World Economic Forum’s (WEF) Global Risks Report (Report) was released in January 2022. Now in its 17th edition, the Report provides a comprehensive analysis of the key risks predicted to arise from current global economic, societal, environmental and technological conditions.
The Report represents the combined expertise of the WEF’s Global Risks Practice, and industry and academic partners, in conjunction with the results of a series of consultations with public and private sector regional and thematic experts, the WEF Global Risks Perception Survey (surveying ~1,000 global experts and leaders) and the WEF Executive Opinion Survey (surveying ~12,000 CEO’s across 124 countries).
The Report’s results provide useful insights for today’s business leaders as they create policies and strategic plans responsive to emerging regional and global challenges, and to the perspectives of stakeholders.
In this article, we canvas the Report’s key takeaways to draw out their implications for corporate risk management and economic, social and governance (ESG) strategy in 2022.
1. Climate risks to have a transformative impact on all sectors – early adaptation projected to produce significant advantage over next ten years
Risks – Climate action failure, extreme weather events and biodiversity loss have been pinpointed as the three global risks anticipated to have the most damaging effect over the next ten years. Their projected flow-on effects are extensive, and include intensified rates of involuntary migration, natural resource crises, pollution harms to health, geopolitical resource contestation, social security collapse and livelihood and debt crises.
Increasing rates of environmental degradation and extreme weather events are anticipated to increase pressure on the stability of corporate supply chains and access to land and resources. Likewise, elevated policy and regulatory action in respect of carbon-intensive industries is projected to disrupt markets, limit investment opportunities and prospectively result in stranded assets.
As countries continue to transition to lower carbon economies at varying paces, transnational companies are likely to encounter increasing differences in legislative and regulatory regimes. A ‘disorderly’ global transition, as the Report describes it, is anticipated to result in more frequent and severe supply chain shortages, and disruptions to labour and production for transnational and highly carbon-exposed companies in particular.
Response – These findings suggest that:
- it will be increasingly essential for boards and directors to proactively assess and factor both physical and transition climate risks into decision-making;
- remaining ahead of the curve, adopting net zero strategies and targets early and conducting regular comprehensive climate risk assessments (inclusive of legal and financial risks) may assist in mitigating any disruption to operations; and
- early adaptation is more likely to minimise the impacts of the global transition.
There remain significant first mover advantages to be had in reducing carbon-exposure and establishing a robust net zero strategy.
Strategic investment in carbon emissions reduction and offsetting strategies, biodiversity preservation, renewable energy, resources security and defences against natural disasters are identified as key opportunities for those ready to adapt early. The market gains to be had are vast, with consumer and investor confidence predicted to be increasingly tied year on year to a company’s climate transition ‘readiness’, including its maximisation of net zero opportunities. This effect is likely to intensify as ESG-related financial risk disclosure and reporting becomes both more rigorous and more standardised, indicating that access to capital will be increasingly contingent on robust engagement with climate risks and ESG more broadly.
2. Post-pandemic socioeconomic challenges to intensify focus on ESG strategy and supply chain stability
Risks – The socioeconomic challenges that have flowed from the COVID-19 pandemic are anticipated to persist, and in some sectors, intensify. In the Australian context, ‘debt crises’ (defined within the Report as ‘mass bankruptcies, defaults, insolvency, liquidity crises or sovereign debt crises’) were highlighted as one of the key risks that will take centre stage in the short to mid-term (2-5 years).
The picture painted by the Report’s analysis is clear – rising commodity prices, inflation and debt are predicted to result in the global economy being 2.3% smaller by 2024 than present. Due to the necessity of protecting incomes and preserving jobs, post-pandemic corporate and public debt burdens are high. Public budgets are projected to remain stretched over the coming two to five years, with livelihood crises, mental health deterioration and social cohesion erosion identified as significant emerging global risks.
The economic fallout of the pandemic may be compounded by continuing limitations on international movement and disparities in rates of vaccination, which may in turn produce labour market imbalances and skills gaps, and create disruptions to corporate supply chains and production. Simultaneously, ESG-based investing is significantly altering the financial and economic landscape globally, compelling corporations to address a series of issues including auditing their supply chains for human rights impacts, committing to the decarbonisation of operations and implementing effective modern slavery policies.
Response – Surprisingly, the coalescence of these factors may produce ideal conditions for companies to focus on shortening their supply chains and incorporating ESG-informed principles into their long term strategy. Prudent risk management responses in this space may include:
- development and implementation of a robust ESG assessment and reporting strategy, noting that ESG reporting is increasingly being utilised by shareholders and investors as a proxy to evaluate management, identify the risk and value of actual and prospective investments, and make decisions regarding allocation of capital;
- commencement and/or maintenance of a clear dialogue with stakeholders regarding ESG issues; and
- engagement in comprehensive supply chain due diligence and consideration of opportunities to shorten the corporate supply chain and adopt ESG-informed protocols.
