Enhancing your ESG response: the strategic role of the risk manager

Introduction: doing nothing is not a viable option!

Environmental, Social and Corporate Governance (ESG) factors have been around for over a decade, but whereas they were once considered “nice to have” principles or an ethical stamp of approval to show that you were a good, moral company, times have changed. ESG has now become a financial and strategic imperative; many ESG factors are now demanding Board level attention, with climate change particularly dominating recent (largely pre-COVID-19) discussions at the World Economic Forum in Davos at the beginning of the year¹.

Doing nothing is not a viable option, particularly in the mining sector; investors are demanding climate disclosure, central banks are working together to ‘green the financial system’ and expectations of employees and customers are rapidly shifting as ESG truly enters the mainstream.
In a world of potentially 9 billion people by 2030 – including 3 billion new middle-class consumers² – the challenges of expanding resource supply to meet future demand are unprecedented but will need to be considered with ESG in mind. Mining is one of the key sectors of the transition to a low carbon economy, with materials such as lithium, cobalt and rare earth elements required for end products, from photovoltaic cells through to new smartphones.

Boards looking at operations through an ESG lens
If your CEO or CFO hasn’t been asked about your company performance through an ESG lens, then rest assured it is coming, and coming soon. It is becoming increasingly apparent that ESG performance is going to be an important driver for mining industry stakeholders - lenders, insurers, shareholders, regulators – even consumers. Indeed, it’s likely that the money will increasingly follow those mining companies with the highest proven ESG credentials, as recognition of the systemic nature of issues such as climate change and a plan to manage them increasingly become key indicators of appropriate risk management.

Add to this the idea that COVID-19 may accelerate the broader appetite towards ESG as financial markets look to build resilience to systemic risks, and there is an even stronger case for enhancing your ESG response. Much like the warning signs of the 2008 financial crisis, is it time to pay attention to the ripples before they turn into waves.

The strategic role of the risk manager: pivoting from risk to opportunity
The good news is that risk managers can be proactive in addressing ESG; furthermore, many industries are finding that the insurance sector is uniquely placed to help them, given its experience of being on the front-line of managing the impacts of a changing climate over many decades.

As we navigate the challenges of a COVID-19 affected world, it will be critical to maintain momentum and interest in this area; the effects of oil prices dipping into negative figures and disruption to global cargo markets are placing a sustainable recovery high on the agenda and triggering new infrastructure projects in an effort to bolster GDP.

As we explain in this article, there’s never been a better time for risk managers to bring together a system-wide perspective, play a critical strategic role in guiding the Board’s ESG response and pivot from risk to opportunity.

ESG drivers: a changing climate, and a climate of change

Since the industrial revolution, and particularly over the last 50 years, the world has experienced significant economic growth, powered by ever-increasing use of natural resources, driven in turn by a substantial increase in global energy demand. This increase in human activity is known as ‘The Great Acceleration’ and has resulted in many benefits, lifting millions out of poverty and creating our modern world. However, it has also had some unintended consequences, including unprecedented changes in our climate.

Indeed, events that would have seemed unimaginable only a few years ago, such as PG&E becoming the first recognised corporate casualty of climate risks in the energy sector³, or the Chairman and CEO of BlackRock discussing climate risk and referring to a fundamental reshaping of finance⁴, are now becoming the norm and receiving Board level attention.

In July, BlackRock announced they had identified 244 companies that were making insufficient progress on climate risk. 53 had voting action taken against them on climate issues, and 191 were warned they would risk voting action against management in 2021 if they do not make significant progress.

Source: BlackRock ⁵

Environmental threats dominate
For the first time in the history of the World Economic Forum’s Global Risk Report 2020, environmental threats dominate issues on senior leaders’ agendas, as evidenced by the position of the green diamonds in Figure 2 of Margaret-Ann Splawn’s article earlier in this Review. To more fully understand why there has been such a significant shift in the ESG zeitgeist, it is useful to understand current views of the science, the frameworks being used and the actions that central banks, regulators and investors are taking.
These factors will have a big impact on your role as a mining risk manager, and there has never been a better time to get up to speed with the ESG landscape and help your Board develop a strategic response.

