Assessment of Sustainability Risks and Opportunities

In order for directors to understand the scope of their responsibilities with respect to overseeing sustainability and determine how to best focus their energies, an assessment must be conducted of the issues, risks and opportunities that are material to the company’s operations, environment and communities.[1]  KPMG called on boards to conduct assessments, but conceded that identifying the strategically significant ESG risks and opportunities for a company is complex, as they vary by industry and sector, and even within industries, and that there is no standard approach that companies can take.[2]  However, KPMG recommended a two-step process described in the following paragraphs that most companies could easily use as guiding principles during the assessment stage.  The first step would be to identify and assess all the ESG and CSR issues that are material to the business and/or its stakeholders.  The second part—“material to stakeholders”—is important because it will assist the board in anticipating and understanding questions and pressures that the company may receive from the environment in which it is operating.  Admittedly, the list of potential issues is long and should generally start with the following:

• Climate change impacts
• Waste generation and management
• Water and other natural resource scarcity
• Environmental degradation
• Product and worker safety
• Supply chain management
• Workplace diversity and inclusion
• Labor practices, talent management and employee relations
• Health and human rights
• Executive compensation
• Political contributions
• Board independence, composition and renewal

This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
When assessing each issue, the company needs to analyze the likelihood and magnitude of the associated risks and opportunities and realize that weights and measures may change as time goes by and that assessment has to be a continuous process and not a one- time exercise.  In order to align the assessment with strategy, reference should be made to the issues that peer companies have cited in their sustainability reporting and to feedback from stakeholders collected during the assessment process.  While the directors do not have the time or skills to do the assessment on their own, they should nonetheless understand the steps that management is taking and use the process as a means for improving their own awareness of key economic, social and environmental sustainability issues that are engaging governments, businesses, other organizations and individuals in the worlds in which the company is operating.
The second step acknowledges that companies, regardless of their size and available resources, do best when they focus their attention on issues, risks and opportunities that are “strategically significant”.  While it is common for the initial assessment process to generate a list of six to eight issues that could affect the operating efficiency of the company, KPMG recommended that the directors themselves select and concentrate on just two or three issues that will fundamentally affect the company’s ability to remain competitive and which customers, suppliers and other stakeholders agree will be key to the company’s long-term success.  Selection is often difficult and choices will vary depending on factors such as the company’s principal basis for competing in the marketplace.  For example, a company dependent on strong branding needs to focus on issues that might adversely impact the company’s reputation and a company competing on price will be interested in initiatives that have the potential to further decrease the cost structure or provide protection from unexpected price increases in inputs.
While identifying risks is an important part of the assessment process, and many companies conduct the assessment under the broader umbrella of their enterprise risk management systems, KPMG admonished directors to make sure that management also takes into account opportunities that may lie within ESG and CSR issues and which can be leveraged by the company to compete in the future on the basis of innovation and disruption.  A few of the examples mentioned by KPMG included solutions that would thrive in a low carbon world such as products that facilitate energy storage and efficient energy use; services that support greater access to education, affordable housing and financial products that reduce income inequality; products and services that promote health and well-being and healthy lifestyle choices; and technology that accelerates the sharing economy.
Once the board has selected the most strategically significant issues, it needs to work with management to create specific goals and “commitments”, a process described further below, and establish metrics and key performance indicators that the board can use to measure progress.  The directors should also be sure that these issues are highlighted in communications to stakeholders that demonstrate how the company is integrating them into its long-term strategy for overall value creation.  Finally, the board should be sure that management is prioritizing the issues when making decisions about allocation of resources and that information regarding the issues is being disseminated throughout the organization so that different functions can develop their own systems and practices to make the best contribution to the new product and services that may be necessary in order to create a competitive advantage.
It is important to emphasize that KPMG and others recommend that boards focus on just two or three issues because directors have limited time and their attention needs to be carefully managed so that they can have the biggest impact.  This does not mean that management should adhere to the same limitations and, in fact, the board should task management with continuously monitoring a wider range of material issues using internal and external resources allocated by the board for that purpose.  Directors should expect regular reports from management on the evolving portfolio of ESG and CSR issues, risks and opportunities so that the board can, if necessary, make changes in how it goes about exercising oversight in this area.  Material, although not strategically significant at the present time, issues also need to be managed as part of the company’s enterprise risk management system and will need to be discussed and disclosed in reports to regulators such as the Securities and Exchange Commission and in stakeholder communications.
Sources for this article included S. Taylor, Seven Steps to Implementing Board Oversight of Sustainability (February 21, 2017); and ESG, Strategy and the Long View: A Framework for Board Oversight (KPMG LLP, 2017), 8-9.  KPMG recommended that the provisional sustainability standards developed by the Sustainability Accounting Standards Board, which cover a broad range of industries in numerous sectors, can provide a reference point for identifying industry-specific sustainability factors that are reasonably likely to have material impacts.
This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedIn, Twitter and Facebook.