ESG risk management questions financial firms should ask themselves

Despite their uniqueness, ESG risks do not require financial firms to reinvent risk management practices. Rather, they should be incorporated into firms’ existing risk management frameworks. A prudent approach will consider a firm’s existing risk management strategy and a materiality assessment of the impact of ESG on its business.

Firms should ask themselves:

• Does our materiality assessment cover financial materiality?
• Which ESG risks are the most critical and how can we plan for them?

Firms will be challenged to make forecasts in the absence of robust ESG data. Without a sophisticated understanding of the variables that could weaken their business models, it will be difficult for them to mitigate ESG risks and maintain a competitive advantage.

Therefore, as part of the process of aligning ESG risks with their risk strategies, they should engage in scenario planning, which will enable the development of risk-based approaches to address the impact of physical risk (e.g., temperature, agricultural productivity) and transition risk (e.g., policy, regulation) on their operations and position themselves to meet future regulatory expectations. Reference scenarios published by the Intergovernmental Panel on Climate Change (IPCC) are a practical starting point.

Examples of scenarios include an ‘orderly’ transition to net zero, in which global temperatures rise less than 1.5 degrees, a ‘disorderly’ transition, in which policies are delayed and global temperatures rise by two degrees, and a ‘hot house world’, in which policies fail. The outcomes of these scenarios will have implications for many drivers of a financial firm’s performance, including credit, market, liquidity, insurance and non-financial risk.

Firms should ask themselves:

• What data do we need to inform our ESG risk management strategy?
• Are we using scenarios to support this strategy?
• How would these scenarios help us to navigate ESG risks?

This article was developed from the Protiviti webinar ‘ESG Risks in FSI – it’s nothing new – or is it?’. Click here to watch the webinar. For more information on Protiviti’s Risk and Compliance and ESG solutions, please contact Managing Director and EMEA Sustainability Lead Ellen Holder in Frankfurt at [email protected].