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.