Could You Be Wrong in Thinking Climate Change Does Not Affect Your Business?

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Introduction: what The Economist has to say about climate change and business

More than a year ago, we started off a series of blog posts on mandatory non-financial disclosures with a post on climate change. At that point, four risk groups of climate change were identified and suggestions were made on how to integrate climate risks in your overall risk management strategy. It is time to revisit and update the story on climate change, as climate science is advancing and impacts are becoming clearer.

As a heuristic (always a good idea, see this post), we gathered that the number of times The Economist, a weekly current events newspaper, wrote an article on ESG-related topics (i.e. risks stemming from environmental, social or governance aspects) would be a proxy for how serious firms should take ESG-risks. Climate change was the topic of the most articles by far in the period from roughly the end of 2015 to the end of 2017. We counted the following number of articles on ESG-topics:

  • Climate change: 38 articles.
  • Renewable energy: 18 articles.
  • ESG-risks: 12 articles.
  • Natural resource depletion and pollution: 11 articles.

Here’s how we think these topics fit together:

Please note we don’t claim any scientifically established causal relationships here; just a framework to put different topics loosely together and offer a way to think about interrelations. If you are looking for a scientific take on this, please visit the excellent report A Guide to SDG Interaction: from Science to Implementation from the International Council for Science.

Since climate change as a topic has the highest count in articles, is central to other topics such as the worldwide push for renewables and natural resource depletion (see schematic above), and climate change is advancing rapidly, we felt it was time to update our previous post on climate change risk. The importance of climate change risk is echoed by The Economist:

Ignoring the climate issues altogether looks like the biggest risk of all.

We will therefore revisit the four business risks already identified earlier (i.e. asset and infrastructure risk, yield and price risk, regulatory risk and reputational risk), and will propose a number of new risk groups that we found by reading recent articles by The Economist on ESG-topics.

Climate change and business risk, updated

In the table below, you will find all the business risks stemming from climate change found in The Economist. New risks (compared to our earlier blog post) are shown in bold italics. First, there are two additional business risks added to the risk group ‘external stakeholder actions to curb climate change’. Second, we found an entirely new risk group: ‘funding risk’.

For every business risk identified, we will now briefly describe the risk, give the examples found in The Economist, and offer a way to mitigate the risk.

Regulatory risk. More and more jurisdictions are introducing cap and trade schemes or carbon taxes. This inevitably means that firms have to take into account (future) carbon prices in investment decisions. According to the Carbon Pricing Leadership Coalition (a World Bank funded outfit that puts together business and governments to advance carbon pricing), ‘as of 2017, 42 national and 25 subnational jurisdictions are pricing carbon’. That already accounts for more than 20% of global CO2 emissions. In Canada, the announcement of a national carbon price puts high emitters at immediate risk. The province of Quebec in Canada, for instance, is lobbying to funnel $1 billion to Bombardier, an aircraft-maker, to make up for its payments of carbon taxes under a nationwide introduction of a carbon tax. Even if your own government is not imposing a carbon tax, there is increased risk that other governments start installing an import tax for every ton of CO2 emission in the making of a product. Indian steel makers, for example, will have to take into account a carbon tax when exporting to the EU, even though they do not currently face a carbon tax in India. What to do? More and more firms are using a price for carbon emitted in their long-term investment decisions. Putting a price on carbon in decision-making – and using a realistic price, say in the range of €50-60 per ton – will take into account any future carbon tax or cap and trade system. The Economist lists a number of companies that already use such internal carbon prices: Microsoft, DSM, AkzoNobel, Indian cement manufacturers ACC, Ambuja & Dalmia, French building materials producer Saint-Gobain, and supermarket chains Carrefour and Sainsbury’s.

Reputation risk. The sectors that face reputational risk include an obvious one and a, maybe, not so obvious one. To start with the obvious sector, the fossil fuel industry, it is not only CO2 emissions that are the target of environmentalists, but also methane leaks. That leaves companies like Shell, BP and ENI vulnerable to reputational risk even if they pledge to switch more and more to natural gas (infamous for methane leaks). Already, NGOs such as the Environmental Defence Fund are drawing attention to methane emissions in the production of natural gas that ‘now surpasses cow burps as a source of [methane] emissions’ according to The Economist. A sector that, as of yet, has not attracted the attention of environmental campaigners, is the cement industry. That might be about to change however, as more and more NGOs draw attention to an increasing number of industries now that it becomes clear that humanity is unlikely to keep temperatures less than 2°C warmer than pre-industrial times. Cement, together with steel, makes up a large part of the CO2 footprint for any building. And as firms try to lower their CO2 footprint, buildings, and thus cement, is another link in the chain in trying to reduce emissions. Firms that are exposed to this type of risk (i.e. reputational) are, according to The Economist, especially the major players in the cement industry, e.g. Heidelberg Cement Group and Cemex. Examples for mitigating these risks, as listed by the same newspaper, include setting publicly available targets (and reporting against those targets), carbon capture and storage, and using higher internal carbon prices for long-term investment decisions.

Shareholder pressure. An unlikely pressure group that turns its attention to climate change, are shareholders. Unlike environmental groups, who strive for direct reduction in emissions, shareholders would like to see that companies identify the impact of climate change regulations and policies on business plans. Again, the industry where shareholders are, at the moment, most active is the fossil fuel industry. The Economist refers to Shell, Total, Chevron and Exxon as firms where shareholders are particularly active to push towards pricing in carbon in investment decisions as the preferred mitigation strategy. Total goes further: ‘It plans to set out its ambition to develop an energy mix by 2035 consistent with Paris-style global-warming limits, including a pledge to invest $500m a year in renewables, and a “symbolic objective” to raise their share to 20% of its portfolio, from 3%. In an effort to complement its acquisition of a solar-energy company, it launched an offer to acquire a battery-maker, which will bolster its expertise in electricity storage’. Hidden in this mixture of Total’s plans, are a plethora of mitigation strategies that would please many shareholders pushing for just that: increasing the stake in renewable energy, taking head of broad international movements like the Paris agreements and adjusting strategies accordingly, and setting publicly available targets. Do this, and add to the mix internal carbon prices for investment decisions, and your firm will have a good policy mix to satisfy shareholder demands.

Lawsuit risk. In an article dubbed ‘Lawsuits against climate change’, The Economist points out that the number of lawsuits where the negative effects of carbon emissions are central, are rising. The targets are both governments and big energy firms. Ironically, governments also sue energy firms: San Francisco is taking BP, Chevron, Exxon and Shell to court. All of this is made possible by improved climate science: ‘Scientists are increasingly confident that they know roughly what shares of the greenhouse gases in the atmosphere were emitted by individual countries, and even by the biggest corporate polluters. (..) just 90 belched out 63% of all greenhouse gases between 1751 and 2010.’ In a fascinating report by the Carbon Majors Database, all these companies are listed. Unsurprisingly, the 90 firms are either big energy firms, mining corporations, or cement manufacturers. Even if your firm is not listed, you might want to check if a similar study is done for your own country, and you may find that your company is listed in that ranking. Climate litigation is on the rise. The focus is on big energy firms for now, but cement manufacturers and mining corporations might be next. The sooner you map your firm’s GHG emissions and estimate the risk that an interest group or government targets you in the near future, the better.

Decreased access to capital markets. The last new risk that we identified as compared to our last post on climate related risk for companies, is a funding risk. As climate change becomes more of an issue, investor demand for green bonds is increasing. At the same time, investors are backing away from industries that run greater risk from climate change (these risks are, essentially, all other risks described here). Moody’s, a rating agency, puts energy firms and car makers, for example, in a higher risk category. This can obviously translate in lower stock prices and higher premiums in bond markets. Big investors are adopting climate strategies rapidly. Allianz, for example, is not putting money in firms that derive more than 30% of their energy from coal; and even the biggest asset management firms like BlackRock have set-up dedicated green-bond funds fueled by investor demand. Another recent development is that rating agencies are threatening cities with downgrades if they don’t do more on climate change mitigation (also see asset and infrastructure risk below). Companies might well be next.

