Integration with Risk Management
Caption 11:
Are the environmental commitments driven by risk management or opportunity?
In truth, it began out of risk management. We knew the world was changing rapidly and expectations of businesses were changing, and quite frankly we wanted to be able to defend ourselves if we were attacked on an environmental issue. But we soon realized that this wasn't a defensive area at all. In fact, we started seeing it as something we could be proactive about, a business strategy. It's not an easy path, but we now see it as the greatest opportunity we have to create value for our customers, cut costs, increase morale, grow responsibly, and do the right thing for the planet.
How does this environmental commitment fit into Wal-Mart's mission as a company?
We've built our business on improving the quality of life for our customers, associates, suppliers, and their communities. And we have innovated all the way down and up our value chain to increase the value we offer and to grow our business. Our environmental commitments fit perfectly into this model. In fact, innovation is essential if we are going to make good on our commitment to improve the quality of life for customers and people around the world. Like other innovations that have defined our business, empowering our people and trusting them with responsibility are key to our success.
Extract from interview of Wal-Mart CEO Lee Scott on how striving for sustainability is leading to a better Wal-Mart and a better world.
Background
Organizations that proactively identify and manage risks tend to be in a better position to seize opportunities. This applies to managing sustainable development opportunities and risks, which include environmental, social, and economic issues. These opportunities and risks are best considered as part of an existing risk strategy and approach, rather than as a newly created layer of risk management focusing specifically on sustainability issues. Integrating sustainable development opportunities and risks into an existing framework and strategy should allow for a better understanding of their relationship to an organization's business goals and other activities. As was the case with Wal-Mart (see Caption 11), it often inspires employees to consider the opportunities presented to an organization by sustainable development issues. A good measure of whether sustainable development is embedded into organizational operations and general good management is the extent to which an organization (a) astutely manage risks, attuned to social and environmental sensitivities, and (b) recognizes the opportunities for improving both its financial and sustainability performance.
The key aim of a performance-based enterprise risk management (ERM) process, such as the one espoused by the Committee of Sponsoring Organizations of the Treadway Commission in its 2004 Report Enterprise Risk Management - Integrated Framework, and in the IFAC/CIMA 2004 report on Enterprise Governance, Getting the Balance Right, is improving an organization's risk management by integrating strategic planning, operations management, and internal control. Through regular and ongoing communication with an organization's key stakeholders, an ERM approach will facilitate coordination to provide a unified picture of risk for stakeholders.
According to IFAC/CIMA's Enterprise Governance report:
Central to the requirements of enterprise governance is a clear relationship between the management of risk and the fulfillment of business objectives... It is this recognition of a performance-driven approach to risk management - one that is wholly aligned with the spirit of good enterprise governance - that has given rise to the concept of enterprise risk management.
This report defines the key steps required for developing an appropriate performance-focused approach for risk management at the board and executive management level. The steps that are outlined in the report include (a) establishing an acceptable risk appetite, (b) a risk management strategy, and (c) a risk management framework.
An ERM framework allows better management and responsiveness to risk factors that cover a range of issues and responsibility areas. For example, companies participating in an emissions trading scheme can find that carbon risk management will cover a range of risk areas, including:
- Cash flow risks, such as increased expenditure on measures to reduce emissions, or to purchase allowances;
- Reputation risk, which may influence financial ratings and market capitalization; and
- Capital cost risks, such as more stringent credit conditions as a result of increased credit risk.
Investors may also factor an organization's carbon-related risks into estimates of its future cash flow streams.
Key Considerations
Integrate risk management: Sustainability opportunities and risks spanning environmental, social, or economic performance should be considered as part of an ERM framework, rather than as specific risks that are managed outside the existing risk management strategy and framework and related policies. Where an organization has specialists who manage aspects of their sustainability program, for example environmental or health and safety specialists, risks associated with these activities should be considered within the wider ERM framework. As with other risk types, specific managers and specialists can advise how to manage the risk, including whether to transfer some or all of it, how to minimize it, and/or how to maximize upside opportunities (the risk management hierarchy is covered below).
Gather information: To properly appraise and integrate sustainable development risks, an organization might need more information about those risks, to put it in a position to compare them with other risks. The approach to managing and assessing these risks will depend on the quality of information on these risks. However, as part of developing a risk management strategy, it is also important to consider the resources required to obtaining information, as there will be a point where the cost of obtaining information exceeds the benefit. For example, the cost of research required to assess the benefits of a reduction of environmental risk might outweigh the risk itself.
Assess potential impact: After a risk profile is established, risks need to be measured for potential impact. This can involve a number of steps, including: (a) calculating the benefit and costs (including potential reputational impact) associated with each risk; (b) estimating the probability that a risk will materialize; and (c) determining the expected impact of each risk by multiplying potential cost and probability. In his 2008 book, Making Sustainability Work, Marc Epstein shows in chapter 7 how measuring social and political risks can lead to the their integration in ROI calculations.
Interpreting risk and causation: As with all types of risk (but perhaps more so with environmental risk), it can be challenging to interpret risk factors and causation. In his article, Tensions in the Environment, in the Financial Times Managing Risk series, Forest Reinhardt reinforces the importance of clear interpretations of environmental risk. For example, environmental risk is both the business risk that arises from social concern about the environment, and the public risk of damage to the environment and to public health and safety. The two interpretations are not the same. Either kind of risk can exist without the other, and although business risk is more relevant to an organization, public activists will be interested in the wider environmental risk. Professor Reinhardt states that:
Because "environmental risk" encompasses so many different but interrelated risks, it is imperative that managers think precisely about the kind of risk that they are really trying to manage. Above all, managers need to bring to the job of environmental risk management the same analytical tools that would instinctively apply to other risk management problems. They need to understand the effects of various possible investments in the management of that risk, whether the investments are in risk-shifting, risk reduction or risk information. They must also understand how environmental risk management relates to the overall goals of the company.
Dealing with risk: Consider a set of options for dealing with risk (see Caption 12) that starts with a proactive approach as opposed to a reactive one. The first step, 'risk to opportunity,' involves considering the opportunities that might arise from discussions on potential risks. It could be called an opportunity assessment. Organizations may have potential revenue drivers to consider, for example, generating new revenue streams from low-carbon products, and new sources of income such as from carbon credits (in a carbon trading system). Many organizations have turned discussions on climate change risk into a dialogue on identifying opportunities to develop new products and services, and to enhance their market credibility. Subsequent risk actions are risk avoidance, mitigation, and the option of taking no action in response to a potential risk. The Sigma Project (Sustainability Integrated Guidelines for Management), launched by the UK Government in 1999, has useful guidance on many aspects of sustainability, including on dealing with (sustainability) opportunity and risk. Another useful Sigma guide covers sustainability issues; this guide briefly explains common sustainability issues. The issues included in the guide can also provide a useful indication of the sources of typical sustainability risk facing organizations.
