More and more organizations are understanding the need to incorporate environmental, social and corporate governance risk management into their overall risk management system, and it is easy to see how the sustainability or CSR departments of these organizations are striving to achieve their integration in a cross-cutting manner in the organization.
Leaving aside the various guides and recommendations that have been published for some time now and that I take for granted that any professional in the field should know and analyze, I would like to share five personal reflections from my own experience and I hope that some of them may be useful.
1st reflection: Risk & uncertainty
I think there is a slight confusion when referring to extra-financial risks because it seems easy to fall into the temptation of treating them as any other risk. However, it seems obvious that the main characteristic of this type of risk is uncertainty and that unlike any other risk that we can manage by means of probabilities, extra-financial risks must be managed as possibilities before different scenarios and we cannot know with certainty their impact if they were to materialize.
2nd reflection: Risk & Risk Factor
Based on this differentiation between risk and uncertainty, I wonder to what extent it is valid to treat extra-financial risks as a new risk, but not to ask whether it should be treated as a risk factor. At this point, understanding the difference between risk and risk factor is fundamental. In a very simplified way, we could say that risk is any process with a probability of an unfavorable outcome; on the other hand, we could define the risk factor as any process that increases the probability of risk.
In other words, treating non-financial risks as risk factors does not imply any change in the organization's overall risk management model, although it does entail the need to identify these risk factors and relate them to the traditional risks managed by the organization so that measures can be evaluated to minimize their possible impact.
In my opinion, it is the responsibility of the Sustainability Area to identify extra-financial risk factors and to propose measures to traditional risk managers to minimize their impact. But it is the traditional risk managers who have the final say and are responsible for their management.
This treatment also greatly facilitates integration into the global risk management model and its presence in the different areas of defense to ensure proper management, control and supervision.
Furthermore, it also makes it easier for the Board's risk committee to assume the final responsibility for overseeing all this work.
This is not to diminish the importance of a supposed sustainability committee that could be present in the organization and that probably makes sense from a more strategic perspective, but in my opinion, if it is about risks, I think it is positive that no differentiation is made.
3rd reflection: Extra-financial risks & Financial economic impact
Assuming that we have decided to treat extra-financial risks as risk factors and that they consequently increase the probability of some of the traditional risks, it seems reasonable that these factors will have an economic-financial impact and that this impact should be taken into account in the financial planning process. Not doing so is tantamount to saying that these risk factors do not affect us.
Consequently, its integration into the financial area is much more natural and it is not necessary to change any of the organization's internal processes.
4th reflection: Scenarios, short term & long term
It is easy to be tempted to evaluate the possibilities in the face of long-term scenarios....in some ways it is a way of delaying their impact on the income statement....however, I suggest that we do not forget the short-term scenarios since the behavior of the markets and the decisions of many investors are already anticipating the effects.
In this sense, transition risks require a deep analysis and, as an example, the evolution of the emission allowances market:
- Annual average 2017: 5.83 euros
- Annual average 2018: 15.88 euro
- Annual average 2019: 24.79 euros
5th reflection: Prudence & diversification
That last thought should probably go without saying, since one of the first things we all learn in managing organizations, and especially when dealing with the risks we face, is the need to apply the principle of prudence. I believe I am not wrong in saying that it matters little what anyone thinks about the risk factors that have been identified materializing. From a business perspective, what really matters and what is expected of each of its members is that they act responsibly and with due diligence in managing potential risks. And just as we learned the importance of being prudent, we also learned that the best way to develop this principle is through an adequate selection and diversification of the risks we assume.