As shown in Figure 1 to the left, 2020 represents a fundamental fork in the climate change road; the actions we take now and in the coming years may well determine the future of the world’s climate system. Views on how extreme weather events will change in a warmer world vary, depending on the type of event and its individual characteristics. This is where modelling future climate scenarios using state of the art scientific knowledge can play a key role in your strategic planning and risk management processes.

While a 2°C increase in temperature may not seem important, it’s worth bearing in mind that for the last 10,000 years it’s the relative climate stability of +/- 1°C that has, at least in part, been the foundation of our collective progress today: a climatically stable nursery for civilizations to grow. Beyond 2°C, or even 1.5°C according to a recent IPCC (Intergovernmental Panel on Climate Change) report⁶, we are going in to uncharted territory with increasing risk of climate tipping points.

There has been a significant and rapid increase in concentrations of atmospheric carbon dioxide (CO₂), especially since the 1970s, reaching levels unprecedented for at least 800,000 years, during which time we’ve been through many ice ages and warm periods (including inter-glacials such as our pre-industrial climate). In fact, palaeoclimatological evidence shows that the last time CO₂ concentrations were this high was at least three million years ago. Temperatures were two or three degrees higher than pre-industrial climate and seas were 15-25 metres higher.

CO₂ is a greenhouse gas that acts like a thermal blanket around the Earth, and it’s getting thicker every year. In response, our planet is warming, sea levels are rising and weather patterns are changing. The rapid increase in CO₂ takes time to exert these impacts on the planet, and so the emissions produced already will continue to affect our climate for centuries to come. If we continue along a similar pathway – continuing to increase carbon emissions – global temperatures could rise over 4°C by the end of the century, and this has been quoted by some as being an uninsurable world⁷.

The current ESG landscape: a framework for climate-related financial risks

As the worlds of ESG, climate science and finance have come together in recent years, a new language of climate-related financial risk and disclosure has developed.

One framework you may be increasingly aware of is the “physical, transition, and liability” financial risks from climate change, which Margaret-Ann Splawn referenced in her article. This framework was first set out in a report by the Bank of England in 2015⁸, published alongside a seminal speech on ‘Breaking the Tragedy of Horizon’ by the then Governor of the Bank of England, and Chair of the Financial Stability Board, Mark Carney.

As illustrated by Margaret-Ann, these three channels of climate risk are highly relevant to the mining sector and are already having a meaningful financial impact across natural resource sectors.

Physical risks
Physical risks are the direct risks arising from damage, loss of business or supply chain disruption due to the increasing intensity of weather extremes and climate. For the mining sector, sites are often located in remote and climate-vulnerable areas; extreme weather events and climate variability have the potential to damage fixed assets and disrupt supply chains.

Assessment of physical risk can help mining companies understand their operational risks and respond to extreme events. Key locations may not be impacted by water stress or flooding right now, but that could change and soon. This is where the use of those IPCC scenarios is incredibly useful because they give an evidence-based frame to consider possible futures for asset management and new capital expenditure.

Transition risks
Transition risks are the financial impacts of moving towards a low or zero-carbon economy, such as the re-pricing of carbon intensive assets. For the mining sector, transition risks may arise from changes in government policy, for example through taxes to limit supply or demand or changing demand for resources through new supply chains.

Understanding how the transition to a low carbon economy could shift demand will be essential as risk managers consider how to make investments in the most sustainable way - whether this is by improving the efficiency of existing infrastructure, by investing in new technology or by committing expenditure to new projects. 49% of annual global GDP – more than $39 trillion – is now covered by regions of net-zero targets, according to the latest analysis from the Energy and Climate Intelligence Unit (ECIU)¹¹. Investors have a growing concern over the viability of high carbon business models in an increasingly carbon-constrained world.

Creating an effective climate risk mitigation plan is not impossible, and there are opportunities such as the potential to take advantage of developments in renewable energy generation to eliminate diesel and increase electrification in mines. It is also a conversation for the whole value chain, such as the requirements for new types of transport if existing sites are retrofitted for new use – biomass and coal have very different storage requirements¹². This is where trusted partnerships to enhance research and development will become business essential.

Liability risks
Liability risks include those that arise from parties who have suffered loss or harm due to climate change and seek to recover damages from those who they view as responsible. These risks could arise from a failure to adapt, mitigate or disclose the financial risks from climate change.

