How ESG practices help to enhance corporate resilience

THE world we live in is environmentally challenged and is now posing risks to human health, leading to human cost.

The monetary costs of climate change now represent a significant financial risk to economies and businesses globally. The World Health Organisation is calling for progress in the areas of clean energy, work and economic growth and climate action to reduce some of the world’s most serious disease threats.

Companies must look to adapt their value-creation plans in the new business landscape and optimise performance against current and future key environmental, social and governance (ESG) issues to safeguard their operations and ensure long-term success.

To thrive in the 2020s, companies will need to understand the forces that will shape the next 10 years and recognise the rising opportunities to their advantage.

Building a resilient business is increasingly dependent on businesses preparing for the impact of non-financial risks, as the risks from ESG issues such as climate change, water scarcity, talent retention, waste management have now become more apparent, with the growing investor attention and action on ESG issues.

To succeed in the coming decade, investors and companies must equip themselves with forward-looking and proactive approaches to determine materiality and its impact to the business. The objective of a company is to ensure sustainable economic prosperity to its shareholders and stakeholders, while preserving the social and environmental equity and value creation to the nation.

The impact of Covid-19 signals not only a health crisis of severe proportion, but also a reflection of the broader trend of more planetary crises to emerge. This is the wake-up call for an imminent restructuring of the global economic order. It is time to incorporate the risks and threats of not only pandemics, but also climate change, waste management and biodiversity loss and shift towards green and circular economy.

In an ever-changing world where businesses are faced with emerging issues, it is paramount for companies to address a paradigm shift in its existing business models. The impact of ESG risks will threaten and harm our capital markets and will affect corporate performance. Recent examples include:

> More than 20,000 employees and contractors staged a walkout at Google, noting the company’s culture of sexual harassment, lack of transparency and non-inclusivity (1) ;

> The Federal Reserve imposed a cap on Wells Fargo’s assets and forced changes to the company’s board, citing “widespread consumer abuses” and poor corporate governance practices (2); and

> The Wall Street Journal called PG&E’S 2019 bankruptcy following the devastation of the 2018 Camp Fire in California “the first climate-change bankruptcy” and noted that the uncertain risks posed by climate change will likely cause significant disruptions across industries (3).

(1) BBC News. Google staff walk out over women’s treatment. 1 November 2018. https://www.bbc.com/news/technology-46054202

(2) CNN. The Fed drops the hammer on Wells Fargo. 3 February 2018. https://money. cnn.com/2018/02/02/news/companies/ wells-fargo-federal-reserve/index.html

(3) Wall Street Journal. PG&E: Wired to Fail. 28 Dec. 2019. https://www.wsj.com/articles/pg-e-wired-to-fail-11577509261

It is the responsibility of boards and management to review how business model is changing and will continue to be disrupted and how should companies should be better prepared to reduce risk exposures and minimise financial impact and missed opportunities.

Over the past few years, global and Malaysian political shifts have impacted on the business community. However, it is our experience that many businesses are still operating under the business as usual model, notwithstanding changes in our political situation, shifts in regional and global geopolitical risks and economic conditions.

Despite the call to action by the Securities Commission and Bursa Malaysia for companies to report the management of climate risk, we find that many corporations in Malaysia still rate this risk as “Medium to Low”.

Most Malaysian companies rate climate change risk from an internal perspective, for example, electricity cost rated as operational overhead risk and expense based on how much electricity is consumed in its operations and not across how the electricity was sourced, which bears the direct impact to carbon emissions into the environment nor are companies measuring how much carbon footprint does each product consume in its productions and delivery to the end-user.

Environment and social issues have the potential to impede corporate plans, performance and even business models. To discharge fiduciary responsibility, directors need to be able to understand and evaluate material risks facing the business.

When a social or health matter such Covid19 or an environmental force poses material risks, directors now need to consider those risks in decision-making in order to adequately discharge their fiduciary responsibility.

Investors and financiers are making connections between sustainability and materiality on one hand and against financial performance on the other hand. As a result, these stakeholders are focusing on the critical role the board plays in ensuring the resilience of the company’s assets and its longterm business strategy.

Our preliminary analysis of total shareholder return of 25 public listed companies on Bursa Malaysia Securities Bhd from Jan 2017 to Dec 2019 revealed that companies with a clear direction and purpose on sustainability management, with institutionalised sustainability targets and metrics and with good disclosure on sustainability performance, were able to deliver better total shareholder returns and demonstrate higher business resilience.