Asset and infrastructure risk. As 2017 proved, with hurricanes Harvey and Irma as horrifying examples, climate change increasingly poses a threat for assets and infrastructure. As wet places get wetter and stormy places get stormier, cities around the world are making plans to raise roads and improve drainages. Your business would be well advised to do the same. As an example, you could use impact models (such as the Inter-Sectoral Impact Model Intercomparison Project (ISI-MIP)) to establish which of your business locations are at risk, and implement a mitigation strategy for those locations accordingly. We could not find any specific examples in The Economist of businesses that have already implemented mitigation strategies for asset and infrastructure risk, however. It mainly refers to cities and governments to take action to protect assets and infrastructure. Your firm should follow the example of cities.

Price and yield risk. What we discussed for asset and infrastructure risk, more or less also holds for price and yield risk. Although The Economist acknowledges the risk (‘by 2050, even if temperature rise is successfully limited to 2°C, crop yields could slump by a fifth’), we could not find any mention of individual firms that are already affected by this. Again, this should not be a reason for a wait-and-see attitude. A good starting point is the Agricultural Model Intercomparison and Improvement Project (AgMIP). This major international collaborative is an effort to improve agricultural simulation and to understand climate impacts on the agricultural sector at global and regional scales. AgMIP produce highly useful maps for your businesses to gauge the impact of climate change on yields for crops in your supply chain.

Industry climate change risk profile

Reading through the business risks in the previous section, you will have been able to quickly assess if your firm faces a particular risk or not. By deconstructing climate change risk into seven distinct business risks (i.e. regulatory, reputational, shareholder pressure, lawsuit, funding, asset & infrastructure, and price & yield), you now have a tool to help you decide if the – arguably – abstract concept of climate change is relevant to your organization.

By way of summary, we have added specific industries (mentioned in The Economist articles that we consulted) to the individual business risks identified. This isn’t to say that other industries aren’t impacted by each type of business risk. See the table below:

Coming up with the right strategy mix to mitigate these risks might not be easy. Renewable energy, insurance policies, carbon capture and storage, (higher) internal carbon prices, improving drainages, moving production locations: they could all be visited as possible solutions. Keep in mind that the combination ‘climate change’ and ‘business’ does not feel like a realistic combination. We would argue that this is normal human behavior, since climate change is not a risk that has hurt your business in the past. But we hope to have shown with examples taken directly from The Economist, that your competitors and fellow business organizations are already fully taking on business risks stemming from climate change. A final word of caution from Nicholas Taleb:

People in risk management only consider risky things that have hurt them in the past (given their focus on ‘evidence’), not realizing that, in the past, before these events took place, these occurrences that hurt them severely were completely without precedent, escaping standards.

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Veel gestelde vragen rondom de Wet bekendmaking niet-financiële informatie (NFI)

This post is about the translation of the EU regulation on disclosure of non-financial information to a Dutch national regulation; this entry will, therefore, be in Dutch.

1. Welke organisaties moeten aan de wet bekendmaking NFI voldoen?

Organisaties van openbaar belang (beursgenoteerde ondernemingen, banken, verzekeraars en kredietinstellingen) met meer dan 500 werknemers, een balanswaarde groter dan 17,5 miljoen en een netto-omzet van meer dan 3,5 miljoen.

2. Wij moeten toch al niet-financiële prestatie-indicatoren betrekken bij onze bedrijfsanalyse in het bestuursverslag? Wat verandert er nu precies?

Klopt, u betrekt al milieu- en personeelsaangelegenheden in uw analyse. Echter, de huidige Wet gaat verder omdat:

  • u een verklaring moet opnemen; deze verklaring gaat verder dan dat u prestatie-indicatoren betrekt in uw analyse; wat u dient op te nemen in deze verklaring vindt u in het antwoord op vraag 3.
  • naast milieu- en personeelsaspecten dient u nu ook sociale aangelegenheden, mensenrechten en bestrijding van corruptie en omkoping te bespreken in uw bestuursverslag.

3. Wat zijn de belangrijkste Wetspassages?

Artikel 2, lid 1: De rechtspersoon maakt als onderdeel van het bestuursverslag een niet-financiële verklaring openbaar en doet mededeling omtrent:

  • artikel 3, lid 1b: het beleid, waaronder de toegepaste zorgvuldigheidsprocedures, alsmede de resultaten van dit beleid (…);
  • artikel 3, lid 1c: de voornaamste risico’s, negatieve effecten, en risicobeheersmaatregelen van zakelijke betrekkingen en producten of diensten;
  • artikel 3, lid 1d: niet-financiële prestatie-indicatoren die van belang zijn voor de specifieke bedrijfsactiviteiten.

4. Wat houdt niet-financiële informatie precies in?

Niet-financiële informatie wordt in de Wet gedefinieerd als informatie over milieu-, sociale en personeelsaangelegenheden, eerbiediging van mensenrechten en bestrijding van corruptie en omkoping.

5. Wat zijn voorbeelden van de verschillende NFI-aspecten die in de wet genoemd worden?

  • Milieu: gebruik van duurzame energiebronnen, broeikasgasemissies, waterverbruik en luchtverontreiniging. Maar ook informatie over natural capital, natuurlijke hulpbronnen (drinkwater), of bijdragen aan een circulaire economie.
  • Sociaal: dialoog met plaatselijke gemeenschappen, eerbiediging van bestaande landrechten, recht op informatie.
  • Personeel: gelijkheid mannen en vrouwen in arbeidsvoorwaarden, raadpleging van werknemers, recht op vereniging.
  • Mensenrechten: werkomstandigheden, werktijden, kinderarbeid, slavernij, vrijheid van meningsuiting, etc.
  • Corruptie en omkoping: maatregelen om corruptie en omkoping tegen te gaan.

6. Waarom moet onze organisatie NFI rapporteren / wat is de achtergrond?

De EU betoogt dat door bekendmaking van NFI de samenhang, vergelijkbaarheid en transparantie van rapportages verbeterd wordt in het belang van stakeholders zoals investeerders en consumenten. De Wet moet er bovendien voor zorgen dat risico’s met betrekking tot duurzaamheid inzichtelijk worden gemaakt.

7. Wanneer en hoe moeten wij rapporteren?

  • Organisaties van openbaar belang moeten over 2017 NFI bekend maken.
  • NFI dient opgenomen te worden in het bestuursverslag; daarbij mag gebruikt gemaakt worden van een kaderregeling (zoals ISO 26000, Integrated Reporting of het Global Reporting Initiative); u dient te melden welke kaderregeling u gebruikt.
  • Een separaat duurzaamheidsrapport is niet voldoende. De verklaring omtrent NFI dient opgenomen te zijn in het bestuursverslag.

8. Hoe verhoudt de bekendmaking NFI zich tot ons duurzaamheidsrapport?

Bekendmaking van NFI voor oob’s is wettelijk vastgelegd; een duurzaamheidrapport is niet verplicht. In uw duurzaamheidsrapport heeft u meer vrijheid in de onderwerpen die u communiceert (en de manier waarop).

9. Kunnen wij NFI ook nog voor andere doeleinden gebruiken?

Jazeker. Wij raden aan NFI te integreren in uw bedrijfsprocessen. Processen waar NFI  een bijdrage kan leveren aan een betere bedrijfsvoering zijn bijvoorbeeld risico management, stakeholder management en het strategieproces.

