10.3 Types of Sustainability Risks: Environmental, Social, and Governance (ESG)
Sustainability risks are environmental, social, or governance events or conditions that, if they occur, could cause a negative material impact on an organization’s value, operations, and long-term viability. These risks are often interconnected and can have cascading effects across different aspects of an organization’s operations and the broader economy. Understanding and managing these risks is crucial for effective risk management and sustainable business practices (Segun, 2023).
Video: “Sustainability 101: ESG Reporting” by Constellation [3:47] is licensed under the Standard YouTube License.Transcript and closed captions available on YouTube.
Environmental Risks
Environmental risks stem from an organization’s impact on and dependence on the natural environment. Key environmental risks include (COSO, 2018):
- Climate Change: The increasing frequency and severity of natural disasters pose significant threats to business operations, supply chains, and infrastructure.
- Natural Resources: Depletion of natural resources can lead to increased operational costs and supply chain disruptions.
- Waste Management & Pollution: Mishandling of industrial waste and increase in pollution
- Environmental Opportunities: Pollution, deforestation, and other forms of environmental damage can lead to regulatory penalties and reputational damage.
Social Risks
Social risks relate to an organization’s impact on and relationship with society, including its workforce, customers, and communities. Key social risks include (COSO, 2018):
- Human Rights: Violations in the supply chain or operations can lead to legal consequences and severe reputational damage.
- Labour Standards Problems: Poor working conditions, unfair wages, or lack of diversity and inclusion can result in talent retention issues and negative public perception.
- Social Inequality: Growing wealth disparities can lead to social unrest and market instability.
- Community Relations: Failure to engage positively with local communities can result in loss of social license to operate.
Governance Risks
Governance risks are how an organization is managed, overseen, and held accountable. Key governance risks include (COSO, 2018):
- Corporate Governance: Poor decision-making structures, lack of transparency, or unethical practices can lead to financial losses and reputational damage.
- Regulatory Compliance: Evolving sustainability regulations can create compliance risks and additional costs.
- Business Ethics: Unethical business practices can result in legal penalties and loss of stakeholder trust.
- Executive Compensation/Board Pay: Excessive or misaligned executive pay can lead to stakeholder dissatisfaction and reputational issues.
| 3 pillars | 10 themes | 37 ESG key issues |
|---|---|---|
| Environment | Climate change |
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| Natural resources |
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| Pollution and waste |
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| Environmental opportunities |
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| Social | Human capital |
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| Product liability |
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| Stakeholder opposition |
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| Social opportunities |
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| Governance | Corporate governance |
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| Corporate behavior |
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Interconnectedness of ESG Risks
It’s important to note that these risk categories are often interconnected. For example:
- Climate change (environmental risk) can lead to resource scarcity, which may cause social unrest (social risk).
- Poor governance practices can result in inadequate environmental management or labour issues.
- Social issues like inequality can influence consumer behaviour, affecting a company’s market position.
Managing ESG Risks
Effective management of ESG risks requires:
- Integration of ESG factors into overall risk management frameworks
- Development of new metrics and tools to measure and monitor sustainability-related risks
- Enhanced disclosure and transparency around sustainability risks and opportunities
- Alignment of business strategies with sustainability goals
Image Description
The image presents a colourful DNA-like spiral graphic that outlines the steps for integrating and managing Environmental, Social, and Governance (ESG) risks within an organization. Each segment of the spiral corresponds to a step in the ESG risk management process:
- Governance & Culture for ESG-Related Risks (represented by a yellow circle with people icons)
- Strategy & Objective-Setting for ESG-Related Risks (represented by a blue circle with gear icons)
- Performance for ESG-Related Risks (represented by a green circle with a magnifying glass and plus sign icons):
- Encompasses three sub-steps: a. Identifies Risk b. Assesses & Prioritizes Risks c. Implements Risk Responses
- Review & Revision for ESG-Related Risks (represented by a purple circle with document icons)
- Information, Communication & Reporting for ESG-Related Risks (represented by a red circle with communication and reporting icons)
The DNA-like spiral visually connects these steps, illustrating the integrated and continuous nature of managing ESG-related risks.
By understanding and proactively addressing these risks, organizations can mitigate potential threats and identify opportunities for innovation, efficiency, and value creation in a rapidly changing world (COSO, 2018).
