Managing environmental, social and governance (ESG) risks can be challenging for companies, due to possible resulting reputational damage or legal liabilities. Global Risk Dialogue looks at five important ESG issues for 2020.
ESG factors cover a wide spectrum of issues that have the potential to impact a company‘s reputation, including environmental stewardship such as climate change or carbon emissions; relationships with employees, suppliers and customers; human rights; and anti-corruption practices.
Sustainability-conscious investors, regulators, governments and potential customers increasingly expect companies and their boards to appropriately focus on ESG issues.
It is unsurprising, then, that investing in ESG is big business: worth over $30trn in 2018, with estimates to surpass $50trn over the next 20 years [1] . But not every investor is the same. For example, some refuse to invest in companies not divested from tobacco, fossil fuels or weapons stock.
Conversely, some activist investors seek companies in order to influence improvements through shareholder proposals, board meeting attendance or direct communication with officers.
Five key trends that will impact businesses’ ESG footprint in 2020 and beyond are climate change, water management, biodiversity, human rights and governance policies. What challenges do companies face – and how can risk management respond?
The 1 minute dialogue
- ESG factors cover a wide spectrum of issues that have the potential to impact a company's reputation
- Investors, regulators, governments and the public increasingly expect companies and boards to focus on ESG issues
- Impact of climate change, water management, biodiversity degradation, exploitation in supply chains and corporate governance issues are main ESG trends to watch in 2020
- Effective management of sustainability issues is now a competitive advantage
1) Climate change drives increased exposure for business
Climate change is a key challenge of the coming decade. In the Allianz Risk Barometer 2020 climate change was selected by 17% of respondents as the top business risk – up from 13% in 2019. Its growing cost is already noticeable, as the number of weather-related or flood loss events has increased by a factor of three to four since 1980 [2]. And according to a recent report from Climate Transparency, there are 16,000 fatalities in G20 economies due to extreme weather events every year with the economic impact estimated to be $142bn annually [3].
Climate change can affect businesses in many ways. An increase in physical losses from more severe weather events is the exposure businesses fear most according to Allianz’s survey, as rising seas, drier droughts, fiercer storms and massive flooding pose threats to factories and other corporate assets, as well as transport and energy links that tie supply chains together. Further, businesses are concerned about operational impacts , such as relocation of facilities, and potential market and regulatory impacts.
“There are also litigation risks, which can easily become reputational and financial risks, as in the case of fossil fuel companies,” says Christopher Bonnet, Head of ESG Business Services at AGCS. “Climate change cases targeting ‘carbon majors’ have already been brought in 30 countries around the world, with most cases filed in the US. It’s not just governments and regulators who are putting pressure on companies to positively respond to climate change, however. Climate-linked activism against corporates is a developing trend – particularly in Europe – and boards are increasingly challenged by investors and other stakeholders.”
Overall, Allianz estimates that responding to the challenges posed by climate change could cost companies worldwide as much $2.5trn over the next 10 years. However, it can also provide new business opportunities, such as renewable energy production methods, battery production, rare earth mining or new technologies like hydrogen generation from excess renewable power.
Insurance is also responding: Allianz, selected by the Dow Jones Sustainability Index as the most sustainable insurer in the world over the last three years, has specifically addressed climate change in its ESG response to insurance and investing (see below).
Allianz Climate Strategy and Performance: Timeline
2000: Begins sustainability integration
2012: Begins climate neutrality in business operations
2015: Exits from coal investments – divested $359.4mn in proprietary investments and around $6.3mn in fixed-income securities
2017 to 2019: Named most sustainable insurer in the Dow Jones Sustainability Index (DJSI)
2017: Applies ESG scoring in the investment of policyholders' money
2018: Implements climate package: Allianz investment portfolio (insurance policies) will be gradually adapted (interim targets every five years including reporting) to Paris climate targets; climate neutrality until 2050; all coal-based business models will be removed from the insurance portfolio in five-year steps until 2040; membership of the Science-Based Target Initiative; and will switch to 100% renewable electricity by 2023
2019: Co-initiation of the Asset Owner Alliance, an association of asset owners, with the aim of making the portfolio carbon-neutral by 2050; has set ambitious climate target of reducing by 1.5˚C by 2050.
While it takes an entire corporate team to prepare to adopt climate change guidelines – officers, management, governance and reporting, risk management, employees and market-facing functions – risk managers should drive ESG and climate change focus internally to influence decisions, says Bonnet.
