ESG: What do boards need to know?

ESG: What do boards need to know?

Michael Bruch, Global Head of Liability Risk Consulting/ESG at AGCS, answers the key questions.

Q: Which areas of ESG are causing the most concern, and what is the role of the risk manager and board of directors in overseeing these?

A: ESG investment is growing significantly and we are seeing several important trends emerging, in particular surrounding climate change, human‑rights violations and severe corruption allegations. The major challenge for corporates is that there is no standardized approach to calculating ESG metrics. Truly understanding the relative benefits and limitations of the various metrics can help to build a more complete ESG picture and highlight opportunities for change. So, for example, risk managers need to be able to assess the ESG risks associated with any transaction and – crucially – they also need to be able to inform others of the nature of those risks.

It’s important to note, however, that identifying and mitigating risks is not limited to the risk‑management function in a company. ESG risk topics should be integrated into enterprise risk management and all relevant operational processes. What we are noticing in many of the industry sectors of our client community – and in particular the power and utilities sector, which is heavily challenged by the transition of its own business model into a more green energy‑related power supplier – is that ESG and sustainability are having a high impact on virtually all functions within the company.

Q: What are the consequences for companies that don’t meet ESG expectations or fail to live up to their own commitments?

A: The consequences can be severe – and far‑reaching. Take climate‑change litigation as an example. Climate change is a subject that cuts across all stakeholders as well as company employees. So we have seen increasing levels of engagement from employees, who want to know that their employer is doing the right thing by the environment. At the same time, there are institutional investors – pension fund and fund managers – pushing for more action from boards to protect the environment. And then there’s the question of reputational risk. If companies don’t live up to their commitments or, worse still, if they attempt to greenwash their credentials, their reputation can plummet. Disclosing misleading corporate messages about climate‑change impact poses a severe risk in terms of company liability.

Q: We know that climate change is one of the key ESG factors driving litigation and investor/shareholder actions against companies. But how widespread is this kind of action?

A: According to the London School of Economics (LSE)7, there have been more than 1,800 cases of climate‑change litigation in 40 countries as of the end of May 2021. The majority were in the US (1,387), followed by Australia (115), the UK (73) and the EU (58). The numbers are steadily growing, and the implications are significant.

In a recent landmark ruling, for example, a Dutch court ordered Royal Dutch Shell to reduce its carbon emissions by 45% compared to 2019 levels by 20308 – much deeper cuts than it had planned. The ruling only applies to the Netherlands, but it could have wider consequences for the energy industry elsewhere.

For the moment, this kind of litigation remains concentrated in high‑income countries, but we’ve seen cases in Colombia, India, Pakistan, Peru, the Philippines and South Africa. We expect it will continue to grow in the Global South.

7 LSE, Global trends in climate litigation: 2021 snapshot, July 2, 2021

8 BBC, Shell: Netherlands court orders oil giant to cut emissions, May 26, 2021

Q: What other tips can you suggest to identify and mitigate ESG risks?

A: What we have learned from our own ESG experience is that you need a strong commitment to ESG at the management and board level, setting specific targets from the top down. Within Allianz, we have implemented our own ESG board, so that all the important group centers are really committed to sustainability and the ESG topic.

The board must acquire the appropriate skills that will enable it to fully understand what the external requirements are for a successful ESG strategy in the long term. ESG matters should be a regular fixture on boardroom agendas, and that way of thinking should be embedded throughout the organization. It should ultimately become part of the company DNA so that everyone sticks to it, everyone embraces it, and at a certain point no one even thinks about it because it’s an integral part of all your processes and everything you do.

At the same time, ESG information can also help to improve the underwriting process, to the benefit of insurers and companies. We have statistically modeled a lot of ESG data points against claims and public litigation and we do see some predictive power there. From an insurer’s point of view, conversations around ESG‑related topics, in addition to financial topics, are becoming much more important