ESG is a Risk Issue

Between headlines proclaiming that “ESG is a loser” and leading organizations making commitments to progress and incentivizing ESG-related metrics, ESG is often in the news. With all the noise out there, it can be difficult to grasp how exactly ESG regulation and adoption of formal programs will shake out in the near and long term.

Though some may say that ESG is not here to stay, that simply isn’t true. Many components of ESG have been in existence for decades and will persist. When discussing ESG, many people default to the environmental aspect – which is fair, carbon emissions and achieving sustainable business operations is top-of-mind for many seeking to decrease impacts on the environment to combat climate change. And the environmental piece of ESG is under the most scrutiny and attack, with the recent Supreme Court ruling limiting the ability of the Environmental Protection Agency (EPA) to regulate carbon emissions.

Even with the regulatory landscape being less than solidified, ESG is here to stay. Why? Because ESG is a risk issue for organizations.

Even with the regulatory landscape being less than solidified, ESG is here to stay. Why? Because ESG is a risk issue for organizations.

Growing public and investor attention to how a company manages ESG introduces several risks to an organization should they choose to follow a path of inaction or inaccuracy. Let’s discuss some of the risks that a lack of attention to ESG can cause for an organization.

Reputational Risks of Ignoring ESG

Public and investor attention is focused on ESG. Whether we’re talking about a customer choosing companies that prioritize sustainability and ethical sourcing, or investors that require ESG disclosure, this is a relevant conversation in the current climate (pardon the pun).

Let’s start with the public/consumer perception of ESG. We’re facing record-breaking temperatures globally and climate change activism is at an all-time high. Though there are some who deny the existence of climate change, the warming effect is impossible to ignore. Organizations that choose to ignore the climate crisis and make little to no effort to combat their own greenhouse gas (GHG) emissions are facing heightened scrutiny. The recent Supreme Court decision to limit the EPA’s ability to regulate carbon emissions is a step in the wrong direction but may have a galvanizing effect, as companies seeking to do the right thing do so without regulatory requirements.

Investor and public attention to a company’s efforts to make improvements also mean that organizations need to make progress and disclose key ESG metrics. Either that, or risk losing investor confidence and funding.

Investor and public attention to a company’s efforts to make improvements also mean that organizations need to make progress and disclose key ESG metrics. Either that, or risk losing investor confidence and funding.

The list goes on for how ESG can have an effect on reputation too, and some examples touch both areas of reputation and an organization’s supply chain – read on for more on that.

Impacted Supply Chains

All organizations have a supply chain to manage – from vital components for manufacturing to packaging and shipping supplies and more. Supply chain disruptions, heightened by COVID-19, have caused myriad issues for companies. These disruptions seem to wax and wane as world economies have adjusted to operating in this uncertain environment. Some issues with supply chains are inevitable, caused by shortages of necessary manufacturing materials or logistics problems. But some are caused by issues that fall under the ESG umbrella.

For example, the recent news that a subsidiary of Hyundai used child labor at an Alabama factory is a clear social issue that impacts the supply chain. While Hyundai’s statement says the company, “does not tolerate illegal employment practices at any Hyundai entity. We have policies and procedures in place that require compliance with all local, state and federal laws," this incident is a clear example of how third parties can have profound impacts on organizations they work with. Though SMART, the company that actually employed the minors, is mentioned in the news as the entity that violated these laws directly, much of the reputational damage will likely fall on Hyundai, the more well-known company. Additionally, the fallout from this factory’s violation likely means critical components to Hyundai will be delayed while this is investigated and sorted out.

This should serve as a cautionary tale for third-party due-diligence and ongoing monitoring for compliance-related issues. Not only does this ESG issue impede the manufacturing of critical parts for Hyundai, it also carries reputational risks of being associated with child labor.

Third-party operations and COVID-19 disruptions are not the only factors impacting supply chains – more and more, we are seeing environmental impacts causing issues as well. Droughts, wildfires and other climate-related issues have disrupted manufacturing and food production.

For example, droughts and wildfires are causing global food shortages and food insecurity for many – a clear ESG issue. Another cause for supply chain disruption is a lack of proper planning and infrastructure to make changes to support more environmentally sustainable production. For those who have been following along with the situation in Sri Lanka, their government is spiraling into a collapse for a number of reasons, one of which can be traced back to the ban on chemical fertilizers for their crops.

Some critics have (unhelpfully and incorrectly) deemed the collapse of the government to be the fault of ESG, but this analysis fails to address the true origin of the issue: a lack of fiscal management and a too-rapid introduction of the chemical fertilizer ban. Though banning chemical fertilizers is a step towards a more environmentally conscious and sustainable future, this decree was issued with no real plan in place and lacked major elements of infrastructure to support such a change. Though this is just one of several reasons for the unfortunate collapse of the Sri Lankan government, it serves as an example of the cascade of effects when change is made too rapidly without proper planning.

All Culminating in Financial Risks

Whether we’re discussing an organization’s reputation suffering from a news story that sheds light on unethical or unsafe practices, or a supply chain that is impacted by climate or labor issues — it is clear that many risk areas overlap with ESG.

A tarnished reputation will drive away investors, consumers and even prospective employees. Organizational reputation can be damaged by many factors, but environmental carelessness or inaction, or inattention to social issues, are clear ESG risk factors to consider.

Supply chain malfunctions due to climate-related disasters or human rights issues effect not only the reputation, but also the ability to procure necessary materials. Both examples will have negative financial impacts to any business. Organizations are well-advised to conduct thorough and ongoing third-party due diligence and develop robust contingency plans should their suppliers fail to deliver. The old adage, “those who fail to plan, plan to fail” is relevant here – the uncertain environment means that disruption is not a matter of if, but when.

What Now?

For some, getting buy in for ESG is getting easier, but many organizations are still in the early stages. To begin, it’s important to create a sense of urgency around ESG, clearly communicating that this is a risk issue and building a case to get started before regulatory requirements are in place. Forward-thinking organizations are prioritizing this and setting the tone in absence of regulation, understanding the importance of addressing ESG now, instead of waiting until the government dictates action.

For more information about what ESG measures include, the value of a robust program, and how to get started

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