What is ESG Risk? (Overview, Definition, and Examples)
ESG risks include a company's environmental, social, and governance factors that could cause reputation or financial harm.
As environmental, social, and corporate governance (ESG) investing grows, and consumers and job seekers seek out more sustainable businesses, companies and their boards of directors must be on the lookout for ESG risks.
According to Bloomberg’s insights, ESG investing is expected to reach $41 trillion by the end of 2022, and skyrocket to $50 trillion in 2025. Not calculating and preventing risks proves costly.
Read on to learn more about ESG risks.
What is ESG Risk?
ESG risks are social, environmental, and governance variables that affect a company’s financial position or operating performance. In 2020, the Bank of America research team estimated $600+ billion in market cap for S&P 500 companies had been lost to ESG controversies in the previous seven years.
Regardless of industry or size, every organization remains vulnerable to ESG risk. Since the concerns can cause reputation or financial harm, OnBoard recommends every board of directors create an ESG strategy to mitigate ESG risk. Without it, an organization faces a triple threat:
- Losing financing from ESG investors
- Losing socially-conscious customers
- Violating regulations, which can result in huge fines
Types of ESG Risks
ESG risks fall into 3 categories. Here are the most common risks for each category.
Environmental risks refer to how a company impacts the environment. They include factors such as:
- Carbon footprint
- Water usage
- Waste disposal
- Greenhouse gas emissions
- Impact on biodiversity
Environmental risk management includes complying with environmental regulations. Failing to do so can be costly.
In 2017, environmental crimes, including illegal waste discharge and conspiracy to violate the Clean Water Act, resulted in the International Petroleum Corporation of Delaware (IPC) paying a fine of $1,300,000 and $2,200,000 restitution.
Similarly, AIREKO’s demolition activities in 2012 exposed about 450 people to asbestos fibers. The construction company was sentenced to a fine of $1.5 million and an additional $172,020 for victims’ medical examinations.
Social risks are generally diverse and can be subjective. Common social risks include:
- Wage equality
- Workplace safety conditions
- Supplier/vendor practices
- Human rights violations
- Diversity, equity, and inclusion
- Data privacy
When managing social risks, we recommend focusing on 3 critical areas:
- Ensure suppliers meet your ESG standards.
- Make sure the workplace conditions promote employees’ health and safety.
- Ensure the organization doesn’t take unethical advantage of its customers or employees.
Social risks affect brand image and customer loyalty.
In a 2021 study, 83% of customers said they would base their ongoing support on how an organization treated its workers during the pandemic.
Governance risks refer to how a business operates, including its governing policies.
- Transparent communications
- ESG disclosures
- Board structure and diversity
- Corruption and fraud prevention
- Organization integrity and ethics
- Executive compensation
Companies should consider industry-specific compliance regulations and the board’s role when overseeing risk management policies.
Brands that underestimated the consequences of governance risks ended up paying an arm and a leg for this mistake. For example, Volkswagen admitted to falsifying emission tests in 2015. This ESG scandal has cost the globally renowned car maker billions in fines, penalties, buyback costs, and financial settlements.
Your company’s governance risk management should promote transparency and discourage illegal conduct.
What Is ESG Risk Score?
An ESG risk score, or risk rating, measures a company’s exposure to environmental, social, and governance risks. The score rates the organization’s ability to balance its financial performance against sustainability risks.
ESG rating procedures commonly review various factors, including:
- Carbon emissions
- Water sourcing
- Biodiversity and land use
- Toxic emissions and waste
- Packaging material
- Consumer financial protection
- Product safety and quality
- Worker safety training
- Labor management
- Supply chain labor standards
- Board diversity and independence
- Executive compensation
- Business ethics
- Accounting practices
Third-party agencies like Bloomberg, MSCI, Refinitive, and JUST Capital calculate ESG scores for different companies. Each agency has specific ways of calculating and rating scores. They leverage algorithms and analysts to convert ESG metrics into siloed environmental, social, and governance scores. Then, they merge the scores into a single primary rating. Most agencies assign scores on a 100-point scale. The higher the score, the better the organization manages ESG risks.
Investors use the ESG score to gauge a company’s reputation, stakeholder relationships, and risk.
ESG Risk Management Starts with the Board
As investors use ESG criteria to make financial decisions, boards must assess their company’s strategies. They should take the lead in ensuring ESG initiatives align with their company’s mission and vision. This includes creating an ESG strategy.
When calculating risks, building risk management strategies, and conducting other crucial board business, a board management platform helps boards move smarter and faster. OnBoard’s purpose-built platform comes with tools that foster collaboration and increase integrity and transparency for better ESG practices.
Want to equip your board of directors with the tools they need to succeed? Request a free trial of OnBoard today.
About The Author
- Josh Palmer serves as OnBoard's Head of Content. An experienced content creator, his previous roles have spanned numerous industries including B2C and B2B home improvement, healthcare, and software-as-a-service (SaaS). An Indianapolis native and graduate of Indiana University, Palmer currently resides in Fishers, Ind.
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