Bae, Kim & Lee Consultant Lee Yeon-woo
As regulatory and stakeholder issues escalate around environmental, social and governance factors, companies must now monitor associated risks more strategically. Unfortunately, ESG issues are sensitive to public choices, rely on future scenario-based materiality and require longer time horizons. Thus, the difficulty of quantifying ESG risks has led companies to adopt different risk management procedures.
Since ESG risks can turn into significant negative impacts throughout a company’s value chain if not managed appropriately, companies now engage through effective scenario planning and to establish a well-designed strategic fit with other business operations while diligently adapting to frequent regulatory changes.
Rare physical risks but more impactful
Climate change is a huge environmental risk, and it is linked to other environmental issues. The Climate-Related Financial Reporting Working Group classifies the physical risks associated with climate change into two groups: acute and chronic. For example, disasters caused by extreme weather events are serious risks that could disrupt the ordinary logistics of a business. The drought that makes forests more combustible and prone to wildfires linked to electric utilities is an example of increasing chronic risks around the world.
In 2019, Pacific Gas & Electric in California nearly went bankrupt after four trees hit power lines and a massive wildfire destroyed the entire town of Paradise. PG&E eventually came out of bankruptcy, but experts view the PG&E case as a recordable climate change fiasco. Such failures would have been less significant or caused no damage years ago, but California’s forests had become much more combustible due to climate change. South Korea experienced a similar wildfire in 2019 in Goseong, Gangwon province. Due to this disaster, the Korea Electric Power Corp. still under investigation for improperly handling a very high voltage wire that fell due to high winds, causing damage to some 2,000 buildings.
Physical disasters related to climate change are on the increase and they can lead to many different negative externalities. The risks to life, operational, legal and reputational will be immense if specific security measures such as security blackout programs are not monitored and verified regularly.
Transition risks during the “greening” process
The 192 countries that are responsible for 96% of global greenhouse gas emissions have submitted Nationally Determined Contributions in accordance with the Paris Agreement by 2020. The Convention’s Adaptation Committee- United Nations climate change framework recently commissioned synthesis reports from these countries to check their progress. While the physical risks of climate change, such as forest fires, can be industry specific, most companies will face some degree of risk as they are forced to switch to low-emission business programs. of carbon. For example, one type of transition risk may be financial risk when companies make investment decisions in renewable energy.
The Climate-Related Financial Reporting Working Group has systematized risks during transition periods into four groups: regulatory / legal, technological, market and reputational risks. What companies should do is monitor the four types of risk along their value chains. For example, market risks include the price of materials, uncertain market signals during sourcing and logistics, as well as changing customer preferences when marketing environmentally friendly products and services. . Reputational risks have also become more critical as stakeholder activism exerts more influence over board decisions than ever before. Overall, ESG risks interfere with the non-financial risks of other stakeholders such as credit institutions and investment firms.
As a first step, energy companies will be subject to most of the transition risks due to increasing pressure to ensure that their energy consumption and production meet green standards. Reports show that two-thirds of the world’s fossil fuel reserves must close to meet Paris Agreement targets. The automotive, shipbuilding and construction industries that consume raw materials like steel and cement should also carefully assess and implement transition risk management.
The recent 76th United Nations General Assembly detailed the progress and topics of the 2030 Agenda for Sustainable Development. The agenda highlights the implementations for sustainable consumption and production, concerns for present generations and future, desertification, biological diversity and coastal zone management. The upcoming Convention of the Parties 15 of the United Nations Climate Change Conference will discuss the development of the biodiversity footprint and measurement standards. The largest international conference since the Paris Agreement will be the COP26 summit, which will take place from October 31 to November 12.
New risks will continue to emerge, and they will arise from legal and compliance conflicts. These regulatory risks will soon lead to other types of risks if they are not managed on time. The unique feature of ESG risk is its interconnected and extensive impact throughout the value chain. Therefore, companies must monitor and assess risk factors and transmission channels such as rising compliance costs or declining profitability. Then, materialize financial and non-financial impacts such as supply chain or talent acquisition risks. Companies should diligently monitor all types of risks and implement an ESG management system that is strategically tailored but differentiated from previous risk management.
Lee Yeon-woo is a consultant with the Korean law firm Bae, Kim & Lee. – Ed.
By Korea Herald ([email protected])