Businesses often find it difficult to justify investing in sustainable materials, practices, technologies, and solutions. But increasingly, the cost of not being sustainable outweighs the investment.
That’s because sustainability isn’t merely a brand value. It’s a risk mitigation process. And it’s becoming a prominent factor that investors, financial institutions, and regulating bodies consider when evaluating an organization’s financial health and overall investment risk.
Regardless of whether an organization presents itself as sustainable, sustainability risk management is a nonfinancial process with significant financial implications.
In this article, we’ll cover the basics of sustainability risk management, including:
- What sustainability risk management is
- Sustainability risks
- Challenges with sustainability risk management
What is sustainability risk management?
Sustainability risk management (SRM) is how an organization responds to threats and recognizes opportunities that stem from environmental, social, and governance (ESG) factors. It requires balancing operational needs and business goals with the practices, decisions, and regulatory compliance necessary to avoid or mitigate sustainability-related costs.
While parts of this process largely rely on nonfinancial data, sustainability risk management has become an increasingly important responsibility for chief financial officers, as an organization’s SRM can directly impact costs.
As one of many areas of risk that large organizations have to manage, sustainability risk management is a subcategory of enterprise risk management (ERM). And as organizations look to establish environmental, social, and governance (ESG)-related goals, policies, and initiatives, sustainability risk management plays a key role.
What are sustainability risks?
Sustainability risks encompass a broad range of potential harm an organization could incur as a result of poor sustainability practices or decisions. The actual level of risk depends on a specific organization’s location, industry, market, labor pool, public claims, stakeholders, political climate, and other factors. These particular risks typically fall under one of two categories: physical risk and transition risk. Physical risks are risks related to the physical impacts of climate change, whereas transition risks are risks related to the market transition to a lower carbon economy. The most prominent risks to be aware of falling under either of these categories are the items detailed below:
- Non-compliance risks
- Climate risks
- Insurance risks
- Reputational risks
Non-compliance risks
Environmental regulations can come with steep penalties for violations. But even organizations that aren’t actively harming the environment or engaging in large industrial operations need to devote resources to ESG compliance. Failing to disclose your emissions data, for example, could result in losing investor confidence and funding. You may also wind up with worse interest rates, as your organization may appear to be a riskier investment.
Non-compliance can also result in lawsuits. There’s no shortage of companies that have been sued for “greenwashing,” where their sustainability claims aren’t supported by data. Companies that have made public statements about their sustainability goals or practices are under much greater scrutiny, and there’s significant legal risk for those who claim to be environmentally friendly but aren’t in compliance.
And regarding the social and governance components of ESG and sustainability, there’s obviously significant legal risk with failing to provide an equitable workplace (such as wheelchair accessibility), and organizations with a history of poor compliance and accountability will look riskier to potential investors.
Climate risks
As climate change increases the frequency and severity of environmental disasters, there’s greater likelihood that communities will experience weather-related shutdowns, outages, damage, injuries, and even deaths. For companies that operate in areas that regularly experience natural disasters like hurricanes, tornadoes, flooding, heat waves, earthquakes, landslides, and winter storms, these risks are obviously greater, and they’re more likely to incur expenses as a result.
Part of sustainability risk management involves taking steps to make your infrastructure more resilient to the types of climate-related disasters you’re most likely to experience. This includes diversifying energy investments, hardening infrastructure, and implementing policies that protect employees and assets alike. It may also mean incorporating these risks into your location strategy to choose locations that are less likely to experience severe weather events or be seriously affected when they occur.
Insurance risks
Climate change is rapidly increasing the cost of insurance in the most affected areas. In the worst cases, like Florida, many insurers have determined that providing insurance is simply not viable—the volume and severity of claims is too high for them to remain sufficiently profitable. As for the providers that have remained, their rates are often prohibitively expensive.
Other climate-affected areas will inevitably follow a similar pattern, though more gradually. For organizations that operate in these areas, rising insurance premiums and the possibility of losing coverage may require frequent re-evaluations of each location’s viability.
Reputational risks
Public claims about sustainability can affect an organization’s reputation within their target market. So can a failure to support those claims with tangible actions and outcomes.
