Sustainability: the new face of risk
Sustainability is simply a 21st century extension of traditional risk management. As an emerging arm of an established practice, sustainability requires rigorous interrogation of existing approaches, such as scenario analysis and stress tests, as well as through the development of new, next-generation techniques. However, as I’ve learned at various stages of my career — for example, when developing innovative climate-related risk mitigation plans for countries at the World Bank — robust risk assessment is impossible without reliable data.
By identifying ESG risks, companies can inform their thinking on managing and mitigating those ESG risks. In turn, by reporting the ‘key risk indicators’, investors can use this decision-useful information to allocate capital to the most efficient users of that capital. Together, this group of increasingly risk-aware market participants can foster economic growth that is both sustained and sustainable.
The evolution of risk
The emergence of ESG factors as key signals of risk and return is the latest evolutionary development on the very same continuum of risk management that I’ve been engaged in over my entire career. Since the 1980s, our understanding of risk has become more nuanced — beginning with fundamental credit risk and adding new layers of market, model, operational, reputational, and cybersecurity risk, for example — and it will continue to do so. ESG is simply the next step forward.
This recognition has driven much of my work in recent years. During my time as Vice President and Treasurer of the World Bank, for example, we executed the largest weather and energy derivative the market has ever seen to help a country that is hydropower-dependent mitigate the risk of droughts and high energy prices. We developed catastrophic risk structures to help member countries mitigate and transfer risks related to the extreme weather events exacerbated by climate change. And we used our convening power and international influence to advocate for global standards for issuers of green bonds, a market which the World Bank and the European Investment Bank developed and helped kick-start. These efforts were not focused on driving either economic growth or social outcomes — they were engineered to achieve both.
It is also important to recognise that macroeconomic risks such as global warming are often associated with underlying microeconomic drivers. Where individual actors, such as companies and their investors, may struggle to get traction on an unwieldy megatrend like climate change, they can far more readily manage their energy efficiency if they are a manufacturer, their business continuity planning if they’re in health care, or their product design if they’re an automaker.
In such cases, mismanagement of what would traditionally have been considered ‘non-financial’ risks and opportunities can have clear, direct, and significant financial impacts for both companies and their investors. In other words, ‘non-financial’ risks become financial risks just as in traditional risk management we have seen market risk can become counterparty credit risk, which can become liquidity risk, which ultimately and quickly can become, as we have seen before, fatal for a company.
Creating shared value
With a background in economic research and 30 years applying quantitative analyses in various aspects of business and the capital markets, I have always found it invaluable — even essential—to ensure risk-based strategies are rooted in robust, data-driven models that not only support forward-looking projections but can also be validated through back-testing. The importance of assessing and disclosing financially material sustainability risks and opportunities is no different and helps companaies create sustainable, long-term value for themselves, their shareholders, and society at large.
This blog has been extracted from Sustainability Accounting Standards Board (SASB) Foundation. Read the full blog on their website.
Madelyn Antoncic, PhD, is CEO of the SASB Foundation. She also serves as a member of the Board of Directors of S&P Global Ratings and Fin Tech Acquisition Corp III and serves on the Board of Overseers of Weill Cornell Medicine. Formerly, she has held a variety of leadership roles with global financial institutions in both the private and public sectors, including the World Bank, Goldman Sachs, and Lehman Brothers.
Catch Madelyn Antoncic discuss common principles of materiality and frameworks for cross-sector engagement on climate risk at Governance Institute of Australia's National Conference 2019 in Sydney, 2 to 3 September.