Risk Management Strategies for Operational Execution, ESG Performance and Change Management.

How can SMBs, SMEs and Large enterprises improve and optimise their risk management strategy?

Operational Risk Management and ESG

Traditional risk management strategies, such as those used by businesses in operational risk management, focus on identifying, analyzing, responding to, and monitoring risks and opportunities, within the internal and external environment facing the business.

Often management selects a risk response strategy for specific risks that have been identified and analyzed, which may include strategies such as avoidance, reduction, risk transfer, or acceptance due to a cost/benefit decision. In traditional risk management strategies, risks have tended to be assessed in terms of 2 parameters: frequency and impact. This has also often been the case in terms of Environmental, Social and Governance (ESG) reporting and analysis. For example, globally many companies now report to CDP (previously Carbon Disclosure Project) on environmental risks such as related to climate change and water in terms of the risk frequency and the risk impact. Risks have also tended to be analyzed in isolation with each key risk being assigned to an expert as the risk owner.

Strategies for managing Systemic Risks

In recent decades, we have contributed, collectively, to the creation of a globalized economy in which exogenous risks; risks that originate elsewhere in the global interconnected system and spread to local operations; have become increasingly critical as the Covid-19 pandemic has underscored. While traditional risk methodologies focus mainly on localized, endogenous risks; exogenous risks require a new methodology of systemic identification and measurement.

This transformation of the global risk landscape is exemplified by the latest annual Risk Report from the World Economic Forum (WEF) published in 2021[1]. Since 2007, the WEF has undertaken an annual global study using expert elicitation to assess the top risks facing the global economy over the following 10 years.

According to the 2021 WEF Report, most of the top risks are human-induced systemic risks connected to anthropogenic environmental damage that includes climate change, biodiversity loss and also are closely connected to the current pandemic. The same WEF Report also highlights some of the complex interconnections between these top risks. Indeed, many scientific studies have also indicated how we need to tackle systemic risks together and not in isolation for more effective results.

Faced with this backdrop and in order to reduce exposure to today’s top risks, companies need to design and implement a change management strategy that enables them to identify, manage and integrate systemic ESG risk management across their organizations. At KPMG, we have developed our Dynamic Risk Assessment (DRA)[2] to help assess systemic risks. KPMG’s DRA, in addition to analyzing traditional risk measures around impact and likelihood we also consider other risk parameters including risk interconnectedness and velocity (the expected speed with which risks will affect operations).

As the seminal recent Dasgupta Review on the economics of biodiversity has reminded us our economies are embedded in the natural world and hence systemic risks around climate change and biodiversity are important to businesses everywhere, irrespective of their sector or location. In light of these global systemic challenges, effective corporate risk management must consider their internal and external risks such as arising from climate change and for these to be grounded in the latest peer-reviewed science.

What’s the definition of sustainability risk?

Sustainability risks can be considered as the consideration of non-financial risks encompassing the environment, social and governance risks such as those related to impacts from climate change, water scarcity, biodiversity loss, health, and safety, human rights, anti-bribery and corruption, and compliance with environmental laws and regulations. Many sustainability risks vary between companies based on a range of factors such as sector and location. However, systemic ESG risks such as climate change and biodiversity loss are risks to all businesses as all businesses, and all of us, rely on a stable climate and ecosystem services that are provided to us by the natural world.

Why is it important to incorporate ESG risk assessments in a business framework?

As noted above, many of the top risks facing business are now ESG-related risks and as a result of the modern risk landscape, any effective risk management process must address both financial risks and non-financial ESG risks. What this means is that it is imperative for all organizations, irrespective of size or sector, to proactively monitor their ESG risks as part of their corporate risk management strategy. In this way, they can identify emerging ESG-related risks before they become material. They can also be proactive in designing an ESG strategy to mitigate their ESG risks and capitalize on their ESG opportunities. In short, companies need to develop an internal control system for ESG risk assessments and embed these into their business processes and frameworks.

In addition, given that many of the main ESG risks are systemic risks that the science makes clear are set to become more frequent and more intense under the current BAU trajectory, this has important implications for corporate risk management. It means that past performance will become a much less reliable indicator for future risk exposure. Instead, companies will need to analyze both historic data and also forward-looking data such as scenario analyses for climate risk. As KPMG we are heavily involved with Climate risk analysis solutions[3].

Another implication arising from the future risk profile being different is that both the public and private sectors will need to invest a lot more in resilience and adaptation interventions in order to be better prepared for more frequent and more extreme systemic shocks. If the risk of extreme events such as floods, hurricanes, or a pandemic changes from being a once in a century event to a much shorter time frame, it will mean that the state and governments will need to invest much more resources in contingency planning, disaster preparedness, and crisis management.

[1] https://www.weforum.org/reports/the-global-risks-report-2021

[2] https://home.kpmg/xx/en/home/services/audit/dynamic-risk-assessment.html

[3] https://home.kpmg/xx/en/home/services/advisory/risk-consulting/internal-audit-risk/sustainability-services/climate-risk-services.html