10. Wie controleert of onze organisatie conform de wet rapporteert?

De accountant.

11. Waarop en hoe vindt de controle plaats?

  • De accountant gaat na of de niet-financiële verklaring overeenkomstig de Wet is opgesteld en met de jaarrekening verenigbaar is, en of de verklaring in het licht van de tijdens het onderzoek van de jaarrekening verkregen kennis en begrip omtrent de rechtspersoon en zijn omgeving, materiële onjuistheden bevat.
  • Mocht de accountant op zaken die stuiten die niet in lijn zijn met de verklaring NFI dan maakt zij daar melding van.
  • De accountantscontrole is dus meer dan een simpele aanwezigheidscheck. De accountantscontrole gaat echter minder ver dan een volledige controle van de niet-financiële informatie waarbij de accountant ‘afzonderlijke gedetailleerde controlewerkzaamheden’ zou moeten uitvoeren.

12. Mag onze huisaccountant adviseren over de inrichting van onze NFI-rapportage?

Nee. De Wet toezicht accountantsorganisaties verbiedt dit. Een accountantsorganisatie die wettelijke controles verricht bij een oob, verricht naast controlediensten geen andere werkzaamheden voor die organisatie.

13. Wat zijn grofweg de stappen om te komen tot een NFI-rapportage?

U begint met een quick scan waarin u bepaalt of u klaar bent voor de Wet. Mocht dit niet zo zijn dan kunt u vervolgens prioriteiten voor de bekendmaking NFI stellen, uw rapportageproces inrichten en uw rapportage opleveren. Deze stappen zijn verder uitgewerkt in de figuur bovenaan deze post.

Neem vrijblijvend contact met ons op voor meer informatie.

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The EU Directive on Disclosure of Non-Financial Information: Will It Push the Needle?

Do you think the EU Directive on Disclosure of Non-Financial Information (follow this link) will seriously push the needle on sustainable practices? Or will it just be an exercise in box-ticking?

Starting this year, over 6,000 companies in the EU will be required to disclose negative impacts caused by their business operations, including their policies and results on social, environmental and human rights topics. Do you think firms will embark on a serious journey to integrate ESG-aspects in their reporting (for a quick read on this, click here) or will organizations try to comply with minimal effort and the effects on sustainability will, consequently, also be minimal?

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What every manager should know about (5/5): Non-Financial Disclosure

Introduction

This ‘What Every Manager Should Know About’-series is intended for managers whose businesses have to disclose (or feel the need or pressure to disclose) non-financial information. The needs or pressures to disclose non-financial information are manifold. Regulatory compliance such as EU directive 2014/95/EU, NGO pressure, ESG-risk management, demands from investors, and many other factors can all be reasons for a firm to start on a journey of non-financial reporting. Different non-financial topics have in common that they arguably feel unfamiliar to business managers who are trained to mainly think in financial terms. Now that the business case for non-financial reporting is well established (see The Business Case for Non-Financial Reporting), it is time for managers to familiarize themselves with the non-financial aspects of their business operations. In this series, I covered climate change, human rights, new governance, and corruption and bribery. Of course, these merely scratch the surface of non-financial aspects. The range of topics discussed, however, allow us to draw a number of general recommendations that will help you make a plan for implementing non-financial disclosure for your organization. After summarizing these general recommendations, pulled from previous posts in this series, I offer you an additional important point for consideration: which organization function should ultimately be responsible for non-financial reporting?

What we can take from previous posts in this series

  1. Non-financial reporting is tied to risk management. The first thing that you should be aware of is that non-financial reporting is closely tied to environmental, social, and governance (ESG) risk management. Focusing on non-financial aspects will tell you much about the risks your firm is facing in these non-financial areas. In the post on climate change for example, the case was made that focusing on climate change offers your firm the chance to gauge asset and infrastructure risk, price and yield risk, government regulation risk, and reputational risk. Reputational risk was also discussed in relation to human rights. Not adhering to human rights principles, can furthermore lead to risks of disruption in your supply chain because of strikes, bad quality of products, or drops in productivity for example. Managing governance or anti-corruption (discussed in two other posts) in an insufficient manner can lead to anything from reputational risk, to profitability risk, to ultimately risking your firm’s license to operate.
  2. Involving stakeholders is key. In the post on governance, we saw that both an explosion of advocacy groups since the 1970’s and increasing globalization lead to ever more importance and influence of a multitude of stakeholders on your business operations. It makes sense to involve your most important stakeholders when you select the most material non-financial topics for your reporting effort.
  3. Don’t reinvent the wheel and use existing guidelines, certification schemes and overarching (inter)national policy goals. A number of authoritative sources for your ESG-policies are readily available. Posts in this series referred to, among others, the OECD Principles of Corporate Governance, the UN Guiding Principles on Human Rights, and the Anti-Corruption Ethics and Compliance Handbook for Business drafted by the UN and World Bank. In the environmental realm, there is a plethora of multi-stakeholder initiatives that can help your business implement proper policies. For example, WWF endorses a number of multi-stakeholder initiatives, such as the Forest Stewardship Council (FSC) for wood and other forest products, Marine Stewardship Council (MSC) for seafood, the Roundtable on Sustainable Palm Oil (RSPO), the Roundtable on Responsible Soy (RTRS) and the Better Cotton Initiative (BCI). Multiple actors offer tools to help you pick the certification scheme that fits the needs and demands of your business, focusing on social, environmental and governance elements. Beyond certification, your company should be aware of overarching goals set by for example the United Nations (see the Sustainable Development Goals) and governments (see for instance the Dutch push for a circular economy in 2050 which is, in turn, based on an action plan for a circular economy drafted by the EU). Aligning your efforts with those grander (inter)national schemes will help structure your message to stakeholders.
  4. Use a step-by-step implementation plan for your ESG-policies. In both the post on human rights and the post on governance, an 8-step approach to implement a policy on any ESG-topic in your company’s operations (including your supply chain) was proposed:

1) Analyze and prioritize. First, perform a risk analysis and determine where your priorities need to be.

2) Engage stakeholders. Engage widely with stakeholders and formalize the dialogue. The engagement should lead to a decision on a compliance strategy: a code of conduct or certification scheme that has the support of your stakeholders.

3) Select suppliers. Select suppliers that are willing to work together on your priority ESG-topics and are willing to work towards compliance with your targets.

4) Develop KPIs & implement processes and policies. Develop KPIs together with suppliers and other stakeholders. Important: do not forget to design and implement processes, policies and systems that can actually deliver on your KPIs.

5) Evaluate. Evaluate your (and your suppliers) efforts on a regular basis. Follow-up frequently to see if expectations are being met and evaluate progress.

6) Enhance performance. Use supplier development strategies to enhance performance. Implement collaboration and training programs at the supplier, invest in assets, or offer technical and (potentially) financial assistance. Informal evaluations and audits could encourage suppliers to take initiative.

7) Report. Communicate your efforts and results according to the compliance strategy you chose in step 2 or integrate the results in your current ESG-report. Reach out to all stakeholders involved in step 2 and get their feedback.

8) Review. Set-up a periodic review board. Make sure it is composed of in-house professionals and external academic, NGO expertise, and worker unions. Review performance evidence quarterly to identify patterns and explore possible solutions

Assigning non-financial reporting to the CFO

Now that we have a number of guidelines on how to implement non-financial policies and reporting in your organization, the next question would be: ‘who should be in charge?’ For a number of reasons, the answer to that question is unequivocal:

  • Non-financial reporting may not be financial reporting, but it is reporting. Consequently, the person in charge should know how to deal with data gathering, reporting processes, reporting systems, compliance and auditing.
  • Non-financial reporting is closely tied to risk management. The person in charge should have strong knowledge of enterprise risk management.
  • Non-financial reporting has implications for the firm’s strategy and vice versa, the person responsible should have a role in which she can influence decisions on both fronts.

