Overview
At the early stages of the new
millennium, there is little doubt that certain major
risks will dominate global business affairs in the
years to come; in particular sustainability related
risks. Such risks are becoming more aligned with traditional
governance needs. This article reviews some of the
themes and trends affecting organisations and the
risk levels that pose a threat to value. By structuring
risk management activities into a more cohesive and
sustainability orientated process organisations can
reduce their risk levels.
The essence of this is to protect the average 12.5%
of market value at risk from sustainability issues
by bringing together various elements of risk management
into a sustainable and economic/enterprise risk management
system.
Such an approach helps business, non-profit, and government
organisations improve their economic, environmental
and social conditions and increase their "capital"
in these areas.
Introduction
The business case for sustainable
and economic risk management of a wide range of contemporary
issues is summarized in this article. The main message
is that whatever the current preferred methods to
assess companies - business ethics, corporate social
responsibility (CSR), corporate responsibility (CR),
accountability, best practice, sustainable development
and other methods - the broader view is that there
is a growing interest in the value of values and the
benefit of viewing sustainability issues as business
issues and key to corporate governance as it evolves
through various compulsory and voluntary approaches.
Moreover, there is an increasingly broad definition
of what constitutes value as intangible assets (also
called non-financial and extra-financial) gain in
importance, such as:
- Brand value and reputation;
- Goodwill;
- Stakeholder and shareholder value; and
- Customer loyalty, retention and value.
It is important to note that these
intangible assets are quite often of a higher value
than tangible assets. For example, 71% of the value
of the UK's largest listed companies is estimated
to be linked to the above factors. The essence of
this article is to protect this value by bringing
together various elements of risk management into
a Sustainable and economic/enterprise risk management
system. The sustainability approach is summarized
well by Patrick Cescau, Group Chief Executive of Unilever:
"The agenda of sustainability and corporate responsibility
is not only central to business strategy but will
increasingly become a critical driver of business
growth... I believe that how well and how quickly
businesses respond to this agenda will determine which
companies succeed and which will fail in the next
few decades." (Speech by Patrick Cescau, Group Chief
Executive of Unilever, at the 2007 INDEVOR Alumni
Forum in INSEAD, Fontainebleau, France (25 May 2007))
Identifying trends, themes and risks
"The farther backward you can look the
farther forward you are likely to see."
-Winston Churchill
Traditional risk management is closely
linked to compliance whereas sustainability management
is linked to having a more predictive ability to stay
ahead of the competitive environment wherever the
organisation is located. Many of the hazards and risks
that are reviewed nowadays are newly emerging and
their frequency and severity are still unknown.
Trends
The level of hazards and risk is increasing. In addition,
the nature of the risk environment in which organisations
have to operate is changing, with challenges beyond
the reach of even individual countries. An important
trend on a global level is the increased demands from
stakeholders including shareholders, investors, lenders,
governmental and non-governmental bodies. For instance,
increased governmental demands can be seen in the
form of:
- Corporate codes of conduct;
- Tax increases;
- New taxation like carbon taxes;
- Customer loyalty, retention and value.
Themes
Trust
in organisations and business
There is a real risk that the traditional trust in modern
systems of business and management is being lost in
general. Businesses and politicians rate as some of
the least trustworthy entities in the world, whilst
NGOs and campaigners rate amongst the highest. There
are key factors underlying this. No doubt however, future
risks can be reduced by increasing the trust others
have in your organisation. In the UK, the Customer Trust
Index contains a wealth of information and sample findings
are:
-
Nine out of ten
people say trust is very or fairly important when
they decide to buy products and services from a
company.
-
However the problem
for business is that whereas 57% say they are inclined
to trust companies in general this falls to a low
of only 7% would trust on-pack information;
-
Ethical behaviour
counts – Advanced factor analysis across all
45 combined drivers of trust and mistrust showed
corporate responsibility to be the most important
overall driver; and
-
It is clear that
getting the basics right gives companies a good
start. Of paramount importance – according
to three quarters of people interviewed –
is “keeping promises and delivering what it
says it will.”
In addition, in the UK the rating
agency SERM has focused on sustainable enterprise
risk management (see further below). SERM has found
that a key issue for companies is customer retention
and that having earned trust, over half of consumers
(54%) would reward a company by personally recommending
them to others. Therefore one key to success in the
modern business arena will be winning and keeping
the trust of consumers and - as a result - the wider
society, which influences their views on many occasions.
It is estimated that a unit of trust is ten times
easier to loose than to create; this is one of the
key drivers behind reputation risk management.