As highlighted by Margaret-Ann, there are over 1,800 climate laws and policies which are increasingly viewed as a tool to influence policy outcomes and corporate behaviour. Liability settlements (or costs of court cases) may well grow if such cases start to win compensation from high carbon sectors. While liability risks can be passed to insurance firms if policies allow and the market capacity is there, damage to reputation and subsequent uninsurable claims could be significant. Combine this with increasing climate-related disclosure reporting and you can see why investors are increasingly interested in asking more questions. As regulatory and legal frameworks adapt, litigation risk may benefit from much greater attention.

Not so new risks pose new challenges
In many ways, these risks are not new per se; they translate into existing categories of financial risk such as credit, market, business, operation and legal risks that risk managers have been dealing with effectively for many years. For example, physical risks such as storms or droughts can lead to operational risks in the form of risks to key infrastructure such as tailings dams¹³.

But as new sources of financial risk, they do present new challenges, not least a more extensive modelling of the natural world and developing a much more granular understanding of the transition to a ‘net zero’ future (see Figure 1 page on 34 for more details).

That’s one of the reasons why Willis Towers Watson is now working in multiple sectors and geographies across the world to help clients manage and respond to ESG and climate risks.

What’s coming next: a strategic opportunity for risk managers

Over the last year or two, there has been an equally important development which is only just beginning to filter into financial markets, and in turn, into the natural resources sector and through mining markets.

Many of the world’s central banks and supervisors, through the Network for Greening the Financial System (NGFS)¹⁴, have upgraded their view on the financial risks from climate change. As highlighted in Figure 2 overleaf, the risks from climate change are now increasingly seen as having ‘distinct characteristics’ which means these risks need to be ‘considered and managed differently’. Key areas where questions are now being asked include:

Board response: regulators are setting clear expectations that managing the financial risks from climate change requires a long-term strategic response owned by the Board, with the premise of ‘if you don’t consider climate risk to be material, then tell us why’.
Individual accountability: In some countries, such as the UK, banks and insurers are being required to nominate a specific senior executive to be responsible for climate risk¹⁵. A common home for this is the Risk Management team, with the CRO named as the individual accountable.
Climate stress testing: at least 15 countries are now preparing climate stress tests¹⁶, including the need to consider risks up to 2050 and how banks and insurers are adapting their business model to a changing climate and net-zero future. Stress testing is not a new activity and Willis Towers Watson has been helping its clients explore the resilience of their business and risk management strategies for decades. However, designing stress tests to represent current and future impacts of climate change is an emerging field of climate risk analytics, and new developments are being adapted from the scientific community to support this activity. Risk managers should keep an eye on the outputs, because they are testing future lending conditions.

From understanding to action
The conversation continues to move from understanding to action. The UK’s Prudential Regulation Authority recently issued a letter to the CEOs of its regulated firms – banks and insurers – requesting that they fully embed approaches to managing the financial risks from climate change by the end of 2021¹⁸. And the NGFS recently published a set of reference climate scenarios which support the economic case for an early and orderly low carbon transition¹⁹.

This step change in action by central banks is being matched by the private sector, with many companies already signed up to voluntary climate risk disclosure initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD).

As of February 2020, over 1,000 companies with a market capitalisation of over $12 trillion had expressed their support.²⁰ And there’s already clear signs from multiple jurisdictions that TCFD could soon become mandatory, at least for listed companies and large asset owners²¹.

Aligning investments to the Paris Agreement
Some of the world’s largest investors and banks are now going further, not only disclosing risk but also committing to align their investment or loan portfolios to the ‘well below 2⁰C’ goal of the Paris Agreement on climate change²². The Global Sustainable Investment Alliance (GSIA) estimates that ESG investments, i.e. sustainable investing, represent in excess of $30 trillion globally, with industry research suggesting that this will double in the next three years²³.

ICMM explores climate change issues with members
Industry groups such as the International Council on Mining & Metals (ICMM) have been exploring these issues with their members, and several mining companies are already reporting against the TCFD framework²⁴. As the landscape continues to shift, the demands on firms in the wider economy to respond to ESG measures will only increase. And sectors such as mining, that underpin the resources needed for an orderly transition to a resilient, net zero future, are likely to be at the centre of the ESG storm.