How Sustainability Risks Can Impact
The financial impact of deforestation-free supply chains on Brazilian beef production
Brazil is the world’s largest exporter of beef, making up almost 20% of the world market. However, the impact on Brazil’s natural resources – and global GHG emissions – is significant. With only 1% of beef production in Brazil certified as sustainable, NYU Stern’s Center for Sustainable Business led a research project to assess the financial benefits (e.g., productivity and profitability) of shifting to sustainable beef production. This analysis assessed the benefits for all players in the industry’s value chain – namely, ranchers, slaughterhouses and retailers.
The project looked at the benefits of sustainable and deforestation-free practices across five areas: cost reduction, revenue increase, risk avoidance, financial and valuation, and other. Using research, data analysis and interviews, benefits were calculated based on market demand, probabilities and penalty costs consistent with each indicator.
The results are powerful for decision-makers, with evidence that sustainable agricultural practices lead to improved profitability across the value chain. The uptake of sustainable agricultural practices provided the most financial benefit, while the uptake of deforestation-free commitments reduced risk. In particular, ranchers reaped the most benefits as a percentage of total income – between USD$18 million and USD$34 million (12% and 23% of revenues) net present value over ten years.
Enterprise Risk Management: enterprise risk management to environmental, social and governance-related risks, © 2018 Committee of Sponsoring Organizations of the Treadway Commission (COSO) and World Business Council for Sustainable Development (WBCSD). All rights reserved. Used with permission. (See Acceptable Use of COSO Materials [PDF] for permission details).
Sustainability risks are environmental, social, and governance (ESG) factors that can significantly impact an organization’s operations, financial performance, and long-term viability. The following are some of the most critical sustainability risks facing businesses today:
- Climate Change and Extreme Weather Events: Climate change poses both physical risks (e.g., increased frequency and severity of natural disasters) and transition risks (e.g., policy changes, market shifts). These can disrupt operations, damage infrastructure, and affect supply chains (ESG Risk Guard, n.d.).
- Resource Scarcity and Biodiversity Loss: Depletion of natural resources and loss of biodiversity can lead to increased operational costs, supply chain disruptions, and reduced ecosystem services that many industries rely on (World Economic Forum, 2023).
- Social Inequality and Human Rights Issues: Growing wealth disparities and human rights concerns can lead to social unrest, reputational damage, and legal consequences. These issues can affect labour markets, consumer behaviour, and a company’s social license to operate (ESG Risk Guard, 2024).
- Regulatory Changes and Compliance Challenges: Evolving sustainability regulations can create compliance risks and additional costs. Failure to comply can result in penalties, legal action, and reputational damage (ESG Risk Guard, n.d.).
- Technological Disruptions and Transitions: The shift towards sustainable technologies can render existing products or processes obsolete. Companies that fail to adapt may lose competitive advantage and market share (COSO, 2018).
These risks are often interconnected and can have cascading effects across different aspects of an organization’s operations and the broader economy. Effective management of these sustainability risks requires integrating ESG factors into overall risk management frameworks, developing robust sustainability strategies, and proactively adapting to changing environmental and social landscapes.
Following are some of the examples of how organizations are impacted:
Examples
Financial Performance
- Increased operational costs due to resource scarcity or climate change
- Compliance costs from evolving sustainability regulations
- Revenue impacts from shifting consumer preferences towards sustainable products
- Limited access to capital or higher costs of capital due to poor sustainability performance
- Supply chain disruptions affecting sales and profitability
- Potential asset impairment due to climate change and resource scarcity
Reputation
- Damage to brand value and consumer trust
- Strained relationships with key stakeholders
- Negative media attention
- Difficulties in attracting and retaining talent
Long-term Viability
- Threats to license to operate in certain markets
- Risk of technological obsolescence if failing to adapt to sustainable technologies
- Existential threats for companies heavily reliant on scarce resources
| Enterprise-level risk | ESG element | Relevant risk owner | Supporting the risk owner |
|---|---|---|---|
| Risk of increasing raw material prices | Change in prices caused by rising energy costs associated with climate change regulation | Vice president of supply chain | Chief sustainability officer/Sustainability analyst (energy) |
| Risk of injury or fatality in operations | Health- and safety-related considerations | Environmental health and safety manager | Site managers |
| Risk of reputational damage because of poor communication on ESG issues in the supply chain | Pressure for greater supply chain transparency around human rights | Chief procurement officer | Chief sustainability officer |
Effective management of these risks requires integrating ESG factors into risk management frameworks, developing robust sustainability strategies, enhancing transparency, investing in sustainable innovation, and proactively engaging with stakeholders. This approach mitigates potential negative impacts and identifies opportunities for innovation and value creation, essential for maintaining competitiveness and ensuring long-term viability in a rapidly changing business environment (Federation of European Risk Management Association, 2021; Segun, 2021).