As momentum for ESG-based investing grows, shortening the supply chain and building strong local relationships may have positive flow on effects. Adopting a local procurement strategy and investing in supply chain due diligence may assist in eliminating labour exploitation and human rights violations from the supply chain. Likewise, use of a shorter supply chain may help to reduce a company’s overall carbon footprint by limiting the use of carbon intensive processes such as air freight and shipping.
Throughout 2021, a broad reallocation of global capital towards responsible and sustainable funds and businesses was visible in all sectors. Investing in an organisation’s ESG credentials, and conducting supply chain due diligence as a component of this, may bolster positive shareholder sentiment and increase interest from investors and financiers. In this respect, shortening the supply chain may be a prudent risk management strategy as investor sensitivity to the longitudinal risks of climate change, biodiversity loss, labour exploitation and human rights violations in supply chains continues to intensify.
3. Investment in robust cyber security measures is key in response to intensive digitalisation of major industries throughout pandemic
Risks – Technological risks have been highlighted as critical short to mid-term threats both globally and for Australia specifically. At a regional level, ‘failure of cyber security measures’ was identified as a key risk for East Asia and the Pacific, and the number one risk over the next two years for Australia, Great Britain, Ireland and New Zealand.
The COVID-19 pandemic (and associated lockdown measures) has propelled the rapid and intensive digitalisation of numerous industries over an 18-month period. As business and economic activity increasingly occurs online, exposure to cyber security threats is growing. Attacks on large technological systems are projected to become more severe and broadly impactful, with the Report raising concerns that quantum computing may have the capacity to break encryption keys. If so, this may place sensitive financial and personal data at risk. Interestingly this has been brought to bear, as earlier this week the Australian Cyber Security Centre warned Australian organisations they should be on high alert for cyber-attacks as a result of the rising tensions in Ukraine.
Response – While cybersecurity is anticipated to become a key area of regulator focus, the Report emphasises that it is vital that companies engage in horizon scanning and adapt ahead of regulatory shifts. The potential financial implications of disruptive cyberattacks are extensive. Investing early in protections for digital infrastructure, shifting data processing to jurisdictions with robust customer protections regarding data privacy, and upskilling within-organisation IT and cybersecurity professionals may be useful risk mitigation strategies.
As ESG concerns are drawn increasingly into focus, organisations that fail to demonstrate strong corporate governance around cybersecurity may suffer reputational harm.
Key recommendations for ESG strategy and risk management
Invest in rigorous risk assessment – ESG risk assessment should bring together appropriate cross-functional expertise. It is critical that boards, directors and general counsel receive specialist advice regarding:
- regulatory and compliance ESG risks;
- steps that must be taken to proactively and robustly comply with evolving reporting and disclosure requirements; and
- how environmental, social or governance issues may impact the performance, long-term viability and reputation of the organisation.
Carry out in-depth ESG due diligence – risk assessment is necessary on organisational, portfolio and transactional levels to ensure current assets and projects, and prospective acquisitions, do not present unchecked ESG risks. Proactive risk assessment and mitigation is particularly important given the movement of ASIC and other regulators in this space. Scenario analysis may be useful at this stage, as it allows an organisation to pinpoint all types of failure, damage and attrition that could result from physical and transition climate risks and compromise the company’s ability to deliver value.
Set and communicate clear ESG targets to internal and external stakeholders – these should include identification of the metrics by which progress will be measured, establishment of ESG governance and implementation of routine risk assessment, reporting and disclosure processes. This includes both reports to the board and disclosures to shareholders.
Ensure engagement in ongoing risk assessment and horizon scanning – remain alert to changing regional and global circumstances which may signal elevated risk, and adjust the company’s operational processes accordingly. This may mitigate damage flowing from geopolitical events. Establishing an internal mechanism by which the board and senior management will remain aware of emerging compliance or regulatory risks is critical.
Embrace early adaptation and diversify the organisation’s resilience strategies – there remains a clear first mover advantage to be had in adjusting corporate commitments, supply chains, policies and operational processes early to limit carbon exposure and address ESG risks. Early adoption and implementation of a range of innovative practices for identification, monitoring, reporting and mitigation of ESG risks is akin to investing in a diversified portfolio. Investing in a broad range of risk mitigation strategies may more effectively advance an organisation’s net zero position and increase the likelihood of long term success, irrespective of any rapid changes in global conditions that emerge.
ESG: A guide for General Counsel assists General Counsel (GCs) to identify, assess and capitalise on ESG opportunities and to develop a leading ESG risk and compliance culture across their organisation. Click here to learn more.
This publication is introductory in nature. Its content is current at the date of publication. It does not constitute legal advice and should not be relied upon as such. You should always obtain legal advice based on your specific circumstances before taking any action relating to matters covered by this publication. Some information may have been obtained from external sources, and we cannot guarantee the accuracy or currency of any such information.