State Street Global Advisors (SSGA) is a company which engages in US and broader international institutional investing, largely on behalf of its clients. Some of the areas it focuses on include environmental, sustainability and governance (ESG). It recently released a white paper, entitled “SSGA’s Perspective On Effective Climate Change Disclosure”. While the white paper focused more specifically on climate impact and climate risk to businesses in the energy and mineral extractive industry, it set out a protocol which every Board of Directors can use for a wide variety of risks, including compliance risk. I recently had the chance to visit with Rakhi Kumar, the Managing Director, Head of ESG Investments and Asset Stewardship at SSGA on the white paper.
At the board level, the role is oversight not going into the weeds. Kumar said, “one of the things that we want to do is we want to clarify that our job is not to micromanage companies. Our job as a shareholder is to elect the best board we can and give the board the leeway to provide the oversight required to manage/mitigate risk, help set strategy and oversee management.” In the area of climate impact on businesses, SSGA advocates that companies undertake activities to evaluate climate risk to their ownership portfolio. If companies fail to do so, she intoned the company’s “assets can be stranded”.
Kumar provide two examples of stranded assets. One was a real estate company which wanted to construct units on shore lines which would cost a significant amount to protect both in the construction phase and in the management phase through heightened insurance costs. The company eventually declined to make the investment as the long-term climate risk could not be sufficiently mitigated. She also pointed to an industry leader in gas turbines. In that case, the issues was the over-predominance of wind turbines which will eventually take of that industry. She noted that without a product pivot, this current industry leader could lose opportunities going forward.
The white paper listed four areas which would give investors “a holistic picture of how the board oversees, incorporates, manages and plans its activities to mitigate climate risk and position itself for a sustainable future.” Yet they also provide the compliance practitioner with a solid protocol they can present to a Board to help them understand their role in the holistic risk management process; specifically including ethics and compliance.
It all begins with a Board understanding it has a role in both governance and climate impacts. This includes having appropriate expertise on the Board to tap into, either through professional background or subject matter training. Boards need to communicate how they address climate impact. The next area is to establish and disclose the company’s long term goals around greenhouse gases (GHG). This is important for three reasons (1) it focuses the company on managing emissions; (2) GHG goals help to demonstrate a robust risk management process that can inform strategic risk decision-making; and (3) this allows decisions on the true climate related costs of assets.
Specifically related to carbon pricing, SSGA advocates a company establish a range of carbon pricing which “allows companies to express and incorporate the cost of operations, compliance and future regulations into strategic decision-making.” Finally, all of this leads to the end result of having information to help make long-term capital allocations. This allows companies to more readily capitalize on business opportunities and to mitigate risks.
For any Board member, senior executive or Chief Compliance Officer (CCO) the SSGA white paper provides several key insights for the risk management process. By using the process laid out by SSGA it demonstrates that the risk management process is conducted as part of a strategic review and not as an isolated exercise. It affords a direct link between the impact of the risk management process strategic outcomes. Finally, it helps boards think strategically about strategic risks and incorporates sustainability factors into long-term strategy.
This type of approach provides a company another way to further operationalize compliance into the business. From the Board perspective, this type of governance demonstrates to the government the Board is fulfilling its role in a best practices compliance program. There should be a Compliance Committee on the Board. This Compliance Committee should have a subject matter expert (SME) as its chairperson or a part of the Committee. The Board must actively engage in oversight and mitigation of key compliance risks the company is facing.
Now consider SSGA’s third point on establishing a range of values for carbon pricing. One of the key reasons for doing this is to allow you to more accurately value and price assets, both that your organization holds and those you might acquire. If you have to extensively remediate from a climate risk perspective, the cost might be too high in the long term. This type of analysis should also be considered from the compliance perspective. What will be the cost to incorporate a purchased asset into your organization from the compliance perspective? Equally important are the parts of an acquired entity which will either (a) put your company at risk of an ongoing Foreign Corrupt Practices Act (FCPA) violation or (b) devalue or even toxify the asset because some or part of its sales were based on conduct, while not illegal when it occurred, became illegal after it became subject to US jurisdiction.
From the sustainability perspective, Kumar explained, “the biggest challenge companies have is quantifying the impacts of sustainability, putting a dollar value on it. We are used to focusing only on and in the current system that we are in. We do not know how to price these items correctly or how they may impact our strategic risks. That is the challenge and you need to then look at various kinds of scenarios and plan for scenarios. It is about having a robust process, so Boards and investors can understand the impact of climate on a business.”
The final point from the SSGA white paper and my interview with Kumar is the effect of such risk management process and operationalization. It makes companies more nimble, agile and able to respond to business opportunities as well as business risks. If there is a robust risk management process a company can plan out its capital allocation, 1-3-5 and even 10 years down the road. A robust risk management process allows a company to spot business trends and, more importantly, respond more quickly than competitors.
For more from my interview with Rakhi Kumar, check out my podcast Across the Board-Episode 6.
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