SOX

Environmental Risks: Understanding the “E” in ESG

Wole Segun|
Environmental Risks: Understanding the “E” in ESG

Environmental, social, and governance (ESG) risk has become a significant consideration in risk management and a major concern for board members. ESG risk management addresses a company’s exposure to risks resulting from  commitments to environmental sustainability, support for community and social equity, and corporate governance. As stakeholders increasingly prioritize good corporate citizenship, environmental, social, and governance risk has become a critical business goal, placing it directly within the scope of risk and audit professionals. Without clear guidance, connecting ESG issues with operational objectives, business strategy, and organizational risk assessment will be challenging. This article will explore the financial risk explicitly associated with environmental risk and the importance of following through on environmental commitments.

Why Are Environmental Risks a Priority Now?

Over the past few years, news reports of environmental issues have been a daily occurrence. Environmental issues like unprecedented heatwaves, wildfires, hurricanes, and blizzards are impacting our lives, and according to a recent UN report, the impact will continue to worsen. Artificial ecological disasters also worsen natural events. A toxic chemical containment pond was recently breached in Florida, and officials pumped millions of gallons of wastewater into the Gulf of Mexico. Not long after, a gas spill in a different part of the Gulf led to terrifying images of the water on fire. In the same body of water, a red tide (an overgrowth of red algae) exacerbated by the previously mentioned chemical runoff killed thousands of fish, sea turtles, dolphins, and manatees.

Is There a Financial Impact to Environmental Risk?

According to the US Federal Reserve, the effects of climate change “can result in direct financial risks, prompting a reassessment of asset values, changing the cost or availability of credit, or affecting the timing or reliability of cash flows. They can also create risks to economic activity, which can themselves create or amplify financial risks.” 

Businesses are devastated by natural events that are worsened by climate change, and in the meantime, they bear the burden of increased insurance costs. For example, a Reuters article explains that wildfires in the US in 2020 “cost insurers a staggering $7 billion to $13 billion,” which is linked to climate change. They go on to show that “Ten years ago, this was a non-issue for (insurance firms). Now they’re saying ‘This is an extraordinary increase in our risk portfolio.’”

What Is the Responsibility of Risk Management Professionals Regarding Environmental Risks?

As risk management professionals, we must ensure corporate objectives related to environmental commitments are met. Many organizations are making environmental commitments or joining movements like The Climate Pledge. Once this kind of action is committed as a strategic objective, our responsibility is to evaluate the control environment to ensure these commitments actually happen. From a reputational risk perspective, failure to follow through will result in bad press, loss of customers, and loss of investors. Even worse, failure to hold up our commitments will create an even more significant impact on environmental issues and related financial risks in the long term. 

How to Start Assessing Environmental Risks

To help you get started, use these six questions to assess the current situation for your organization’s environmental commitments:

  1. Does your company have existing environmental commitments?
  2. Have the commitments been incorporated into the strategic objectives?
  3. What monitoring programs or committees have been formed related to environmental commitments?
  4. How is the monitoring program actively assessing and measuring risks to achieving the commitments?
  5. What controls are in place to mitigate those risks?
  6. How is progress toward those environmental commitments reported to the board and other stakeholders?

Using these questions to facilitate the conversation with senior management and board members will provide an excellent starting point in evaluating your organization’s response to environmental risk. The insights you gain from the conversations will enable you to assess whether environmental concerns are truly embedded into the strategic objectives, or if these are performative in nature. Answering this question will reveal either commitment to a cause or a pending financial risk. 

Wole Segun

Wole Segun is Senior Manager of Solutions Advisory Services at AuditBoard. Wole joined AuditBoard from EY, where he spent 10 years providing business consulting services around Internal Audit, SOX compliance, and Enterprise Risk Management to clients across multiple industry segments.

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