Environmental Risk: What is it, and why should corporations care?

‍Environmental Risk: What is it, and why should corporations care?

The world is an unpredictable place: this fact has never been seen with more clarity than over the past few years. Environmental degradation has not only put individual livelihoods in danger but has also vastly changed the corporate landscape. The 2022 World Economic Forum Global Risks Report identified the most severe risks on a global scale over the next 10 years, with the top three being ranked as climate action failure, extreme weather, and biodiversity loss.

Do you see a pattern?

Environmental risks are often examined at a macro level, but challenges are also present at the entity and asset level. We are living during an unprecedented time where corporate environmental awareness has never been more questioned or scrutinized at every organizational level. From asset exposure, to supply chain interruptions, to corporate social responsibility policies, companies are facing increasing demands from customers, clients and governments on their environmental sustainability and preparedness.

Corporate social responsibility - also known as ESG (Environmental, Social and Governance) may be growing in scope and importance, but it is still often treated as a ´softer´ organizational priority. The problem is two-fold – for some organizations, the belief that their work is already aligned with ESG values causes a lack of corporate introspection and a failure to act. But perhaps more critically, environmental risk is poorly defined – a lack of a clear scope and framework has often resulted in corporate hesitancy to act, even if the desire to do so is there.

So what is environmental risk? And how can it be defined and measured in a way that encourages companies to act?

‍Environmental risks are material risks

Environmental risks (including climate risks and nature-based risks) are material risks. The impact of these risks differs between sectors, locations and in relation to other internal and external factors, all of which affect organization resilience. The actual scope of environmental risks is broad. While most corporate ESG strategies tend to focus on a reduction in CO₂ emissions (including through methods of sequestration and capture) there are other important elements which play into the overall environmental risk. As identified by the World Economic Forum, climate action failure tops this list, followed by extreme weather events and in third place, biodiversity loss.

Climate action failure

In recent years rising global temperatures have led to an increase in natural disasters, adverse health effects, adverse impact on ecosystems, business losses, and threats to the operational health of corporate assets and infrastructure. Many companies worldwide are already subjected to various regulations with the aim of combating climate change, with initiatives like carbon taxes, emission trading schemes, and other fossil fuel taxes prompting organizations to be mindful about their corporate carbon footprint. However, these policies have varied greatly across sectors, countries and continents, making it difficult for both investors and the general public to critically evaluate how well organizations are performing against climate resilience objectives.

Extreme weather events as risk

Closely associated with climate change, extreme weather events are becoming more and more common. According to the World Economic Forum, corporate losses related to adverse weather totalled around $2.5 trillion globally between 2011 and 2020, representing a 50% increase from the 2001-2010 period. Companies which are inadequately prepared for extreme weather risks have a higher probability of losing assets to wildfires, submergence due to flooding or infrastructure damage due to hurricanes and heat waves, to name just a few examples.

Biodiversity loss

According to the World Economic Forum, more than half of the world’s economic output (USD 44 Trillion) is moderately or highly affected by nature, a figure which is critically affected by ongoing biodiversity loss. The loss of biodiversity poses a significant risk to corporate and public stability, with land overuse, overexploitation of natural resources, and the spread of invasive species causing steep biodiversity loss on a global scale. As ecosystems decline, organizations face a myriad of risks, from a higher raw material cost, to backlash from consumers, investors and authorities.

So why do any of these issues really matter at a corporate level?

Purely on a moral level, it is up to all of us, from individuals - to corporations - to governments, to treat climate change with the seriousness the issue deserves, and to do everything in our power to mitigate environmental degradation for future generations to come. However, there is an added practical incentive for organizations to reframe and rethink their corporate social responsibility policies: Environmental risk is material risk. Organizations should care about ESG policies for the same reason they care about conventional markers of performance such as financial and operational objectives. Companies that turn a blind eye to the negative impact of their operations on the environment put themselves at risk in many ways, from supply chain issues to raw material costing, to consumer boycotting.