Litigation Culture
Part of the response to this reduction of trust in
business is that there is a growing regulation, compensation
and litigation based culture - legislative, regulatory
and industry codes are increasing in number. By way
of example:
-
In the US the number
of class-action lawsuits against US companies rose
sharply in 2004 according to a report by Stanford
Law School and Cornerstone Research, the "Securities
Class Action Clearinghouse Report" cited a 17% increase
in the number of actions filed for 2004 and that
the companies being sued lost $169billion in market
value. This figure was almost treble the figure
for the previous year; and
-
In the UK a recent
litigation case highlights the trend of increasing
fine levels as US and UK authorities have hit British
Airways with £270m worth of fines for colluding
with competitor airlines over the imposition of
fuel charges. The UK's Office of Fair Trading (OFT)
fine (£121.5million USD$ 246million) was over ten
times the level of the previous highest fine. The
U.S. Justice Department levied USD$300 million against
BA and also levied a US$300 million (€218.9 million)
fine on Korean Air Lines Co. Ltd. for colluding
with competitors to fix fuel surcharges on cargo
shipments to the U.S.
Transparency
There are increased demands for greater transparency
and accountability for the business community to justify
their license to operate and analysis suggests the
following:
-
Stakeholder involvement
will continue for the foreseeable future through
their support for a wide range of standards, codes
of practice, laws and regulations covering the many
risk issues that confront companies in today's market.
Current terminology varies as widely as do the types
of codes as, in addition to accountability, responsibility
and sustainability, other terms cover sustainable
development, corporate governance, corporate responsibility
(CR), corporate citizenship and the triple bottom
line! A small sample of the terminologies in use
by key organisations provides us with: the WBCSD
referring to Corporate Social Responsibility; the
UN Global Compact to Responsible Corporate Citizenship;
the OECD Guidelines to Responsible Business Conduct;
and AA1000 to Social & Ethical Accountability. Improved
clarity will be needed in this area;
-
There will be persistent
calls to report performance and an increase in companies
seeking verification and auditing of reports as
well as the holding of standards that indicate reporting
proficiency; and
-
The volume and speed
of media coverage of will continue to increase:
environmental and health and safety incidents; the
levels of fines, loss of reputation and financial
impacts will both increase and become more apparent,
as will the corresponding measurement and reporting
of benefits that are derived from the good management
of these risks.
-
Fortunately, SERM
research has found that the world of business and
industry is not phased by this overall trend. The
response has generally been to get on with business
whilst increasingly recognizing that the issues
represent not only unparalleled challenges but also
unique opportunities.
Partnerships
Today's business risks generally
arise through similar pressures as before, that is from
legislative and commercial or competitive drivers through
to marketplace (i.e. customer) pressures. The main difference
is that the added pressure of the risks arising from
newer, often global, issues poses a potential threat
to virtually all industrial and commercial activity
in the current climate of growing environmental and
social concerns. Since many of these threats are deemed
to be too large, complex or crucial to be left to the
authority that is invested in governments, dynamic partnerships
are important. This involves working with government
bodies, critics and customers to sound out our organisations'
place and reputation within this bigger picture. It
also means a heightened need for much improved systems
of governance in every respect.
The involvement of individuals and business organisations
is seen as paramount to achieve our goals of long-term
survivability and the sustainability of our societies
and organisations within them. This is well phrased
by Michael Porter and Mark Kramer writing in the Harvard
Business Review:
"Leaders in both business and civil society have focused
too much on the friction between them and not enough
on the points of intersection;" and "The mutual dependence
of corporations and society implies that business decisions
and social policies must follow the principle of Shared
Value" (Strategy and Society: The Link between Competitive
Advantage and Corporate Social Responsibility, December
2006).
At the macro level the risks we face as individuals
and organisations are too great for any of us to deal
with individually and we will be required to work with
stakeholders increasingly to help reduce these risks.
This will become increasingly part of corporate governance
requirements.
Global problems requiring global strategies
"From an Asian perspective, I want to emphasise that
there is no alternative to the preservation and strengthening
of the multilateral system. All other solutions, including
regional blocs and bilateral preferentialism, will inevitably
generate fewer opportunities for business - especially
for small and medium enterprises in the developing economies
- less respect for rule of law in international trade
and more trade friction, leading eventually to a significant
decline in global economic growth." Dr Victor Fung,
Group Chairman, Li & Fung Group; and Co-Chairman, The
Evian Group, based in Hong Kong.
Risks
"The significant problems we face cannot
be solved at the same level of thinking we used when
we created them". (Albert Einstein)
Total sustainability related risk
The SERM system of analysis has been selected as a valuable
methodology as regards an approach to risk, corporate
value and appropriate governances. SERM has assessed
that the total organisational value at risk from sustainability
related risks is 12.5% of market value for the 500 largest
companies in the US and EU. The research from the issues
quantified is broken down into three main headings of
sustainability.
| Sustainability
risk category |
Net |
| |
risk to value |
| Economic and socio-economic
risk |
2.0% |
| Social and ethical risk |
5.1% |
| Environmental risk |
5.4% |
| Total Sustainability
Risk |
12.5% |
|
Stakeholder and reputational risk
account for about half of the total sustainability risk.