Climate Quantified^TM: a new way of enhancing your ESG response
Climate Quantified^TM brings together our deep weather and climate analytical experience from the (re)insurance and investment markets, our extensive academic, research and institutional investor relationships, and our multi-discipline expertise and capabilities in a fully integrated service offering.

Furthermore, it embodies a proactive approach to helping shape the global community’s response to climate risks. For example: through our $50 million investment in the award-winning Willis Research Network²⁵ to support open climate and natural hazard research; insights from our Thinking Ahead Institute²⁶ to influence change in the investment world; and our founding role, with the World Economic Forum, in the Coalition for Climate Resilient Investment²⁷.

Sectors such as mining, that underpin the resources needed for an orderly transition to a resilient, net zero future, are likely to be at the centre of the ESG storm.”

Modelling physical risk impacts
We find the starting point for many clients is modelling the impact of their current physical risks from a changing climate such as storms, floods and other extreme weather events on an operational site-by-site basis. We’ve helped a number of clients along this journey; for example, by supporting a large bank to understand its climate risk exposure on a large rail infrastructure project. This engagement focused on physical risks to assets and the anticipated downtime following damage as part of creating a common asset resilience language.

From operational concerns to strategic imperatives
Modelling the likely amounts of damage or financial losses linked to future climate projections (e.g. the years 2030, 2050, 2100 under different climate scenarios) can help to make the impacts of possible future climate change more tangible. Knowledge fosters understanding, and then action; this might include modelling water availability to estimate potential business interruption, or the impacts of droughts or excess rainfall on the construction of different types of tailings dams²⁸. These are issues that can move from operational concerns to strategic imperatives.

Through this type of climate risk assessment, your company will also be much better prepared to respond to increasing expectations of consumers, lenders and investors around climate disclosures and to guide future planning, risk management and strategy.

Risk managers are uniquely placed to ensure their companies are prepared to meet the increasing expectations of disclosure by investors and regulators, embed climate risk into existing frameworks and ensure Boards are taking a strategic approach.

New opportunities to deploy existing resources
A changing landscape means there are new business opportunities and the potential to redeploy existing resources for new revenue generating activity. Investment in research and development for new technologies is one option that could serve to adapt and transform infrastructure to increase the lifespan of sites through additions such as Carbon Capture and Storage, converting coal generation facilities to use biomass as feedstock²⁹ or looking at completely new uses. Companies should learn from the innovation journeys of other sectors to think outside the box to create new value in future stranded assets and establish new business models³⁰.

The risk manager’s role
There are roles for everyone, and risk managers have a unique opportunity to facilitate them in key areas, including:

Governance, including the board’s role in providing oversight of climate risk responses and defining management responsibility for climate risk and ESG
Risk identification, identifying the key channels through which climate risks can impact the company
Risk appetite, including forming a view as to whether climate risk should be considered as a separate element or part of aggregate risk
Risk measurement and reporting, including how to incorporate climate risk into financial risk models and reports and deciding on relevant metrics for decision making - a key element of TCFD disclosure
Reputation risk, including identifying public communications needs and a strategy for communicating a firm’s climate and ESG response

Having a solid understanding within the business will not only prepare you for the changes that are already happening, but also those that are coming down the pipeline. By engaging with Climate Quantified^TM, risk managers can benefit from a structured, data driven and strategic approach and deeper insights into ESG issues. And by being proactive, risk managers can be far better prepared to meet the demands of their regulators, investors and Boards.

Conclusion: is it time to quantify your climate risk and develop a strategic response?

While there may be challenges ahead, the mainstreaming of ESG presents a strategic opportunity for risk professionals, particularly in the mining sector. As Boards grapple with the ESG onslaught, risk managers can play a leading role, providing not only risk quantification and analysis but also strategic insights into a rapidly evolving ESG landscape.

Having a solid understanding within the business will not only prepare you for the changes that are already happening, but also those that are coming down the pipeline.”