For example, a company announcing a net zero target of 2030 and the steps they’ll take to get there could have positive or negative effects on their market position, depending on how their target audience, stakeholders, and employee population generally think about sustainability. Same with diversity, equity, and inclusion (DEI) claims. An organization’s sustainability ambitions could result in boycotts, and so could publicly known sustainability failures, depending on the situation.
Greenwashing accusations can also cause major reputational damage by making consumers, clients, or investors feel lied to, which may cause them to distrust any of the organization’s future public claims.
Sustainability risk management challenges
Unfortunately, effectively implementing sustainability risk management can be quite difficult. Many organizations are ill-equipped to follow through with sustainability disclosures, targets, and public environmental commitments. Here’s why.
Inaccurate sustainability data
Ideally, every business would have a clear understanding of their Scope 3 emissions—the emissions produced by their value chain, but which they do not directly control, such as the production, transportation, use, and disposal of goods. But most are still struggling to piece together data for Scope 1 and 2 emissions, which stem directly from their operations.
The more distributed an organization’s operations are, the more difficult it becomes to organize, analyze, and report on energy consumption in meaningful ways. Different providers use different formats, and every bill has the potential to introduce errors to the dataset, including duplicate data and gaps in billing periods. While solutions like Tango Energy & Sustainability by WatchWire automatically import and standardize this data, many organizations still rely on manual processes that make this process far more costly and error prone.
Without accurate data, it’s impossible to make reliable predictions and successfully monitor progress sustainability goals. And a lack of confidence in sustainability data naturally translates into an inability to perform sustainability risk management.
Inability to predict major industry disruptions
Sustainability is a long-term investment involving a combination of gradual changes such as a reduction in energy consumption, major adjustments like purchasing new equipment or infrastructure, and policies that influence organizational culture and priorities. But when your sustainability goals have too long of a time horizon, you don’t have adequate freedom to respond to changing market conditions.
For example, when they set their 2030 goals, major tech companies couldn’t have taken into account the surge in global demand for data centers that would be brought on by the emergence of generative AI. This major disruption will obviously have an impact on these goals, and that puts companies between a rock and a hard place: they can’t ignore huge new market opportunities in order to stay on target, but there are risks and potential penalties for not making a genuine effort to reach their goals.
Cost of investing in sustainability
Sustainability can come with substantial upfront and ongoing costs. And when these costs don’t directly impact an organization’s bottom line or have an immediate payoff, it’s harder to justify that expense. Some aspects of sustainability investments also have diminishing returns. It may be relatively straightforward and cost effective to improve data accuracy by 60 percent, for example, but every 5 or 10 percent after that may come at too high of a cost to make it feel worthwhile.
Political pushback
Reputational damage is a sustainability risk that can make it especially difficult for some organizations to navigate SRM. Enterprises and other large organizations that emphasize DEI or environmental goals may meet resistance from politicians, other public figures who have influence in their industry, or even simply their target audience. And that’s challenging when investors and regulators place greater scrutiny on ESG factors.
Improve your SRM capabilities with Tango
Sustainability data is the key to making informed sustainability risk management decisions. But if you’re still manually assembling data and performing carbon accounting calculations, you’re increasing the friction of SRM and leaving room for human error. Tango Energy & Sustainability by WatchWire automatically intakes your utility bills and reconfigures and standardizes your data for analysis, flagging common errors for your team to audit.
This drastically reduces the time investment and lowers audit costs by making your data easier to work with and identifying problems before an analyst even begins. Tango also automates and standardizes your sustainability reporting process by integrating directly with ENERGY STAR Portfolio Manager, LEED Arc, GRESB, CDP, and more, enhancing your organization’s ability to remain compliant with any regulatory ordinances.
Additionally, the WatchWire system can help with capacity building for decarbonization efforts such as electrification, renewables procurement, and measuring and verifying any new energy efficiency projects. By monitoring your projects in real time and understanding the return on investment, firms can future proof their business for risks related to benchmarking ordinances, Building Performance Standards, and the unreliability of the energy grid.
With Tango, you have the visibility and reliability you need to both set realistic sustainability goals and monitor your progress toward them.
Want to see what Tango can do for you?