Economic aspects of business risk
There is an average of 2% of risk to market value from
the economic risk issues reviewed. This analysis has
not included a review of many macro economic risks such
as currency fluctuations, interest rates et al, but
covers those risks that the author considers have a
direct impact upon organisations from a sustainability
related perspective covering key aspects of the emerging
risks including: economic crime; fraud; business interruption
and disaster planning risk with crisis management; stakeholder
and reputation risk management; and business, marketing
and new technology related risk.
These risks are in addition to the more standard or
traditional risks associated with business practice,
accountancy and governance issues.
| Economic
and Socio-Economic Risk |
Net |
| |
risk to value |
| Economic crime, bribery &
corruption |
0.3% |
| Business
interruption |
n/a |
| Shareholder and reputation
risk |
Part
of all risks |
| Use of corporate
power |
0.4% |
| Business practices |
0.5% |
| Corporate Governance |
n/a |
| Marketing practices |
0.4% |
| New technology |
0.4% |
| Total |
2.0% |
|
Social and ethical aspects
of business risk
There is an average of 5.1% of risk to market value
from these risk issues. Social risks are as varied as
the communities and cultural groupings from which they
emanate. The risk to market value is mostly from health
and safety of staff and customer issues. The SERM approach
includes a review of external issues such as product
safety, human rights and employment law.
| Social
and Ethical Risk |
Net |
| |
risk to value |
| Community
investment |
0.3% |
| Cultural due diligence |
n/a |
| Human rights/resources
(internal) |
0.7% |
| Human rights (external) |
0.3% |
| Health internal
(workforce) |
0.7% |
| Safety internal (workforce) |
0.5% |
| Health external
(public) |
0.4% |
| Safety external (public) |
1.0% |
| Historic
liabilities from health and safety |
1.2% |
| Total |
5.1% |
|
Environmental aspects of
business risk
There is an average of 5.4% of risk to market value
from these risk issues. The term ‘sustainability’
often means or requires a paradigm shift in favour of
a greater understanding of natural processes, which
are more durable in their efficient use of resources
and inputs and outputs from systems.
| Environmental
Risk |
Net |
| |
risk to value |
| Environmental
incident risk |
1.3% |
| Historical environmental liabilities |
0.8% |
| Air Pollution
- from transport |
0.5% |
| Air Pollution - peripheral
pollution |
0.3% |
| Resource
use - materials |
0.4% |
| Resource use - energy |
0.4% |
| Resource
use - natural resources inc land |
0.4% |
| Resource use - waste generation |
0.5% |
| Resource
use - water use |
0.2% |
| Resource
use - waste water pollution |
0.2% |
| Total |
5.4% |
|
These findings may seem excessive,
but the figures relating to climate change (Air pollution
from production and transportation) have recently been
echoed by other reporters, including the 'Stern' report
on the "Review of the Economics of Climate Change."
For instance, Sir Nicholas Stern has estimated that
the costs of doing nothing about climate change are
£3.68 trillion in damages, or approximately 5-20% of
the global economy at risk.
Further Emerging Risk Issues
The example of the Stern Report findings demonstrate
the magnitude and impact of potential risks are material
to organisations in that they will cause financial losses.
Extensive work is being conducted to bring these to
the readers' attention in future editions. A recent
example of research is that future risks were discussed
at a conference on the subject of 21st century global
risk management at the Evian Group plenary meeting in
Montreux, Switzerland in 2006. Dr Steve Howard, Chief
Executive, The Climate Group and Founding Member, HSBC
Carbon Management Task Force summed up the importance
of these types of reviews and research on emerging risks:
"We live in times of unparalleled risks and opportunities.
As greenhouse gas concentrations climb the search for
creative solutions offered by the Evian Group is to
be welcomed -- there is nothing more important,"
Their findings suggested that there are various global
risks that demand innovation and shared action at national,
regional and international level including:
-
Climate chaos
-
Radical poverty
-
Organized crime
Extremism
-
Informatics
-
Nanotechnology
-
Robotics
-
Genetics
-
Artificial intelligence
-
and Financial
systems.
(Keynote address by DK Matai,
The Evian Group Initiative press release, 10 October
2006).
Concluding Remarks
Having regard to the issues that are facing organisations
at every level the debate over corporate governance
demands a fresh approach to openness and understanding
of the risks that are inherent in business activity
and a more enlightened legislative and voluntary framework.
Appendix
DR. LINDA S. SPEDDING is an international
lawyer. She holds an LL.B. (Hons), LL.M., Ph.D. She is
a Solicitor (England &Wales), Advocate (India) and an
Attorney (USA). She has been an international advisor
to many commercial and professional bodies both in the
private and public sector and provides the ideal mix of
experience as a practitioner and editor who also has a
substantial reputation as an author and lecturer (www.lindaspedding.co.uk).
As a specialist in International Environmental Law and
Energy projects, Dr. Spedding was awarded the Alexander
Maxwell Law Scholarship Trust Award in the 1995-1996 awards
for her contribution in this area. Her work experience
covers commercial law, corporate advice, contracts, consultancy
agreements, project finance, due diligence, joint ventures
and technology transfer.
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