ESG Risk Management

Definition

ESG Risk Management is a general term that collectively denotes the techniques, practices or behaviors that aim to identify, measure and mitigate ESG risks to an individual or an organization.

Motivation

ESG risks, in particular environmental risks through transition and physical risk drivers, pose challenges to the safety and soundness of institutions. As risk drivers, they may affect all traditional categories of financial risks to which such organizations are exposed. To ensure the resilience of the business model and risk profile of such institutions in the short, medium and long term, regulatory guidelines set requirements for the internal processes and ESG risks management arrangements that institutions should have in place.

Structure

ESG Risk management includes the culture, processes and structures that are put in place to effectively manage potential negative consequences of ESG Factors. As it is in general not possible or desirable to eliminate all ESG risk, the objective is to reduce risks to an acceptable level (formally termed Risk Appetite).

In professional / organizational contexts the need to better manage ESG risks is increasingly elevating the concept of ESG risk management into a separate discipline with more formally specified language, rules and tools.

• ESG Risk Identification, apply an analytical approach to the task of identifying, classifying and enumerating the various ESG risks that an organization is facing
• ESG Risk Measurement, quantify (produce numerical measures) for the risks to an organization that are amenable to such quantification
• ESG Risk Mitigation, reduce or eliminate perceived risks exercising whatever options are available to do so

ESG Risk Frameworks

An ESG Risk Management Framework is a formal set of rules, policies, prescriptions, tools etc. that indicate how an entity organizes its ESG risk management activities. Implementation of the framework may be a legal requirement (e.g. imposed by governments / regulators) or a best-practise prescription (e.g. developed by a sectoral association of businesses).

ESG Risk Culture

In contrast with the formal, documented and organized nature of ESG Risk Frameworks, the concept of ESG Risk Culture captures less tangible but equally relevant aspects of ESG risk management. It denotes the combined set of institutional/corporate Values, norms, attitudes, competencies and behaviour related to ESG risk awareness (perception of ESG risk) that determine a firm’s or organizations commitment to sustainability.

Issues and Challenges

• Definitional Challenges
• Methodological Challenges
• Cultural Challenges

References

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