For all these reasons, I propose to hand final responsibility for non-financial reporting to the Chief Financial Officer. Ioannis Ioannou, of London Business School, who has published widely on corporate strategy in relation to ESG-topics, tends to agree in an article in The Guardian:

There are important implications in terms of organisational design and structure. How separate should the strategy and sustainability functions be within a corporation? What should the relationship between the CFO and the Chief Sustainability Officer (CSO) be? Current corporate mindsets consider CSSR [corporate sustainability and social responsibility] issues as peripheral or at best, as separate issues, and therefore there is a clear distinction between strategy and CSSR functions. This is an artificial and dangerous segregation. In fact, for a company that truly understands what strategy will look like in the age of sustainability, the CFO and the CSO should be the best of friends, or even, the same person.

Conclusion

This last installment summarized the main takeaways from previous posts in the series ‘What Every Manager Should Know About’ that focused on non-financial reporting. These takeaways should give you an advantage in implementing both regulatory reporting and voluntary reporting. I covered a number of ESG-topics in relation to non-financial reporting and concluded that 1) non-financial reporting should be tied to risk management; 2) involvement of stakeholders is key; 3) you should use existing guidelines, certification schemes and overarching (inter)national policy goals; and 4) a step-by-step implementation plan for each of your ESG-priorities is needed. In addition, I argued that non-financial reporting should be the responsibility of the C-suite: if not the CFO, then a CSO (Chief Sustainability Officer) that works closely together with experts in governance, compliance, risk and reporting that resort under the CFO. What I failed to discuss is the difference in actual frameworks that structure your overall non-financial report. Again, there is an abundance of frameworks available – e.g. GRI, IIRC, ISO 26000, CDP, SASB – and I hope to give an overview of their respective uses in a future blog entry.

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What every manager should know about (4/5): Corruption and Bribery

Introduction

Now that large corporates have to adhere to EU regulation 2014/95/EU, managers should be more familiar with a number of non-financial topics. The EU regulation on the disclosure of non-financial information asks firms to provide information on environmental, social and employee matters, respect for human rights, anti-corruption and anti-bribery matters.

In this post, the spotlight will be on corruption and bribery. I will give you definitions of bribery and corruption, explain why businesses can benefit from fighting corruption and bribery, and will show you how to implement an anti-corruption policy.

Corruption and bribery, an attempt at a definition

Transparency International (TI) defines corruption as ‘the abuse of entrusted power for private gain’. In addition TI says: ‘It can be classified as grand, petty and political, depending on the amounts of money lost and the sector where it occurs.’ I use TI’s definition of corruption, and not the definition given by the EU in its regulation, because the EU regulation does not include a definition. Nor does the EU provide a definition of bribery. So, instead, to find a less concise definition than the one used by TI, I consulted the anti-corruption convention endorsed by the highest number of states, the United Nations Convention against Corruption (UNCAC). However, UNCAC also couldn’t agree on the right definition…

According to Leslie Holmes, the reason why defining corruption (and bribery) is so difficult is threefold. In Corruption, A Very Short Introduction, he writes that cultural reasons, jurisdictional reasons and scholarly reasons all contribute to definitional confusion.  To solve this – and to elaborate on the definition offered by TI – Holmes proposes a 5-step approach to identify corruption, which I will use in the remainder of this blog:

  • the action (or omission) must involve an individual (an official) or a group of officials occupying a position of entrusted power;
  • the official has a degree of authority in decision-making;
  • the official must commit the act (or omit to do what he should) at least partly because of personal interests or the interests of an organization to which he belongs, and these interests must ultimately run counter to those of the state and society;
  • the official acts in a clandestine manner, and is aware that his behavior is or might be considered illegal or illicit. If uncertain about the level of impropriety, the official opts not to check this because he wishes to maximize his own interests;
  • the action or omission must be perceived by a significant proportion of the population and/or the state as corrupt.

Corruption encompasses both economic improprieties, such as embezzlement and bribes, and social improprieties such as appointing family (nepotism) or friends (cronyism). (Please note that cultural norms might label the same activities as corruption in one culture, but not in another; this is the reason for including the last step — i.e. the action must be perceived as corruption — in the approach to identify corruption.)

The difference between corruption and bribery, thus, becomes clear: bribery is a form of corruption. The OECD further defines bribery by listing some instruments for bribes: gifts, hospitality and entertainment, customer travel, political contributions, charitable donations, sponsorships, facilitation payments, and solicitation and extortion.

Considering the possible elements of corruption above (i.e. bribery, embezzlement, nepotism and cronyism), bribery is arguably the salient form of corruption in the business world. This is perhaps the main reason why the terms ‘bribery’ and ‘corruption’ are almost used interchangeably in guidance documents targeted at the business world. The OECD Good Practice Guidance on Internal Controls, Ethics, and Compliance, for example, uses ‘ant-bribery’ exclusively. When the same OECD joins forces with the United Nations and the World Bank to draft the Anti-Corruption Ethics and Compliance Handbook for Business, however, the nomenclature is ‘anti-corruption’ instead of ‘anti-bribery’. This confusion of terms should not deter us, though. Bribery is a form of corruption. When a guideline calls for business to implement procedures to combat corruption, I think it’s a safe bet that they want you to implement procedures to combat bribery. In the remainder of this post, I will use the terms interchangeably.

Why should businesses care about corruption and bribery?

Your business should obviously comply with rules and regulation (such as EU regulation 2014/95/EU) on the disclosure of your policies and results in preventing corruption and bribery. There are a number of reasons why governments and international organization would push for such regulations (all that follows is, again, from Corruption, A Very Short Introduction):

  • Societal reasons. Corruption can lead to reduced aid. It can lead to increase inequality and a sense of ‘them and us’, or to reduced social capital and low levels of trust, and higher (organized) crime rates. A specific example where society pays the price for corruption relates to the construction industry where corrupt safety inspectors ignore malpractices in return for bribes, leading to unsafe buildings. (Also see my blog on human rights and the Rana plaza disaster.)
  • Environmental reasons. Corruption and bribery can be a problem in issuing permits for natural resource exploitation. One problem that you have surely heard about is illegal logging in countries like Brazil and Indonesia.
  • Security reasons. ‘For a state to exercise its defense, law enforcement, and welfare function properly it needs adequate funding; if corruption reduces government revenue, this has detrimental effects on the state’s overall capacity to protect its people. There is a strong correlation between weak states and high levels of corruption.
  • Economic reasons. Countries that score high on perceived corruption (see for example the corruption perception index 2016 from Transparency International) face lower levels of Foreign Direct investment, have lower tax revenues, and often face issues like ‘brain drain’.

In addition to the reasons that governments and international organization would offer to combat corruption and bribery, surely there is a conspicuous reason for business to do so as well: free competition. Businesses depend on free markets and free competition. Without it, your firm could lose out on business unfairly. It is one thing to lose business to a competitor where there is a level playing field; it’s an entirely different thing if you lose business to a competitor who engages in bribes to secure sales. The UK Secretary of State for Justice, in his foreword to the guidance for business to the UK Bribery Act (2010), says:

Addressing bribery is good for business because it creates the conditions for free markets to flourish.

A second reason why business should care is to maintain its reputation. The numerous corporate corruption cases which surfaced in the last years didn’t do much good. Holmes gives some examples:

The focus so far has been on the negative impact of corruption in the narrow sense (i.e. that involves state officials). But in the 21st century, the general public has become far more aware of the potentially devastating effects of corruption in its broad sense. As one Western corporation after another – Enron (USA), WorldCom (USA), Parmalat (Italy), Siemens (Germany), AWB (Australia), to name just a few – has been shown to have been engaging in misconduct, including bribery and kickbacks to secure overseas contracts, so the public’s trust in the corporate sector has plummeted.