- Christopher Bonnet, Head of ESG Business Services at AGCS
2) Water management strategies critical, as misuse comes under increased security
By 2050, the world’s population is expected to reach 9.7 billion [4] – while global water demand is expected to increase by 20% to 30%, mainly due to demand in the industrial and domestic sectors. Currently, over two billion people [5] are living in areas of high water stress and almost half of the global population – about four billion people – experience severe water scarcity during at least one month of the year. Stress levels will only increase as the demand rises and the effects of climate change intensify.
Besides demand, there is the question of quality. Three out of 10 people can’t access safe drinking water – almost half of those in Sub-Saharan Africa. Six out of 10 can’t access safely managed sanitation services. “Water is a big issue for citizens and companies, alike,” says Bonnet. “Not just concerns about its abundance, but also its purity, its scarcity in a warming climate and its over-use and poor management.”
Agribusiness and farmers, thermal power plants, textiles and garment manufacturers, meat processers, beverage manufacturers, mining and automotive manufacturers are some of the most water-intensive sectors demanding abundant, safe water, but how companies treat such resources is coming under increasing public scrutiny. Beverage giants, Coca-Cola and Nestlé, are among a number of companies who have been accused of abusing local water resources for production – the former has faced accusations in India over water resources in the past [6], and the latter has faced accusations that it pays too little for the product it bottles [7], to name just a couple of examples, as companies come under growing pressure to adopt more sustainable water management and consumption practices for society at large.
Today, more than ever, companies are expected to protect water resources, prevent pollution and reduce their consumption through modern water management practices. Rethinking existing water supply models can benefit local communities and release water stress in certain areas.
Insurers can help water-intensive businesses to identify and assess their dependency on local water supplies and potential water shortages as part of their business continuity planning.
3) Biodiversity: Increasing degradation brings issues for corporates
Just a few statistics [8] illustrate the problem our earth is facing in the 11th hour. One million natural species are threatened with extinction, many in a few decades, as three-quarters of the land-based environment on earth and about 66% of the marine environment are impacted by human activity.
Land degradation due to storm or drought has reduced the productivity of 23% of the land’s surface globally – costing up to $577bn in annual global at-risk crop production while depriving up to 300 million people of their livelihoods due to coastal habitat loss. Plastic pollution has increased tenfold since 1980, even as 300 to 400 million tons of heavy metals, industrial waste and sludge are dumped annually into global waters.
Authorities warn continued focus primarily on economic growth and unregulated competition will only exacerbate the crisis. Sustainable consumption practices can slow, but not completely eliminate, future biodiversity loss, in part because warming will continue in all scenarios.
One million natural species are threatened with extinction. About 66% of the marine environment are impacted by human activity. Picture: Adobe Stock
Human disruption of key ecosystems can have a real impact on the environment. For example, a 28% reduction in mangrove cover in Southeast Asia to allow more commercial shrimp farming in recent decades contributed to a loss of natural protection against tsunamis and cyclones that impacted the devastation of the 2004 Boxing Day tsunami [9]. Other examples of disrupted biodiversity are deforestation in Amazonian and Indonesian rainforests which both suffer increasing pressure from industrialization and related fires to clear land. “There’s no question human activity affects the earth’s health,” says Bonnet. “Businesses must understand profitability will actually be reduced if they continue to exploit natural resources without considering the reputational, fiduciary and regulatory consequences of their actions.”
More and more companies are adopting so-called "circular economy" strategies with the aim of no longer allowing products to become waste after their use. Instead, they are reintroduced into the production cycle as secondary raw materials. Products made of secondary materials range from leftover food to building materials from scrap tires. Nike's "Reuse-A-Shoe" program recycles running shoes into athletics tracks and playground surfaces. Especially, resource-intensive industries benefit from the reprocessing of used materials.
"Companies which are leveraging the sustainable aspect of existing products or committing research and development resources to bring sustainable products to market are more likely to find a competitive advantage and be more efficient in managing other sustainability initiatives," says Bonnet.
4) Companies are accountable for exploitation in the supply chain
Although human exploitation can take on many forms – forced labor, forced marriage, modern slavery, child labor, and so on – it can be difficult to detect in the supply chain. Industries such as textiles, food and agriculture, electronics, sports, construction, hospitality and domestic service have been especially connected to modern slavery and suppliers in those sectors are at-risk, although all sectors are vulnerable.
In the past five years, the Bangladesh Accord on Fire and Building Safety has greatly improved the dire safety situation in Bangladeshi garment factories, following the devastating Rana Plaza collapse, which killed 1,134 workers in 2013. The tragedy highlights how many global clothing multinationals abused workers for long hours, six days a week, at poverty wages. Still, in the years since, at least 40 workers have died and over 500 have been injured in incidents [10].
