Last year in the U.S. we faced 20 separate billion-dollar weather and climate-related disasters (NCEI), an ongoing pandemic, social unrest, and an evolving transition into a greener economy.
Strengthening Operational Resilience
Given these significant challenges, we need to look at environmental, social, and governance (ESG) and climate risk issues holistically to develop the robust risk management programs needed to improve operational resilience, create opportunity, and manage risk. To do this, an organization must look beyond its four walls to understand how it affects the world and how the world affects it.
At the forefront in many financial industry conversations, the shift toward an operational resilience posture is both paramount and driven by national and global regulation. Recognizing, identifying, and incorporating ESG and climate-related issues is an important step in strengthening an organization’s ability to become more resilient.
Environmental, Social, and Governance (ESG)
ESG represents a broad range of issues like environmental sustainability, climate change, diversity, equity & inclusion (DE&I), supply chain dependencies, information security, and enterprise risk management. Integrating and managing risk in each of these domains helps create resilience with an organization’s people, locations, third and fourth parties, technology, and data as shown in the graphic below.
Consumers and Investors Are Driving Change
Financial services firms are under increasing pressure to integrate ESG and climate risk factors into processes, infrastructure, and overall decision-making. Many regulators now require reporting these risks into board discussions, external filings, and investors updates.
Recent research has shown that consumers also are prioritizing these concerns and consider ESG and climate change important when choosing to invest with a bank, a financial service provider, or onboard suppliers/service providers. It’s becoming increasingly clear that a strong focus on ESG, DE&I, and climate change creates a competitive edge and can positively impact the bottom line, especially when ongoing technology and data are used to drive that change.
Why is this Important?
Intersection with Operational Resilience – How it Converges
Operational resilience encompasses risks relating to people, culture, environment, data, and sustainability of operations within the risk framework. Operational management is integral to an organization’s governance framework.
The industry is well versed on management and measurement of credit risk and financial risk. Just as strong credit risk management capabilities can provide the assurance and confidence needed for a bank to take on more risk, strong ESG framework and climate risk management capabilities can enable the same prudent risk taking with regard to climate-related business opportunities.
Regulation continues to play an integral role in creating ESG and climate risk-focused strategies. If operational risk encompasses aspects of climate change and ESG, an organization it will become more resilient.
Globally, there have been more than 2,000 laws and policies relating to climate change alone, often prompted by commitments to the United Nation’s Paris Climate Agreement.
*not an exhaustive list
Specifically, on climate risk, much of the focus from regulators has been on data collection and disclosure requirements. In a push for more attention to climate-related risk, the U.S. recently announced that it has joined the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The impetus for this is further being driven by Financial Stability Oversight Council (FSOC) on Climate risk. There are three main areas of focus: creating a risk management framework, identifying the necessary data, and quantifying the size of climate risk through “stress tests.”
Organizations that harness technology to inform strategic decision making and move beyond merely meeting regulatory requirements can create a competitive edge. According to an October 2021 survey by the World Economic Forum, only 9% of surveyed companies were using technology to collect, analyze, and report on ESG.
A company’s board of directors must lead the way to help ensure that ESG is viewed holistically from an operational resilience and risk management standpoint. A few questions that boards must now be asking include the following:
- What’s our overall exposure to climate change?
- How do we attract and retain top talent?
- How do we create a governance framework to guide us?
This is just to name a few.
Given these significant challenges, ESG, and climate risk must be built into risk management programs to inform decision-making, create opportunity, manage risk, and achieve resilience.