The Economist, in a review on a new book about corruption, puts it like this:

Corruption is never far from the front page. In recent weeks, thousands of Romanians protested against plans to decriminalize low-level graft, and Rolls-Royce was hit with a [$835m] penalty for alleged bribery. Meanwhile, long-running corruption scandals continue to roil political and corporate leaders in Brazil and Malaysia. The growing attention has spurred governments to pledge action, as dozens did at a global anti-corruption summit in London last year.

Anti-corruption policies thus help companies (i) to defend free markets and (ii) build their reputations as trustworthy and reliable business partners. One way to do this is to explicitly report on bribery and corruption (just as the EU directive demands). Some see this as an extension of corporate governance reporting (see my blog on new governance) and propose to add it to other corporate governance disclosures. Holmes describes the evolution to a quadruple bottom lining as follows:

Since at least the early 1990s, more and more companies have been presenting their annual reports not merely in terms of financial performance – the traditional ‘bottom line’ – but also of their social and environmental achievements. (…) This triple bottom lining – also known as the 3Ps approach, namely ‘people, planet, and profit’- is usually presented as ‘sustainability reporting’. But in recent years, there has been a push to add a fourth bottom line, governance. This would include reporting on what a company has been doing to reduce bribery and corruption. It is argued by proponents of this ‘quadruple bottom lining’ that firms would benefit from reporting a fourth line, since it should enhance a company’s reputation.

To be able to report on your efforts to prevent bribery and corruption — as Holmes describes, and the EU regulation demands — you first have to implement the proper procedures within your firm. This is the subject of the next paragraph.

How to implement an anti-corruption policy

In implementing an anti-corruption policy, you could revert to one of the many guidance documents available. I already mentioned the UK Bribery Act Guidance and the OECD Guidelines. What follows is a (very) short overview of best practices from the Anti-Corruption Ethics and Compliance Handbook for Business drafted in a joint-effort by the OECD, the World Bank, and the UN Office on Drugs and Crime (UNODC). This is not so much a step-by-step guide on how to implement an anti-corruption policy, but an exhaustive list of things to keep in mind while drafting, implementing and following up on your policies and procedures to combat corruption.

  1. A risk assessment, addressing the individual circumstances of the corruption and bribery risks faced by your firm and its business partners, should be the basis for any anti-corruption program.
  2. Support and commitment from senior management for the prevention of corruption. Senior management’s involvement should be strong, explicit and visible.
  3. Develop an anti-corruption program. The program should at least include your firm’s anti-corruption efforts, including values, code of conduct, detailed policies and procedures, risk management, internal and external communication, training and guidance, internal controls, oversight, monitoring and assurance. The program should be applicable to all employees.
  4. Oversight of the anti-corruption program. Top management appoints a senior officer to oversee and co-ordinate the compliance program with adequate level of resources, authority, and independence. The senior officer in charge, reports periodically to top management.
  5. Clear, visible, and accessible policy prohibiting corruption. Here, you can think about preparing and disseminating an internal anti-corruption manual.
  6. Detailed policies for particular risk areas. Areas often mentioned are: gifts, hospitality and entertainment, customer travel, political contributions, charitable donations and sponsorships, and facilitation payments.
  7. Application of the anti-corruption program to business partners. Here, you should consider all business partners you may need to include in rolling out your compliance program, such as contractors, suppliers, agents, lobbyists, consultants, auditors, representatives and distributors.
  8. Internal controls and record keeping. This refers to proper financial accounting procedures and other checks and balances.
  9. Communication and training. Periodic communication and periodic documented training for all employees.
  10. Promoting and incentivizing ethics and compliance. The firm’s commitment to an anti-corruption program should be reflected in its human resource practices. It should be clear that compliance with the program is mandatory and that no employee will suffer demotion, penalty or other adverse consequences for sticking to the program, even if it may result in losing business.
  11. Detecting and reporting violations. The anti-corruption program should provide a safe space, and encourage employees and others to raise concerns and report suspicious circumstances.
  12. Addressing violations. Your firm should consider appropriate disciplinary procedures to address, among other things, violations of laws against corruption and bribery, and the company’s ethics and compliance program.
  13. Periodic reviews and evaluations of the anti-corruption program. Install periodic reviews to assess if improvements to your program are needed.

What’s next?

The ESG-topics covered in this series have some common aspects. First, they could all be seen as posing a risk to your company’s efforts for profitability (or even your license to operate). Second, it could be argued that they are not a core element of your firm’s mission but are ‘hygiene’ factors that do not immediately lead to higher profitability per se, but could hurt profitability if not properly managed. Third, external communication on these topics goes beyond communicating to such direct stakeholders as shareholders, customers and regulators. These three common aspects lead me to propose that ESG-topics should be viewed and managed as an integral topic from both an organizational structure as a business process point-of-view.

In my final post on the EU directive and related ESG-topics, I will, thus, revisit the advice given in previous blog posts, and try to synthesize these in a unifying approach towards managing ESG-topics relevant for your organization.

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What every manager should know about (3/5): New Governance

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold: First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall business and risk management strategy.

The first blog in this series discussed climate change; the second post discussed human rights.

For the third installment in this series on non-financial information, I will focus on governance. Not the governance business managers might already be familiar with; but a new governance arising from a world where a diverse multitude of stakeholders influence the decision-making process within the firm.

I will discuss what new governance is, why new governance is a good way to manage your ESG-risks, and how you should go about implementing a way of working that takes into account new governance.

Corporate Governance

Governance is the process of governing. Governing, in turn, is defined by the Oxford English Dictionary as conducting (i.e. directing or managing) the policy and affairs of a state, organization, or people. Corporate governance, therefore, can be defined as managing the policies and affairs of a corporation.

Business managers will be familiar with corporate governance being described along the lines of the following (and many more) concepts: accountability procedures for board and management team; policies and accountability to shareholders and other stakeholders; transparency; ethical behavior; audit procedures. All these concepts and procedures of corporate governance have been well established: see for example the G20/OECD Principles of Corporate Governance. (Although I have to add that discussions on governance issues such as executive pay, and occurrences of accounting scandals will probably never end, as this article and this article (respectively) in The Economist show; I guess no amount of governance will ever change human nature…)

Since business managers (and their internal and external auditors) already have a very clear understanding of what corporate governance entails, it would not add anything to their knowledge by only restating the principles of corporate governance as defined by (e.g.) the OECD. Instead, I will focus on a broader definition of governance. As you will see, this broader definition will help you understand how governance is a more extensive issue than just corporate governance, and how it is linked to those other ESG-risks: environmental risk and social risk.

Beyond Corporate Governance: New Governance

Setting rules, regulations and policies to govern the organization internally is not sufficient to manage a business organization in the twenty-first century. A number of developments in the last decades have pushed governance from hierarchical structures (such as those followed by most corporates and all national governments) towards new forms of governance.

The first of these developments is the ‘explosion of advocacy groups during the last third of the twentieth century’ as Mark Bevir calls it in Governance, A very Short Introduction. Without a doubt, the increasing range and variety of stakeholders are getting an ever stronger say in policy development, whether it be government policy or corporate policy. A second development is that the rise of globalization has called for global governance to manage international flows of good, money and financial products or investment. Increasing globalization necessitates governance of non-economic issues such as security, food safety standards, climate change, and other issues affecting global commons that transcend national boundaries (e.g. clean air and water, protecting marine life).