The current challenges and uncertainty of the future requires companies to re-evaluate their mainstream risks and ESG factors, given that ESG cohesion is already gaining scrutiny from regulators and investors, long before this pandemic crisis.

Companies should review the existing risk management processes to ensure the adaptability and agility of the companies’ enterprise risk management framework in addressing the changing risk and market landscape. When assessing risk, the systemic and interdependent nature of ESG risks can make evaluating their impact quite challenging. Esg-related impacts are likely to occur or intensify over a dynamic time frame.

Directors need to consider, frame conversations and question management to identify the connections and dynamics of these risks against corporate strategy. Boards should also be aware of the contagion effect of various ESG risks and that when one event or risk is realised it may have a domino effect across multiple areas of the economy.

For example, risk arising from weather events giving rise to infrastructure damage, agriculture losses and spike in commodity prices, caused by increasing severity of floods, are all examples of how impacts from climate risk can spread through the financial system and the companies they underwrite.

Covid-19 has also reminded companies on the importance for sustainable innovation as this safeguard’s companies’ business resilience in the long term. Business leaders have become more anxious of the outcome of the pandemic and the impact on their business continuity.

ESG considerations have a role in advocating and institutionalising innovation and has become a fundamental aspect of business continuity and sustainable growth. Innovation is focused on long-term resources and environment efficiency, rather than short-term revenue and profits.

A good business continuity plan would ensure that resources are not consumed faster than they can be regenerated and the ability to sustain and rebounce during the period of prolonged interruptions.

Change to meet emerging risks, companies must innovate as it facilitates to manage emergent issues, for example, the new practices and policies required across mechanisms that enable top-down and bottom-up change at different levels of the organisation, with systems and networks and employee behaviours and incentives.

The maintenance of resilience will require effective innovation as it is a central aspect of adaptation. For businesses, where failure is not an option, rather than focusing on increasing the time between failures, the focus should shift to re-engineering resilience and minimising negative impacts and creating new opportunities.

There is a need for visibility into supply chain data, and ability to provide services digitally across borders. Transformation of the supply chain management determines whether companies have secure and diverse, cost-effective and most importantly, the availability of supplies in the future.

During a crisis, ensuring supply of materials becomes critical for the survivability of companies. Investing in supply chain management technologies improves the management of supplies across network and better manages unpredictable supply shocks.

Another key effort required from businesses is to improve supplier risk identification and communication before, during and after disruption. This would enhance companies’ supply chain resilience to vulnerabilities related to the overall management of long supply networks.

Companies should establish credible networks, consisting of suppliers, customers, peers, the government and regulators that are focused on supplier risk management. It is also imperative to incorporate supply chain disruption as a mandatory part of the supplier performance evaluation metrics.

Supply chain and transport risks should be assessed as part of procurement, management and governance processes. During the evaluation, suppliers should be communicated to participate in supply-chain mapping programme to respond to any event such as the pandemic outbreak and these programmes can be a useful tool to provide solutions to achieve business resilience.

Leveraging on advanced technologies such as the Internet of Things (IOT), artificial intelligence (AI), robotics and 5G, companies must be designed to anticipate and meet future challenges, even at times of a pandemic outbreak, trade war, regulatory change, labour dispute or supply chain issues.

The increasing demand for remote interactions amid the pandemic has demonstrated the need for 5G technology as a long-term infrastructure. The convenience, fast speed and elevated connection density will drive solutions for remote interactions that companies are currently exploring.

Challenges arising from the Covid-19 accelerate the use of existing and new technologies and tools as consumers and employees are under mandatory control order, and millions of people are ordered to work from home.

Companies focused on becoming learning organisations to learn, improve, or innovate will gain an edge over their competitors. Companies should leverage a variety of metrics to remain resilient and focus from maintaining to improving and innovating activities, processes and procedures.

This facilitates companies to secure new ways of collecting data and analysing the real value of metrics to understand the context of data, its incremental improvements and key obstacles. Continually understanding and responding to stakeholders feedback from data monitoring allows companies to use information about events in the past to drive future actions.

Kasturi Nathan is partner and head of governance and sustainability, KPMG Malaysia while Phang Oy Cheng is eexecutive director, governance and sustainability, KPMG Management & Risk Consulting Sdn Bhd. The views expressed in this article represent the individual perspectives of the writers and do not necessarily represent the official views of any affiliated organisations.