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The rise of ESG: Airmic Masterclass 2022

Climate
Climate and Resilience Hub|Climate Risk and Resilience

July 11, 2022

ESG and risk experts came together to explore the power of culture in managing ESG risks, and the role of risk managers in leading strategic conversations on change for the better.

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Risk managers have an important role in managing environmental, social and governance (ESG) risks, including climate-related risks, and in demonstrating values-driven leadership in climate change action, according to opening comments at the first Airmic Masterclass 2022 by WTW Head of Climate and Resilience Hub, Rowan Douglas CBE.

Douglas argued that recent years have seen risk management insight give the policy objectives of ESG tractable enablement, pointing to the recent publication of Bank of England (BoE) stress tests around UK physical climate risk up to 2050 as one example.1 This case-in-point demonstrates how ESG can be interpreted as a set of risks.

BoE’s projections indicate if banks and insurers do not respond effectively, climate risks could cause a persistent and material drag on their profitability, equivalent to an annual drag on profits of around 10-15% on average. The bank points out losses of this magnitude could make individual firms, and the financial system overall, more vulnerable to other future shocks.

Douglas called to mind the old adage of, ‘What get measured, gets managed.’ Until risks are recognised, spending on resilience appears a cost. However, once risks are quantified, as they have been in BoE’s recent exercise, they cannot be ignored. With the BoE projecting total losses for the financial sector alone reaching up to £350bn in a severe physical climate risk scenario, investing in resilience starts to make economic sense.

Risk professionals can work to better disclose climate and ESG risks, and show when such risks are reduced, there can be a positive impact on the cost of risk.

Douglas also discussed the notion of ‘the invisible hand’, philosopher and economist Adam Smith’s concept which theorised that unintended greater social benefits and public good can be brought about when individuals act in their own self-interests.

The time has come, Douglas argued, to “retrain the invisible hand to enable the wellbeing of communities” as a consequence of those self-interested drivers on reducing climate risk. In light of this, Douglas made a plea to corral the skills of the risk sector: “Your country and the wider objectives of ESG need you.”

Relocating risk professionals’ skills as critical to the local and global challenges we face on climate in particular, brings the conversation round to ethics and values, argued Douglas. It was this theme that was the core focus of the session’s masterclass speakers: Institute of Business Ethics Director Ian Peters MBE, Google Cloud Industry Sales Leader Andrea Williamson, and Marisa Hall Co-head of the Thinking Ahead Institute, an innovation network founded by WTW, whose presentation we explore in detail below.

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The power of culture in managing ESG risk

While the Thinking Ahead Institute focuses primarily on the investment community, many of the concepts apply across financial services and risk sectors, including the idea that culture and sustainability are interwoven.

Hall argued while strategy can be mimicked, culture can be the single most unique differentiator of an organisation, a complex DNA that drives the way organisations think and behave. Culture is needed to build truly sustainable firms.

“My generation and my parents’ generation have…squandered the opportunity to use the biggest increase in wealth and the fastest technological advances in history for good and instead worshipped the god of material wealth. I apologise for that,” so said private equity firm Terra Firm founder Guy Hands.2 Hall described this statement as a damning but uncomfortable truth on the power of culture and setting the scene for growing demand for more purposeful leadership.

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What is a sustainable organisation?

Hall described a truly sustainable firm as being characterised by a range of traits centred around collaboration and innovation. Sustainable organisations build research relationships across a wide range of multi-disciplinary fields, connecting topics such as climate change, diversity and biodiversity, and seek innovative approaches to thinking about tomorrow’s problems.

Crucially, Hall argued, truly sustainable organisations can balance the maximisation of risk-adjusted returns with the impact of these choices via the prism of ‘3D investing’. This approach considers real-world outcomes as the critical ‘third dimension’.

Sustainable firms connect talent and key stakeholders, working towards diversity of thought to generate better decisions. They are culturally effective, focusing on purpose and people as their central tenets, with stronger calls for social justice and greater alignment with sustainability. To be a truly sustainable organisation requires transformational change.

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What is culture?

A full definition of culture does not simply focus on the way things are done, but why they are done the way they are, taking in values and beliefs, leadership, incentives, governance and the way strategies are developed.

“Culture eats strategy for breakfast” is the famous quote from management consultant and writer Peter Drucker and Hall agreed culture is embedded in the very heart of organisations, driving the way organisations think.

The corollary to What gets measured gets managed, is how much more we can and should be measuring, including the building blocks of culture.

The Thinking Ahead Institute culture model operates a scorecard of 10 metrics to identify where organisations are in terms of culture, where they want to be and, and helps build a roadmap to get there. These metrics are centred on client focus, people and teamwork ethos, empowering leadership, high performance, integrity and respect, purpose, diversity and inclusion, innovation, transparency and staying power.

Truly sustainable organisations score highly when their people and teamwork ethos is characterised by empowering leadership, collective ownership, high motivation and a sense of belonging. They also perform well in terms of transparency and there being no gap between what the organisation says it does and what it actually does.