The old form of hierarchical governance (via national or international institutions) is increasingly replaced by multi-stakeholder governance models. According to Bevir, the features that these new models have in common are:

  • they combine established administrative arrangements with features of markets and networks;
  • they are multi-jurisdictional and often transnational;
  • they involve an increasing range and plurality of stakeholders;
  • governing arrangements, different levels of governance, and multiple stakeholders are often linked together in networks.

Business firms should be aware of new governance because they increasingly run into non-economic issues that transcend national boundaries. In many cases, they will find that the issue at hand is governed by new governance, instead of by old-fashioned hierarchical governance (i.e. national rules and regulations).

Corporate Governance vs. New (or Network) Governance

Although governance in business organizations is already in place in the form of corporate hierarchical governance, business managers need to be aware of new governance in the form of network governance. There are roughly three types of governance according to Bevir:

Most of the typologies focus on three ideal types: hierarchy, market, and network. Each of the ideal types relies on a particular form of governance to coordinate actions. Hierarchies rely on authority and centralized control. Markets rely on process and dispersed competition. Networks rely on trust across webs of associations. (…) Box 1 provides an overview of the resulting types.

As for corporate governance, organizations are – by their very nature – steeped in hierarchical thinking. In addition, the market variety of governance should not hold too many secrets for business organizations either. Network governance, however, is a different matter. Because of developments described earlier – dramatic increase in advocacy groups, and increasing multi-stakeholder governance for transnational issues –, organizations are faced with mounting pressure to start using network governance as an additional governance model in organizational processes.

Implementing Network Governance

Implementation of network governance within a business organization – to manage issues that transcend the sole responsibility of the company – might feel unconventional for business managers for two reasons. First, companies are built on hierarchical foundations and compete in markets, but the principles of network governance – based on trust – will feel new and alien in a business environment. Second, corporate governance is still very much focused on shareholders (as opposed to stakeholders) as Bevir argues:

A key principle of corporate governance is thus the rights of shareholders. The main issue of corporate governance is how to ensure that the rights of the shareholders are properly safeguarded.

Network governance introduces the concept of interdependency between multiple stakeholders, which comes with a number of sets of conflicting modi operandi: trust vs. authority, interdependent vs. dependent, diplomacy vs. rules and commands, and reciprocity vs. subordination. (Again, see box 1.) It is, thus, not an exaggeration that the ways of network governance are a-typical for how most business managers are used to conduct their business.*

Taking into consideration that i) network governance is a-typical for any business organization, ii) the need for implementing network governance is increasing, and iii) not being able to handle new governance poses an (ESG-) risk in itself, I propose that organizations start implementing new governance on a case by case basis, in order for the organization to get used to the processes of network governance.

In my previous blog post in this series, I introduced an 8-step approach on how to implement a human rights policy in your organization. Here, I repeat that approach in a slightly different format to highlight the elements that I think will help you understand where network governance comes into play.

An approach to start working on an issue that needs involvement of many stakeholders should always start with a broader ESG-risk analysis to determine where your firm’s priorities should be. After that – and this is the first step of implementing network governance in your organization – engage stakeholders. Engage widely with stakeholders and formalize the dialogue. The engagement should lead to a decision on a compliance strategy: a code of conduct or certification scheme(s) that has the support of your stakeholders. (The next four steps in the 8-step approach are mainly geared towards supplier selection in such a way that you can deliver on your results, so I will not discuss these here.)

After you have results from your activities and operations, report and communicate your efforts and results according to your compliance strategy or integrate the results in your ESG-report. Reach out to all stakeholders involved and get their feedback. The last step is setting up a quarterly review board. Make sure it is composed of in-house and NGO experts, external academics, and local stakeholders such as unions and local communities.

In short, to put you on track for implementing network governance in your organization, you should: engage stakeholders, report to stakeholders and get their feedback, and finally discuss your results in a quarterly review board. Putting so much emphasize on stakeholder processes (and regular transparent public reporting) might feel unconventional in a business environment, but it is the only way to adapt the firm’s processes to face non-economic transnational issues.

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. In addition, by implementing the new governance model, your firm will report on ESG-topics in such a way that your stakeholders will endorse your efforts. Implementing network governance thus becomes a powerful mechanism to reduce your overall ESG-risk and manage your firm’s reputation.

(* On a more philosophical note: network governance might also feel a-typical or unconventional because of the reign of the two main theories in international relations. Realists seem to accept that international issues are power-issues not all too different from Thucydides’ history of the power struggle between ancient Athens and Sparta. (Reading the classics really never is a waste of time.) Liberals hope to solve international issues through international institutions and law. Network governance (in this case called global governance), in contrast, seeks a solution that is not found in realist or liberal views; it tries to solve international issues through informal norms and self-monitoring. This could also be called the multi-stakeholder view, I suppose. For a short introduction on these views, again refer to the excellent little book by Bevir on governance.)

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What every manager should know about (2/5): Human Rights

0-mazars-infographice-eiu-survey-march-2015_oe_full

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold. First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall business and risk management strategy.

The first blog in this series discussed climate change. You can read it by following this link.

The second blog of the series will discuss the aspects of human rights you should be familiar with as a business manager. I will discuss what human rights are, what the key drivers for respecting human rights are and, finally, how you can build a supply chain that respects human rights.

Defining Human Rights

What should the relationship between business and human rights be? The United Nations (UN) defines the role of business as respecting human rights; as opposed to states, that must protect human rights. Paragraph 12 of the UN Guiding Principles on Business and Human Rights (UNGP) states:

The responsibility of business enterprises to respect human rights refers to internationally recognized human rights – understood, at a minimum, as those expressed in the International Bill of Human Rights and the principles concerning fundamental rights set out in the International Labour Organization’s Declaration on Fundamental Principles and Rights at Work.

Both the International Bill of Human Rights and the International Labour Organization (ILO) are part of the broader human rights movement that arguably started with the Enlightenment. In the table below, the Bill of Human Rights and the ILO are put into historical perspective. I highlight the texts which are referred to in this post (i.e. Bill of Human Rights, ILO, and UNGP) in blue:

table-complete

As we can see from this non-exhaustive timeline, human rights are ever evolving and expanding. In the words of Andrew Clapham in Human Rights: A very Short Introduction:

The human rights catalogue will continue to expand as new challenges emerge and new constituencies find it helpful to frame their claims as issues of human rights.

To list all articles in both frameworks (International Bill of Human Rights and in the ILO’s Declaration on Fundamental Principles and Rights at Work) will not be very helpful for managers to develop a first understanding of business and human rights.  Instead, I use clusters of human rights introduced by The Economist Intelligent Unit (EIU) in a report on the ‘challenges for business in respecting human rights’ (ranked in the order in which companies scored them as relevant to their activities):

clusters-of-rights

Not all rights are the same explains Clapham. We distinguish between:

  • Absolute rights: genocide, crimes against humanity, slavery, and torture are international crimes which are prohibited at all times.
  • Rights limited through legal restrictions designed to protect a defined legitimate objective: rights to liberty, fair trial, freedom of expression, belief, assembly, association, and property; any restriction on these rights has to be justified as proportionate to the aims pursued by the restrictions.
  • Rights that have built-in limitations: free speech and privacy.
  • Social, economic and cultural rights (sometimes called ‘aspirations’ instead of rights): food, education, health, housing and work.

Now that we have an understanding of the historical background of human rights, relevant clusters of human rights for business, and awareness that rights can have limits; we turn to the business drivers of respect human rights that go beyond mere compliance.

