Is your risk radar robust enough?

26  September 2018 - By Saskia Ligteringen

With the number of Environmental, Social and Governance (ESG) regulations increasing everyday it is no wonder that non-financial risk management is becoming crucial for an organisation in order to stay ahead of the game. Since 2013, there has been a 72 percent increase in the number of recorded regulations concerning non-financial issues. In a recent webinar hosted by Datamaran three leading professionals gave us their insights into why managing ESG risks matter from a risk management (The Committee of Sponsoring Organizations of the Treadway Commission - COSO), investor (Nasdaq) and corporate perspective (Novo Nordisk). 

Risk perspective

Non-financial risks can have an impact on the long-term viability of organizations. This means that organizations now have to think beyond the one and two year perspective to a much longer term horizon as they evaluate the potential impacts and outcomes from non-financial risks. 

A 2018 study undertaken by World Economic Forum has shown that non-financial risks have become more mainstream, and as such should be an integral part of Enterprise Risk Management process. These risks should in fact be part of the overall risk assessment and monitoring in the marketplace of emerging risks.

“Enterprise Risk Management is not something that is bolted on or something one can do part time or add on to some existing processes. Enterprise Risk ManagementERMERerm should be interwoven throughout all aspects of an organization, so one should be able to see it winding through the vision, mission and core values, the setting of business objectives, the performance of risk management, and then ultimately in enhancing the organisation’s value.” - said Paul Sobel, Chairman of COSO. 

The study by the World Economic Forum identifies the top five risks based on an impact standpoint, four of whom would sit under the ESG umbrella: extreme weather events, natural disasters, climate change mitigation and adaptation to name a few. 

Whilst identifying the key non-financial issues is possible, measurement of those remains a big challenge. It is hard to measure exactly what the outcome is going to be or how severe it might be. However, as organizations begin to recognize the fact that they have to act, they start to think of different ways they can deal with these risks. Another characteristic that is worth noting is that these risks tend to be very long term in nature. Some risks that are just a blip on the radar screen can be managed and mitigated. Others though can actually have an impact on the long-term viability. 

Investor perspective

“Companies should be paying more attention to non-financial issues” - says Evan Harvey, Global Head of Sustainability at Nasdaq.

Over the last three years we have seen a rapid rise in ESG regulations, meaning companies need to be paying more attention to non-financial issues in order for the organisation to survive long-term. However it should be noted that not all the regulations are issued by governments are mandatory, for example there are voluntary initiatives, recommendations and guidance that are coming out from Stock Exchanges and Securities Exchange Commision. 

“Scale is the reason many Stock Exchanges and Securities Exchange Commissions have been responsible for the growing number of initiatives regarding non-financial issues.” explained Harvey. By looking at two working groups who are talking about ESG disclosures and transparency issues - one via the UN and the other via the WFE - it is easy to understand why ESG have become so prerogative. With 45,000 listed companies around the world and with around $80 trillion US dollar market cap - depending on how this is - suddenly non-financial issues become very important. Even tiny changes, iterative changes towards more transparency, towards better practices, better integration of ESG principles could have a tremendous macro economic impact on scale. 

Another trend that is emerging is the need to understand and get a better insight into corporate performance signals beyond the traditional balance sheet. “Many investors are looking for signals that show management and performance excellence and data-driven decision making - all while integrating new principles in the way companies are run. Investors are moving away from the mentally of “return at any cost”, and more towards returns, while making a positive impact.” - commented Harvey. ESG or non-financial disclosures can be a better forecast of the long term value because a robust balance sheet does not mean there will not be tremendous consequences due to risk failures. 

An evolution is on the way in terms of how we view risk in a corporate context. Being able to understand and mitigate potential problems before they are effect investor value and stakeholder values have become essential for organisations if they wish to survive long term. 

Corporate perspective

Novo Nordisk does not refer to ESG issues as non-financial but more to “pre-financial” as their role is to inform on the performance of the company. When looking at “pre-financial” issues, Novo Nordisk looks at three different elements.

Is your risk radar robust enough? The corporate perspective.

When looking at “pre-financial” issues, Novo Nordisk looks at three different elements.

“Like many companies out there who are struggling to keep up with all the “tennis balls being thrown at them” we try to make sense of it all in a systematic way via frameworks and procedures.” - said Susanne Stormer, VP of Corporate Sustainability at Novo Nordisk.

While discussing value it is easy to understand the term when it is linked to financial value, which can be measured by share price, market cap and shareholder dividend. However, when looking at value for employees or the value for patients, such as considering whether they are able to have a better quality of life, it can become more complex. These non-financial issues do not have commercial value, which means it is difficult to measure and assign a dollar sign to them. For guidance on this complex topic, Novo Nordisk leans on different organizations’ initiatives like Nasdaq’s and COSO. For example when defining what is material for the organisation, what their goals should be and what to report Novo Nordisk uses the COSO framework. In their reports, one can recognise words, such as, validity accuracy, consistency, timelines, which are referring to responsible business and human rights throughout the value chain. Understanding these risks and valuing them, as mentioned before, can be the greatest obstacle for businesses as well as how to integrate them into different frameworks.

“Latching non-financial risk management issues to existing framework allows a company to create a more robust approach the organisation already understands. This is the first step as they have to understand they can not compare apples with oranges.” - advised Stormer. However, this approach will allow for organisations to think what is the risk to function, the risk to the company's ability to stay afloat and which areas will be most impacted. 

Three different perspectives all agree on the same point that non-financial risk management is an essential business management practice. Monitoring of non-financial or pre-financial issues continuously quickly turned into a “must have” internal business process.

Global Insights Report: The Three Big Wake-Up Calls For Boards

The events of 2020 brought risks related to public health, climate change, and diversity, equity, and inclusion to the forefront of public consciousness. Yet, too many businesses are failing to incorporate external and ESG risks into their long-term strategies and to think about business model innovations to reorient towards long-term value creation.

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