How CFOs can manage sustainability risks and create long-term value
Seek and you may find
Sustainability risks aren’t just concerns to be managed. They can also drive performance and help to build and protect a company’s brand.
- Business risks are sustainability risks
- Where’s the value?
- Where to start?
- A path to sustainability leadership
- Related articles
Business risks are sustainability risks
Environmental, social, and governance (ESG) risks increasingly demand the attention of chief financial officers (CFOs). Companies that aren’t addressing these issues may be caught flat-footed as these pre-financial risks become central to business strategy. Consider the following situations:
- A beverage company loses access to water due to local water scarcity or loss of social license to operate in surrounding communities.
- A technology company fails to listen to its highly skilled labor force. Employee turnover increases and the company loses its competitive advantage.
- A consumer products company faces brand and reputational damage and consumer backlash for instances of human rights violations in its supply chain.
After reading these examples, you might be thinking, "I’ve never considered these risk areas as sustainability risks; they’re just business risks." Yes, they certainly are business risks, and that’s key to understanding their impact on your long-term financial performance and unlocking potential "hidden value" in your business. They should grab your attention. Consequently, CFOs should advocate sustainable business practices and transparent ESG reporting on how their companies’ value is sustained over time.
So what’s holding you back? Managing environmental resources can help avoid business interruptions, just as managing your workforce helps to avoid turnover. Furthermore, understanding your supply chain can help reduce the risk of brand damage. As Goldman Sachs has stated, “If you ignore sustainability, you’re going to be worthless." If you’re beginning to see that there is value from addressing these risks, then read on.
Where’s the value?
The business context for ESG impacts is evolving rapidly and challenging corporate executives to translate global megatrends such as climate change, resource scarcity, and population growth into tangible risks and opportunities for their business to manage. ESG impacts are generally longer-term in nature, and in many cases, beyond the direct control of a company. This makes the linkage of ESG impacts to business value even more challenging. But methods of accounting for sustainability performance are advancing to meet this challenge. This is where the role of the CFO emerges: At the intersection of sustainability and financial performance, the CFO is the person most qualified to define and communicate how a company’s management of ESG risks contributes to value creation.
Sustainable value can be created in many ways. Pioneering companies often start by focusing on risk and cost reduction. Over time, they develop strategies for increasing value creation, ultimately including intangibles such as brand and culture.1 Encouragingly, such actions also serve the dual purpose of helping to avoid potential brand and reputation damage that often accompany sustainability risks.
1 For more information, see: Lubin, David A. and Esty, Daniel C. “The Sustainability Imperative,” Harvard Business Review, May 2010. Available at: https://hbr.org/2010/05/the-sustainability-imperative.
Where to start?
While pressure mounts for businesses to grow the bottom line and be good corporate citizens, sustainability risks can go unrecognized as the opportunities they are, ripe for value creation. Integrated thinking, and specifically promoting greater collaboration between a CFO and a chief sustainability officer (CSO), is necessary to help the company more intentionally take advantage of such opportunities and move beyond a narrow focus on short-term profits.
Here are three actions CFOs can consider to begin addressing sustainability issues:
- Organize internally. Alignment of a company’s internal team is important because sustainability and corporate performance are inextricably linked. Addressing material risks (i.e., ESG trends, events, and uncertainties that are reasonably likely to have material impacts on their financial condition or operating performance) requires breaking down silos and engaging in integrated thinking.
- Focus on the material issues. Material risks vary depending on the industry, and determining which ESG risks need to be treated as material is an essential step in crafting a sustainability reporting strategy. Material risks can affect a company’s financial statements in a number of ways, having both short- and long-term impacts.
- Tell your story. Recent developments, both in the United States and internationally, demonstrate the intensifying sustainability focus among investors, companies, and policy makers. These include:
- Financial Stability Board (FSB) Task Force on Climate-related Financial Disclosures (TCFD): The FSB TFCD developed recommendations for voluntary climate-related financial disclosures aimed at providing useful information to lenders, insurers, and investors.
- Securities and Exchange Commission (SEC): While only 4 percent of the concept release published in April 2016 addressed sustainability disclosure, 66 percent of non-form comment letters discussed the topic.
- World Federation of Exchanges (WFE): More than 85 percent of respondents to WEF’s 2016 Exchanges and Sustainability survey require some form of ESG disclosure in their markets.
- World Economic Forum (WEF): Four of the top five risks in terms of impact are environmental per the WEF’s 2017 Global Risks Report.
These developments should be a wake-up call to CFOs and other C-suite executives about the potential risks of inaction.
A path to sustainability leadership
The importance of sustainability risk to businesses is growing in the face of heightened expectations among shareholders, regulators, communities, and other stakeholders. If left unaddressed, these pre-financial risks could turn into clear and tangible financial impacts. Yet there’s no reason that certain risks—effectively identified, measured, and communicated—shouldn't help drive corporate performance and protect a company’s brand and reputation. Companies that address these issues directly with the guidance and involvement of the CFO can be better prepared to create enterprise value while meeting ESG reporting demands and broader stakeholder expectations of responsible risk management. After all, if risk can be leverage to drive performance, can you afford to ignore it?
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