Drivers for Implementing Human Rights Policies

Besides compliance (a primary driver), there are a number of reasons why your company should have proper human rights policies in place. These include the protection of the company brand and reputation. Reputational risk is especially high if a firm has complicated supply chains. A 2015 article in the Journal of Business Ethics explains:

Social issues become relevant in supply chains because of the involvement of multiple suppliers who directly affect the reputation of the buying firm. Additionally, an enlightened stakeholder (both internal and external) holding the firm accountable for social issues in supply chains forces the firm to take responsible supply chain actions.

Two examples that are known throughout the business and human rights community are the Rana Plaza disaster and the Rohingya case in Thai fisheries.

In the Rana Plaza disaster in 2013, over a 1,000 garment workers died in the collapse of a factory building in Bangladesh. The EIU report rightfully links it to a failure of respecting human rights:

Spectacular failures of human rights protection still claim headlines. To cite just one of several recent examples, the tragic collapse of the Rana Plaza commercial building in April 2013 led to renewed questions about the quality of companies’ oversight of their suppliers’ human rights practices as well as the role of government in protecting such rights.

How events like these can hurt your companies’ reputation was shown by the bad news coverage Primark, a low cost British garment label, received when it was linked to the disaster (see for example the article Disaster at Rana Plaza in The Economist).

Another example that shocked the world in 2015, was the enslavement of Rohingya (an ethnic people from Myanmar) aboard Thai fishing boats. The Guardian reports:

Rohingya migrants trafficked through deadly jungle camps have been sold to Thai fishing vessels as slaves to produce seafood sold across the world, the Guardian has established.

The seafood was traced to individual leading supermarkets worldwide that had to take immediate action to manage their reputation.

External and internal stakeholder pressure is often mentioned as another driver to implement human rights policies. NGO’s, local communities, investors, and employees can all pressure the corporation into doing more on human rights topics. Risk management might be a fourth driver for implementing human rights policies and procedures. Risks to manage are, apart from the reputational risk already mentioned, risks that stem from disruptions in the supply chain because of issues with human rights (e.g. strikes, bad quality of products, or drops in productivity, etc.). A final driver, which is sometimes overlooked when it comes to human rights policies, is performance improvement. Workers that are well taken care of tend to perform better, which will, in turn, lead to higher output or higher quality of products in your supply chain.

With these five sets of drivers (i.e. compliance, protecting the company reputation, external and internal stakeholder pressure, risk management, and performance improvement) there is surely a business case for implementing human rights policies in your supply chain. We will now discuss how to do just that.

Implementing Human Rights Policy in Your Supply Chain

From all the ESG-topics that firms try to grasp, human rights might prove to be the most difficult one. The head of government relations at Anglo American, a mining corporation, says (in the EIU report):

the notion of human rights abuses is an alien and scary one among technical functions who are more used to ‘impacts’ and structured, technical processes to address them, as opposed to legal ones.

John Ruggie (who drafted the UN Guiding Principles), also in the EIU report, agrees:

It takes time. It takes training. Things have to be translated into operations-speak if they are going to be effectively internalised by people on the ground.

Concluding that implementing human rights policies is not easy, one of the key strategies in implementing those policies is to team-up: involve NGO’s and maybe academia and regulators. In the words of a study published in the Notre Dame Journal of Law, Ethics and Policy:

Human rights are ever evolving so there is a need for open dialogue with government, social groups, NGOs and other stakeholders.

Taking all this into considerations, I propose an eight step approach to implementing human rights policies in your supply chain. This approach borrows insights from the Canadian Network for Business Sustainability, William Bradford’s comprehensive article Beyond Good and Evil: The Commensurability Of Corporate Profits and Human Rights, and Yawar and Seuring’s literature review Management of Social Issues in Supply Chains.

Step 1: Analyze and prioritize. First, perform a risk analysis and determine where your priorities need to be. An example from the EIU report:

Coca Cola conducted a human rights risk analysis of its entire value chain, which identified seven priority risks, ranging from employment and health and safety issues, through to land rights, compliance with transparency and due diligence requirements.

Bradford advises along the same lines:

Corporations should independently perform a rigorous “social audit” to ascertain the current status of their human rights protective practices, the threats to human rights within their spheres of operation, and the internal procedures available to respond to change and rapidly emergent threats.

Step 2: Engage stakeholders. Engage widely with stakeholders and formalize the dialogue. The engagement should lead to a decision on a compliance strategy: a code of conduct or certification scheme that has the support of your stakeholders. Prioritize. Depending on the size of your operations, it might very well be impossible to implement ‘everything everywhere’. On engaging stakeholders, Bradford argues:

With the inputs from NGOs, corporations will be able to further refine their practices and enhance their capacities for compliance while reducing the risks of litigation and injury to reputation.

Step 3: Select suppliers. Select suppliers that are willing to work on respecting human rights. An implementation of virtually anything in your firm can never be just about ‘ticking the box’. Select suppliers that understand what you are trying to achieve and that will work with you in a longer term relationship.

Step 4: Develop KPIs. Develop KPIs together with suppliers and other stakeholders. Again, use the knowledge of your stakeholders. But do not forget to design processes and systems that can actually deliver on your KPIs.

Step 5: Evaluate. Evaluate your suppliers on a regular basis. Since you are implementing something that is also challenging for your firm, you should follow-up frequently to see if expectations are being met and evaluate progress.

Step 6: Enhance performance. Use supplier development strategies to enhance performance. Implement collaboration and training programs at the supplier, invest in assets, or offer technical and financial assistance. Informal evaluations and audits could encourage suppliers to take initiative.

Step 7: Report. Communicate your efforts and results according to the compliance strategy you chose in step 2 or integrate the results in your current ESG-report. Reach out to all stakeholders involved in step 2 and get their feedback.

Step 8:  Review. Set-up a quarterly review board. Make sure it is composed of in-house professionals and external academic, NGO expertise, and worker unions. Review performance evidence quarterly to identify patterns and explore possible solutions. Such formal review sessions might prove invaluable to organizations according to Bradford:

Over the last decade, formal and ongoing dialogues have developed wherein corporations, NGOs, government officials, academics, labour representatives, and community leaders meet to discuss issues of common concern, including monitoring of, and compliance with, CCCs [Corporate Codes of Conduct] governing the protection of human rights. Such dialogues afford corporations valuable and low cost information as to the social expectations of important stakeholders in a setting that enables the ongoing (re)negotiation of the details of broadly-based norms and principles that constitute civil partnerships. In exchange, NGOs acquire additional social status, wealth, prestige, and access. Through dialogues, corporations can calibrate their practices, learn how best to uphold their agreements, and retain the material advantages of identification by NGOs as socially responsible.

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. The discussion on implementing human rights policy – as part of the discussion on disclosure of non-financial information – has shown again that implementing sound ESG-strategies can boost your risk management, manage your reputation towards stakeholders, and enhance performance in your supply chain.

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What every manager should know about (1/5): Climate Change

before-the-flood

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold. First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall risk management strategy.

The first blog in this series will discuss what climate change is and what climate change has to do with managing business risk. If you are in need of a broader perspective on climate change I recommend Leonardo DiCaprio’s clear and informative film Before the Flood.

Defining Climate Change

Climate Change, according to the Concise Oxford English Dictionary is:

The change in global climate patterns apparent from the mid to late 20th century onwards, attributed largely to the increased levels of atmospheric carbon dioxide produced by the use of fossil fuels.

In his insightful book Climate Change, A Very Short Introduction, Mark Maslin writes:

Over the last 150 years, significant changes in climate have been recorded, which are markedly different from the last at least 2,000 years. These changes include a 0.85°C increase in average global temperatures, sea-level rise of over 20 cm, significant shifts in the seasonality and intensities of precipitation, changing weather patterns, and the significant retreat of Arctic sea ice and nearly all continental glaciers. (…) The IPCC [Intergovernmental Panel on Climate Change] 2013 report states that the evidence for climate change is unequivocal and there is very high confidence that this warming is due to human emissions of GHGs [i.e. greenhouse gases, such as CO2].

