consideration at the back of your mind is how stakeholders will perceive the firm’s actions during this crisis.

Are you doing the right thing by your employees? Are you doing the right thing by your customers? Are you doing the right thing by your suppliers and key partners? Are you doing the right thing by your community? In the age of social media, there will be real-time feedback on the appropriateness of your actions. In the age of continuous disclosure, your share price will be gyrating each day based on traders assessment of whether you have this situation under reasonable control where you can.

A lot of fluff is written about values and corporate social responsibility. A crisis is where firms that live what they believe and stay true to their word get to demonstrate to the world their integrity. Customers, employees, shareholders, stakeholders and the community at large will recognise that and reward it on the other side of the bridge.

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Why Firms Will Bring Forward Operating Model Changes Because Of COVID-19

The pace of the COVID-19 collapse in economic activity has been incredible to witness. Many sectors have faced complete decline to zero of their revenue. Many firms were prepared for a crisis and will be dusting off their crisis transformation plans. Having invoked their business continuity plan, many will realise that they don’t need as many resources as they thought they did to run their business.

A firms ability to respond to a crisis depends on its leadership and its willingness to make radical changes to its operating model. Many firms will have found that underinvestment in technology in recent years has not set them up to succeed over the coming months and years. Their employees will be making working from home up as they go, introducing enormous cybersecurity risks into their operating model outside of the organisation’s standard risk management framework.

Other firms will have found that their healthy attitudes towards working from home have made this crisis a smooth transition for their workforce. They may generally be in professional service type industries with the margins to make investments in this or in the public sector where such expenditures are mandatory.

A firms culture before the crisis will determine what things look like for them on the other side of the bridge. It will also help drive whether they make it through the COVID-19 pandemic at all. High performing organisations generally embrace flexibility and openness to change. For some firms, this crisis will be the end of them because they can’t respond fast enough to near-daily requirements to make hard decisions.

However, a crisis is also an opportunity. And many firms will be dusting off their crisis playbooks and implementing cost-saving plans that may have been too difficult due to internal politics to execute over the past few years in an environment of rising profits and revenues.

The other side of the bridge, as many politicians refer to it, will be very different because of the psychological impact of simultaneous health and economic crises. This change means that firms will need to carefully review their products and services and make hard calls about what their customers will be willing and able to buy.

Already, a shift away from premium brands to store brands has emptied the shelves of basics around the world. If this continues, a wave of small businesses selling organic this-or-that will hit the wall within months. Anything luxury will only survive if it can sell at scale to those still earning good incomes on the other side.

Firms will need to simplify their products and services and demonstrate real value-for-money. Sales will be more difficult, particularly in business-to-business environments if all of the sales calls are going to be via video conferencing for the next year. That is if a prospective customer is even interested in taking a sales call unless there is a critical need.

A keen focus on simplifying operations wherever possible, embracing automation and eliminating any discretionary spending will deliver savings. But achieving cost savings isn’t the end of the story. Reducing process complexity, reducing system and application complexity and making hard calls to eliminate entire product or service lines will be needed to drive real change in your operating model through this crisis.

One of the downsides of this crisis is that as each firm tightens its belt, economic activity shrinks more. When they stand down or make staff redundant, the impact on lives is immense. It’s not like a typical recession which generally stems from one or two sectors wider. This COVID-19 disaster is an economy-wide sudden stop in economic activity. Doing the right thing by your customers, your employees, your suppliers, and your community were how many firms marketed themselves in recent years with the increasing focus on ESG issues. Many have failed the crisis test within weeks when you look at how some have responded.

The overall simplification of an operating model can’t happen in a vacuum. Due to the complexity of contractual arrangements and service models between 3rd parties that are a crucial part of many operating models, working with key partners and suppliers through this crisis will be essential. Engaging early with key suppliers and being open about changes to get to the other side is far better than surprising them with sudden cancellations. They have employees and families to look after too.

What is emerging from the scale of this health crisis is that many businesses will make the rational decision to close their doors utterly independent of any policy response from the government. Rash and sudden choices will occur. Firms that could use the JobKeeper payment won’t even apply because the owner has already given up.

Firms will bring forward operating model changes because of COVID-19, and the impact on workers on the other side of the bridge will be immense. Higher levels of automation will particularly hurt the lower-skilled, but its impact will reach high skilled workers over time. No one is safe from the Great Depression playbook.

In Australia, there are many turning to government support for the first time in their life. They may previously have looked down on welfare recipients, but now find themselves with no other choice. One thing that firms will need to monitor is attitudes towards unionisation and general strikes over working conditions through this crisis.

If they don’t care for their workers, particularly the lower-paid ones on the shop floor, they may have industrial relations issues on the other side of the bridge. There will also be legal consequences arising from some of the actions of small businesses. Fair Work will have a lot of work to do, and the Job Keeper payments will provide an ongoing stream of audit and investigation work for the ATO to chase down.

The benefit for the firms that adapt fast and simplify their operating models as quickly as possible is that they will emerge in a stronger competitive position once this is over. If they can reduce fixed costs and simplify processes, then they extend their time horizon to stay in business.

One interesting thing to remember is that landlords are businesses too. In essence, both commercial and residential landlords will have to renegotiate their previously guaranteed fixed revenue streams because commercial reality has completely changed in less than a month. The banks will end up being the primary beneficiaries even after a wave of credit losses once the six-month repayment holiday window is over. Hopefully, there’s a vaccine by then, if not, then dark times are on the horizon.