More enforcement in the area of human rights and holding directors responsible for transparency in supply chains is gaining traction. Corporations that fail to take appropriate steps to eliminate human exploitation from their supply chains could face shareholder derivative suits, more directors and officers (D&O) claims and reputational risks. Businesses need to consider that they are responsible for assessing and policing their supply chains. Insurance risk management can help, but the onus is on companies. "Diligence is key,” says Bonnet. “Companies can instill a supplier code with various degrees of implementation rigor. Risk management can help if businesses supply an audit of a supply system and determine gaps and suggest solutions.”
Companies should hold vendors and suppliers contractually accountable to fair wages, working hours and humane treatment before doing business. By implementing the right checks and balances to address violations, companies can be compliant and forthright to customers, vendors, suppliers and investors. When an infraction is discovered, businesses must act quickly and state publicly that they won’t tolerate violations of their supplier code of conduct.
AGCS itself has a vendor integrity screening process, including prevention of corruption, bribery and other forms of noncompliance, modern slavery, human trafficking and child labor, and has a vendor code of conduct in place complying with essential human rights and standards of the UN and its International Labor Organization (ILO). AGCS maintains a system of quality assurance and auditing activities which cover an internal mechanism to ensure adequate controls for various types of global risks.
5) Governance issues continue to demand business diligence
Increasingly, businesses and their directors are held responsible for corporate practices that foster good stewardship with the earth and its inhabitants, while maintaining sound corporate governance, even as more investors, in evaluating a company, hold it up to ESG standards. “It’s important for company prospects if a company treats its employees right, operates ethically, avoids reputational risks and earns most of its revenues from sustainable activities,” says Bonnet.
Corporate misconduct has resulted from obvious practices such as bribery or corruption, as well as more common, if more recent, practices such as data privacy handling, allegations of financial misconduct and money-laundering schemes. Having inclusive institutional structures in place for multi-stakeholder dialogue and cooperation is essential to ensuring good governance and compliance practices. Well-functioning accountability mechanisms help institutions fulfill their mandates to monitor and enforce the obligations of service providers in the supply chain, as well. Corruption, excessive regulation and/or rigid conformity to formal rules can increase transaction costs, discourage investments, and potentially derail or hinder reforms.
“Good governance relates to systems that have qualities of accountability, transparency, legitimacy, public participation, justice and efficiency. Insurance rewards these best practices. Firms do not want to fail on governance – it’s literally their bottom line,” says Bonnet.
[1] The New York Times, Coronavirus Outbreak Deepens Its Toll On Global Business, February 21, 2020
[2] Munich Re, Trends In Weather-Related Disasters: Consequences for insurers and society, March 2016
[3] Climate Transparency, Brown To Green, The G20 Transition Towards A Net-Zero Emissions Economy, 2019
[3] Climate Transparency, Brown To Green, The G20 Transition Towards A Net-Zero Emissions Economy, 2019
[4] United Nations, World Population Prospects 2019: Highlights
[5] Worldometer, Current world population (as of January 14, 2020)
[5] Worldometer, Current world population (as of January 14, 2020)
[6] Financial Times, Water shortage shuts Coca-Cola plant in India, June 19, 2014
[7] Bloomberg, Nestlé makes billions bottling water it pays nearly nothing for, September 21, 2017
[8] Intergovernmental science-policy platform on biodiversity and ecosystem services (IPBES), Nature’s dangerous decline ‘unprecedented’, May 7, 2019
[9] World Economic Forum, Biodiversity and business risk, January 2010
[10] Clean Clothes Campaign, Six years after deadly garment factory fire, Bangladesh risks new wave of factory incidents, February 9, 2019
[7] Bloomberg, Nestlé makes billions bottling water it pays nearly nothing for, September 21, 2017
[8] Intergovernmental science-policy platform on biodiversity and ecosystem services (IPBES), Nature’s dangerous decline ‘unprecedented’, May 7, 2019
[9] World Economic Forum, Biodiversity and business risk, January 2010
[10] Clean Clothes Campaign, Six years after deadly garment factory fire, Bangladesh risks new wave of factory incidents, February 9, 2019
Download Global Risk Dialogue Winter/Spring 2020
This article is part of the our Global Risk Dialogue. Appearing twice a year, Global Risk Dialogue is the Allianz Global Corporate & Specialty magazine with news and expert insights from the world of corporate risk.
Newsletter
Keep up to date on all news and insights from Allianz Commercial