To be able to visualize why it’s so hard to combat climate change caused by CO2, consider this illuminating analogy from Climate Shock, by Gernot Wagner and Martin Weitzman:

Think of the atmosphere as a giant bathtub. There’s a faucet – emissions from human activity – and a drain – the planet’s ability to absorb that pollution. For most of human’s civilization and hundreds of thousands of years before, the inflow and the outflow were in relative balance. Then humans started burning coal and turned on the faucet far beyond what the drain could handle. (…) Inflow and outflow need to be in balance, and that won’t happen (…) unless the inflow goes down by a lot.

Recently, we have learned (see a recent Guardian article) that the amount of CO2 in the atmosphere reached 400 parts per million (ppm); that’s 40% higher than pre-industrial levels (280 ppm). In Climate Shock we read why this is a serious problem:

Last time concentrations of carbon dioxide were as high as they are today, at 400 parts per million (ppm), the geological clock read “Pliocene”. That was over three million years ago, when natural variations, not cars and factories, were responsible for the extra carbon in the air. Global average temperatures were around 1-2.5°C (…) warmer than today, sea levels were up to 20 meters (…) higher, and camels lived in Canada.

The conclusion that we must draw from this is not that climate change is new. Rather, for the first time in the earth’s history, climate change is manmade and happens at a rate which would make it impossible for us to re-actively adapt our infrastructure accordingly. Think for example of shifting entire agricultural regions, or moving complete cities from their present-day ocean front locations.

For an illustrated (and witty) example of how extraordinary the current spike in average temperature really is, see A Timeline of Earth’s Average Temperature. Below, only the very last brief time period – with a sharp increase in average temperature – is shown; the full infographic shows much slower changing average temperatures in the last 20,000 years.

temperature

Skepticism towards climate change is like denying smoking causes cancer

Perhaps most of the general public would not see climate change as an urgent problem, as Wagner and Weitzman point out in Climate Shock.  Although the science behind climate change is solid and has been accepted by the scientific community on the weight of evidence of the research, there seems to be an amazing amount of skepticism around the subject in non-science circles. In trying to explain this phenomenon, Maslin writes:

…the media’s ethical commitment to balanced reporting may unwittingly provide unwarranted attention to critical views, even if they are marginal and outside the realm of what is normally considered ‘good’ science. (…) Add to this the greater ease of communication, from conventional media, such as newspapers, radio, and television, to more informal blogs, tweets, etc. Normal private debate among scientists and experts can easily be shifted into the public arena and anyone, what ever their level of expertise, can voice an opinion and feel it is as valid as that of experts who have dedicated their whole lives to studying areas of science. Overall, this contributes to a public impression that the science of climate change is ‘contested’, despite what many would argue is an overwhelmingly scientific case that climate change is occurring and human activity is a main driver of this change.’

Or, maybe skepticism has to do with cognitive dissonance (i.e. a state of inconsistent thought, beliefs, or attitudes), write Wagner and Weitzman:

Whenever science points to the very real potential of these types of catastrophic outcomes, cognitive dissonance kicks in. Facts might be facts, the reasoning goes, but throwing too many of them at you at once will all but guarantee that you will dismiss them out of hand. It just feels like it can’t be true.

Leonardo DiCaprio in Before the Flood echoes this:

We keep being inundated with catastrophic news about the environment every single day, and the problem seems to get worse and worse. Try to have a conversation with anyone about climate change, and people just tune out.

The key point here is that the efforts to understand climate change are a scientific effort. Maslin rightfully states that ‘science is no belief system’. As Armand Marie Leroi points out in his book, this has been true ever since Aristotle invented science:

‘A scientist is someone who seeks, by systematic investigation, to understand experienced reality.’

Being skeptical towards climate change is therefore the same is being skeptical towards the process of scientific discovery itself. It is, Maslin states, to ‘deny that smoking causes cancer, or that HIV causes AIDS’.

Climate Change and business risk management

Integral risk management for your organization should include climate change risks. As the authors of Climate Shock put it: ‘First and foremost, climate change is a risk management problem’.  A risk analysis of climate change would lead to defining business risks that stem from both the direct consequences of climate change (like more severe weather events), and risks that stem from external stakeholders’ actions to curb climate change that, in turn, have an effect on the company’s operations or profitability (e.g. tighter regulations for GHG emissions). Without making any claims of exhaustiveness, as a minimum, your organization’s risk assessment should include the following risks in a risk assessment:

risk-matrix

Asset and infrastructure risk. We already see an increase in extreme weather events that could hurt a firm’s assets and supply chains. In Climate Change, A Very Short Introduction, numerous relevant examples are given:

[I]n recent years massive storms and subsequent floods have hit China, Italy, England, Korea, Bangladesh, Venezuela, and Mozambique. In England in 2000, 2007, and 2013/13, floods and storms classified as ‘once-in-200-years events’ have occurred within 13 years and frequently within a single year. Moreover, in Britain the winter of 2013/14 was the wettest six months since records began in the 18th century, while August 2008 was the wettest on record.

Organizations could use climate forecasting models to show which assets and infrastructure are more at risk because of climate change. A next step would be to develop scenarios that would lessen the impacts on your assets and supply chains (e.g. moving operations to areas less affected by extreme weather events).

Yield and price risk. When climate change starts to affect crop yields, it will also affect purchasing prices. The IPCC (Intergovernmental Panel on Climate Change) brings together key climate research conducted all over the world and provides a consensus of this research. The IPCC, 2014 report found:

Based on many studies covering a wide range of regions and crops, negative impacts of climate change on crop yields have been more common than positive impacts. [S]everal periods of rapid food and cereal price increases following climate extremes in key producing regions indicate a sensitivity of current markets to climate extremes (…).

Your organization should know which commodities are most at risk from the impacts of climate change. This should be a starting point for developing scenarios to mitigate yield and price risks.

Government regulations. Now that the Paris Agreement has come into force, we can see governments stepping up their work to implement policies that will make sure global average temperatures well below 2°C. Barack Obama in The Economist:

[S]ustainable economic growth requires addressing climate change. Over the past five years, the notion of a trade-off between increasing growth and reducing emissions has been put to rest. America has cut energy-sector emissions by 6%, even as our economy has grown by 11%. Progress in America also helped catalyse the historic Paris climate agreement, which presents the best opportunity to save the planet for future generations.

Any policy changes that try to curb climate change will impact business-as-usual. As a mitigation strategy, organizations should try to understand possible policy options and work out the effects on operations and profitability.

Reputation risk. Awareness of climate change in general is on the rise. Whenever the public is of the opinion that the firm’s activities are harmful (this obviously extends beyond climate change), there’s a probability that profitability is at risk. For example, the big palm oil trader IOI was accused of illegal logging recently  ̶  contributing directly to climate change because of loss of rain forest that stores CO2  ̶  , experienced extreme negative publicity (see this article in the Financial Times), and saw share prices and revenues tumbling. As a first step in creating mitigation scenarios, firms should make an effort in understanding external stakeholder’s views and wishes towards the firm’s climate change actions. As the IOI example shows, reputation risk does not only revolve around emissions but also around having supply chains that contribute towards climate change by deforestation (e.g. beef, soy, palm oil, and wood fiber). Your organization should therefore not only know which operations are most at risk from the impacts of climate change (direct risks), but should also know which commodities contribute the most towards climate change (reputation and regulatory risk).

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. Reporting on climate change gives you the opportunity to update your risk management framework. By breaking climate risks down into direct and external stakeholder risks, and putting in place mitigation scenarios, your organization will be well prepared for an age where climate change is at the top of the agenda.

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