COVID–19 pandemic highlights the need for companies to adopt a different approach to ESG risk management

May 2020

The tragic outbreak of COVID-19 has taken the world by surprise due to its speed and ferocity and is challenging the overall resiliency of economies and society globally. It has been designated the term ‘systemic risk’, a term also used for cyber security and climate change. 

With regards to the business world, the widespread impact of COVID-19 is also revealing a significant vulnerability in corporate supply chains including lack of resilience. As businesses struggle to protect employees, secure raw materials and components and protect supply lines, companies that invested in mapping the risks inherent in their entire supply and distribution networks before the pandemic have emerged better prepared as they have better visibility into the structure of their supply chains. 

The investment community is now at an inflection point on how to value and assess the treatment of human capital in corporate supply chains given the potential for disruptions and delays due to poor living and working conditions that contribute to the spread of the virus.

The insurance industry is also bracing itself for billions of dollars of claims because of legal action due to COVID-19 against the directors of companies due to alleged lack of preparedness, a lack of emergency planning, a lack of supply chain alternatives or discriminatory behaviour towards some employees.

Traditional risk management approaches which focus on historical data and use assumptions of ‘normal’ distribution to map certain outcomes are now not fit for purpose. Systemic risks such as climate change - with its associated extreme environmental, social, geopolitical and economic consequences - will bring about an entirely new normal, far beyond what any financial model can anticipate. 

What can companies do?

Many businesses are still trying to satisfy investor stakeholder needs by publishing CSR and legally required information in their CSR reports and annual reports respectively but this information is of little value for investors to make informed decisions or understand the risks and opportunities landscape i.e. financial materiality. 

Companies need to carry out holistic analysis of risks and opportunities and for these risks to be factored into an organisation’s board level decision-making. If the companies do not understand these material issues in the first place, there will always also be a gap between the financially material ESG information investors expect versus what the companies are currently providing. 

Following are the two actions companies need to take:

  • Communicate to investors COVID-19’s short and medium-term potential impact on their business, overall operations and supply chains including management preparedness after reviewing the current risk management practices
  • Strive to become a risk intelligent organisation and to have a holistic view of their risks and opportunities which are interdependent as described above. This would involve understanding the key material issues and use of scenario planning as a strategic tool to build plausible narratives for alternative futures on short, medium and long-term time horizons. 

By understanding their ESG risks, planning for them and understanding their material impacts, companies can present a more robust, credible response and demonstrate good stewardship and prudent risk management to their investors, underwriters and wider stakeholders.  This will enable them to take greater control of their narrative and ultimately their valuation.