Matt Scott is a Senior Director in the Climate and Resilience Hub at Willis Towers Watson in London.
Matt.Scott@willistowerswatson.com

Geoffrey Saville is Weather and Climate Risks Hub Leader for the Willis Research Network at Willis Towers Watson in London.
Geoffrey.Saville@willistowerswatson.com

Lucy Stanbrough is Emerging Risks Hub Leader for the Willis Research Network at Willis Towers Watson in London.
Lucy.Stanbrough@willistowerswatson.com

¹ https://www.euractiv.com/section/climate-environment/news/davos-wrap-up-forum-runs-out-of-steam-as-climate-becomes-king/
² https://www.icmm.com/website/publications/pdfs/responsible-sourcing/icmm-circular-economy-1-.pdf
³ https://www.wsj.com/articles/pg-e-wildfires-and-the-first-climate-change-bankruptcy-11547820006
⁴ https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
⁵ https://www.blackrock.com/corporate/literature/publication/our-commitment-to-sustainability-exec-summary-en.pdf
⁶ https://www.ipcc.ch/sr15/
⁷ https://www-axa-com.cdn.axa-contento-118412.eu/www-axa-com%2Ff5520897-b5a6-40f3-90bd-d5b1bf7f271b_climatesummit_ceospeech_va.pdf
⁸ https://www.bankofengland.co.uk/climate-change
⁹ https://www.spglobal.com/marketintelligence/en/news-insights/blog/climate-related-considerations-in-the-metals-and-mining-sector
¹⁰ https://wri.org/applications/aqueduct/water-risk-atlas/#/?advanced=false&basemap=hydro&indicator=w_awr_def_tot_cat&lat=21.40449100321618&lng=50.35686492919922&mapMode=view&month=1&opacity=0.5&ponderation=DEF&predefined=false&projection=absolute &scenario=optimistic&scope=baseline&timeScale=annual&year=baseline&zoom=4

¹¹ https://eciu.net/news-and-events/press-releases/2020/almost-half-of-global-gdp-under-actual-or-intended-net-zero-emissions-targets
¹² P7. https://www.lloyds.com/~/media/files/news-and-insight/risk-insight/2020/below2c_insuranceforalowcarboneconomy_deepdives_pdf.pdf
¹³ https://www.willistowerswatson.com/en-GB/Insights/2020/03/tailings-facilities-and-dam-failure-from-a-risk-management-and-insurance-perspective
¹⁴ 66 central banks and supervisors and 13 observers https://www.ngfs.net/en/communique-de-presse/ngfs-publishes-first-set-climate-scenarios-forward-looking-climate-risks-assessment-alongside-user
¹⁵ https://www.bankofengland.co.uk/prudential-regulation/publication/2019/enhancing-banks-and-insurers-approaches-to-managing-the-financial-risks-from-climate-change-ss
¹⁶ https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/the-road-to-glasgow-speech-by-mark-carney.pdf?la=en&hash=DCA8689207770 DCBBB179CBADBE3296F7982FDF5
¹⁷ https://www.banque-france.fr/sites/default/files/media/2019/04/17/ngfs_first_comprehensive_report_-_17042019_0.pdf

¹⁸ https://www.bankofengland.co.uk/prudential-regulation/letter/2020/managing-the-financial-risks-from-climate-change
¹⁹ https://www.ngfs.net/en/communique-de-presse/ngfs-publishes-first-set-climate-scenarios-forward-looking-climate-risks-assessment-alongside-user
²⁰ https://www.fsb-tcfd.org/wp-content/uploads/2020/02/PR-TCFD-1000-Supporters_FINAL.pdf
²¹ For example, see the Green Finance Strategy https://greenfinanceplatform.org/national-documents/green-finance-strategy-transforming-finance-greener-future
²² See, for example, https://www.unepfi.org/net-zero-alliance/ and https://www.unepfi.org/banking/bankingprinciples/
²³ http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf
²⁴ https://theintelligentminer.com/2020/01/30/investing-in-a-greener-future-for-the-mining-industry/
²⁵ https://www.willistowerswatson.com/en-GB/Insights/research-programs-and-collaborations/willis-research-network
²⁶ https://www.thinkingaheadinstitute.org/

²⁷ https://www.willistowerswatson.com/en-GB/Insights/trending-topics/climate-risk-and-resilience
²⁸ https://www.icmm.com/website/publications/pdfs/climate-change/adapting-to-climate-change
²⁹ https://www.drax.com/press_release/draxs-largest-biomass-shipment-arrives-at-the-uks-biggest-biomass-handling-facility/
³⁰ https://theconversation.com/coal-mines-can-be-closed-without-destroying-livelihoods-heres-how-124336