What is not ESG.

Climate change is a big problem, as are environmental pollution, social inequality, and everything else that usually falls under the ESG umbrella. These are all critical problems that need the attention of management. Keep your system one thought in check and keep reading because this article is about something else.

This article is about the idea of ESG, not the problems it tries to solve. Let’s give the people who came up with this idea the benefit of the doubt and assume that it wasn’t just a marketing gimmick like all the other acronyms before it (ERM, IRM, and GRC) and that they wanted to bring attention to performance beyond profits, which is something that society needs. One thing is clear: short, snappy acronyms and simple ideas that are easy to understand sell. And I have no problem with that at all. I am OK with anything that helps people and the planet get better care.

What is not ESG.

I don’t like when risk professionals, who should know better, think that ESG is “what you see.” “It’s all in your eyes” is a famous phrase by psychologist Daniel Kahneman to describe how our brains are wired to think that the information we have is all the essential information. This is a problem because we don’t usually look for things that aren’t in front of us. When we only have a few pieces of a story, we put them together as best we can to make a complete story. Often, the details we get aren’t whole or are biased.

So, it shouldn’t be a surprise that 95% of the time, when we hear about ESG in the news, at conferences, or in publications, they are talking about climate change and their carbon footprint. Even so, climate change isn’t even a tenth of the problems under the ESG umbrella. That’s the first problem. Many other essential issues get lost in the light of climate change, which is a lot more interesting. Global corporations pollute the air, water, and soil today, but environmental officers still don’t have enough resources and don’t have a say in how corporations make decisions. Rating agencies, banks, and treasury departments are excited about a new round of green financing, but that doesn’t seem to be where the focus is. I have a big problem when climate and future carbon risks are talked about instead of the dangers of today (pollution).

ESG risk does not exist.

When the same ESG experts, rating agencies, auditors, and regulators tell us to find, evaluate, and deal with “ESG risks,” it makes things even more ridiculous. ESG risks are not a thing, just like reputational risks are not a thing. Read my points in the article about reputational risk. Any operational risk could affect society, the environment, or how things are run. Worse yet, the same gurus make it sound like there is a simple way to measure ESG risks. The opposite couldn’t be more accurate. The second problem is that each of the unique risks that fall under the ESG umbrella has its complicated way of assessing the risk that can’t be measured with a single qualitative method.

Even when we tried to use simple stochastic bow-ties to measure all ESG risks in the same way, the estimates were way off because each bet has its bow-tie. If you try to generalize the risk assessments, the VaR estimates will be way off. I was hoping you could learn more about how I’m trying to bring the quantitative approach to ESG, compliance, and other operational risks under one umbrella here. It was easy to set up and looked good, but the back-tests showed that it didn’t work. Let’s look at environmental risks, which are said to make up a third of ESG risks. Threats to the environment include:

-pollution of water

-air pollution

-soil pollution

-climate change

-a change in the rules

-a lot of other stuff

These risks can be seen as a “bow-tie” or “stochastic decision tree.” The problem is that each risk is a different bow tie that is very complicated. Many of the causes and effects are usually set by the laws in your country about the environment. So, international organizations have to make different risk models for water pollution in each country where they have a presence.

Environmental risks are a common operational risk that can be shown as a loss exceedance curve with a narrow body and fat tail. Environmental risks can be offered by a decision tree or a bow-tie, just like most common risks that don’t have a method set by the regulator (market risks, credit risks, and OHS risks usually do).

Many of the tree’s branches aren’t clear, like which regulated class the waste will be put in and, therefore, what rate will be used. Most of the time, local regulators give specific formulas for measuring different environmental risks. There are other ways to deal with different types of pollution and trash. Stochastic risk models can be made from these formulas.

Each place needs a different model because the waste is usually made up of other things. Loss exceedance curves are derived from the risk analysis for each location. If necessary, these curves can be added together. And a list of engineering solutions can be compared to the losses expected from the risk.

Environmental risks

This is only an example of what I was trying to say. Unless ESG risks are evaluated just for show, they are unique, hard to model, and take months to do right. I can see how modeling can help the environment and production teams better budget mitigations, which are usually costly engineering structures that require changes to the way technology works. Social risks must be considered when HR and executive decisions are being made. Governance risks are essential for the legal team and others to view. But, given how hard and complicated it would be, I can’t think of why anyone would want to put all ESG risks into a single risk profile. This is a typical case of consulting bs, where people who don’t understand the math behind it sell the idea of having ESG risks.

The ESG plan should never be in charge of the risk managers.

The third problem I have is that putting all ESG issues under the control of a single executive is just careless. The HSE team has always been in charge of environmental and climate risks, and that should not change. Most of the time, the HR team is in order of social risks, and the legal or IR team is in charge of governance risks. It may make business sense for risk managers to assist them with the quantitative risk models. Risk managers can help build the method for the pollution loss exceedance curve or help the legal team figure out the proper risk-adjusted limits for investment deals or the separation of authority for market risks. It would be silly not to lead the ESG agenda. Risk managers don’t know enough about E, S, or G issues to discuss them, and ESG doesn’t need a “fancy secretary.” Putting E, S, and G in the same category was a big mistake, and we need to get back to the basics by making ESG a part of every critical business decision.

Marketing fads like ESG and ERM are nothing more than trends marketing fads like ESG and ERM are nothing more than trends.

And they should be seen that way. Even though I understand that ratings are important and part of the business game, we shouldn’t lose sight of the damage companies do daily to the environment and society. Not in the year 2050 or the future, but yesterday, today, and tomorrow. Helping the environmental team use quant risk analysis to get more money to deal with pollution problems was the most satisfying thing I’ve done.

If you’re more interested in achieving financial gains instead of perpetuating underperforming woke strategies, call Rubin Wealth Advisors to speak to a professional with the same moral values as you.