Truly sustainable organisations don’t game the system but have purpose-driven cultures. These cultures reflect wider stakeholder interests being factored into organisations’ activities and decisions, expanding beyond producing the best returns and business performance to include contributions to the net zero challenge, positive impacts on wider society and producing the best employee and team experiences.

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Shifting context of ESG means leadership has become tougher

With higher expectations for leaders in the ESG context, there’s an increasing appetite for so-called B-shaped leadership which is better-placed to support transformation.

B-shaped leaders recognise the interconnectedness of everything. They are more thoughtful around how whole systems work, have inclusive narratives, and connect talent from diverse backgrounds and experiences. Hall said these leaders don’t think in terms of cause and effect but view the world in terms of “…loops not lines,” recognising, “The world is messy.”

B-shaped leadership is centred less on business plans and budgets, but on positive stakeholder outcomes. This leadership style is less about dominance and hard power, but empathy and soft power. Strategy is long-term and considers systems and coalitions, rather than being short-term and transactional.

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Building trust and transparency

Organisations and individuals need to act ethically and with integrity to deal with some of the complex challenges of sustainability. Hall argued that gathering ‘truth’ when confronted with a spectrum of data should be seen as a cultural beacon to avoid so-called 'system boltholes' such as greenwashing or ‘pond-skimming’ superficial thinking.

The best organisations pursue an inferential edge as a revered and authentic practice. But with less cultural rigour, organisations can retreat into boltholes where values are compromised. 

Culture needs to be managed and feature more prominently in strategy discussions, particularly in reference to ESG. The question for risk professionals and their organisations is how they can measure and manage and help build truly sustainable cultures.

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Panel discussion: The rise of the risk manager in creating sustainable organisations

The main presentations were followed by an engaging discussion between panellists and delegates. One of the core themes emerging from this was the crucial role risk managers can play in supporting the development of sustainability drivers.

Key discussion points included:

  • If culture is one of the most critical assets, and if the role of the risk manager is to help protect what is considered most valuable, then they should be playing a more significant role in supporting sustainable cultures, particularly where organisations need transformational cultural change in order to become sustainable.
  • The Financial Reporting Council sets out how directors are responsible for ensuring cultures are right and proper.3 This is a risk area that should, therefore, be managed and mitigated. If organisations don’t get culture ‘right’, a risk crystalises, again indicating the role of the risk manager in working to ensure it does not.
  • Risk managers may consider presenting the case that getting culture right is the best insurance an organisation can have against all kinds of exposures. It is this sort of argument that may help shift ESG conversations from the domain of, for example, general counsel, and into a space where risk managers are more able to add their value and be recognised for doing so.
  • Some companies are already combining risk and sustainability functions, but currently this may happen more by accident than by design. We may expect a more purposeful combining of the two spheres over time and as ESG is recognised more widely as a set of risks to be managed.
  • Risk managers can work to challenge around why organisations’ cultures should be audited.
  • While some organisations will want ‘to do well while doing good’, moves around transition to net zero may not always align to fiduciary duties. There will be hard choices where, for example, something delivers a better return but is less sustainable. The role of the risk manager is to examine the risks, putting values against trade-offs and identifying how the risks in play might be managed.
  • Insurers too may need to develop their approaches to avoid penalising organisations making sustainability moves that could be taken as heightening certain risks and therefore generating higher premiums.
  • Boundaries of what gets measured should be widened, as should time horizons. Risk professionals may find themselves participating in a revolution around how risks are expressed to include contingent liabilities over extended timelines, for example, the BoE’s stress tests to 2050. Longer-term risks will be increasingly explicit, as opposed to implicit, and therefore harder to ignore.
  • Risk management is the perfect ‘docking point’ for ESG and the investment function when ignoring risks becomes a deliberate action. This is particularly true around D&O liabilities, including those around climate-related risk disclosure, which could be a catalyst for boards to look at ESG factors and the cultures that support sustainability.
  • Where it proves challenging for boards to appreciate longer-term ‘trends risks’, the risk manager has a valuable role to play in defining the potential erosion of value posed by issues such as climate change. They may also expect to take the lead on directing budgets to recognise the magnitude of sustainability risks when compared to other risks such as cyber.

If your organisation needs support building a sustainable culture or managing ESG risk, get in touch.

Footnotes

1 https://www.bankofengland.co.uk/stress-testing/2022/results-of-the-2021-climate-biennial-exploratory-scenario

2 https://www.ft.com/content/14beafb8-48db-11ea-aee2-9ddbdc86190d

3 https://www.frc.org.uk/getattachment/9fc6c466-dbd2-4326-b864-c2a1fc8dc8b6/FRC-Creating-Positive-Culture-Report_December-2021.pdf

Contacts

Co-Head of the Thinking Ahead Institute at Willis Towers Watson

Rowan Douglas
Head of Climate and Resilience Hub

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