The short-sightedness in observing long-term events

  • 12 May 2023
  • Blog | Leadership & Strategy | Blog

Short-term Crises are the Shadows of Long-term Risks

Looking back at 2022, the world grappled with the peak of the pandemic following the outbreak of the Omicron variant. Russia waged war with Ukraine, killing tens of thousands and displacing millions. Supply chains were disrupted, resulting in a scarcity of commodities and a rise in prices.[1]

“We live in a more shock-prone world”, as the IMF has remarked.[2]

Indeed, businesses were increasingly hit by unprecedented challenges throughout 2022. The ability of a business to deal with short-term crises boils down to how prepared it is for long-term risks. The energy crisis brought upon by the Russo-Ukrainian conflict is a perfect example of how forward-looking strategies are essential in building economic and business resilience, in this case for energy security.[3]

According to McKinsey’s Corporate the Horizon Index, from 2001 to 2014, the revenue of “long-term” firms (i.e., those with long-term vision) cumulatively grew on average 47 percent more than the revenue of other firms, and with less volatility. Apart from the margin of revenue, they found that long-term firms can create more jobs and are more likely to exhibit strong stable financial performance.[4] Though the “long-term firms” are not directly related to performance against environmental, social and governance factors (ESG) in the index, it has shown a strong correlation between long-term vision and stable yet promising financial return.

Sustainable business practices are increasingly important for companies to maintain long-term success. Recent research has shown that ESG performance has a positive association with cumulative abnormal returns and can be used as a risk management tool to enhance share price resilience. The study finds that firms with high ESG performance are more resilient during financial crises.[5]

Investors Demand Credible Long-term ESG Strategy from Entities

As such, investors track long-term ESG performance. They recognize strong ESG performance can be indicative of a company's overall ability to create long-term value. Companies that prioritize ESG practices are more likely to have a positive impact on society, attract and retain high-quality employees, and operate in a way that minimizes risks and maximizes opportunities for growth.

In addition, as investors increasingly prioritize ESG factors, it's becoming clear that sustainable business practices not only align with social and environmental goals, but also with financial performance.

Take climate mitigation as an example, to identify credible transitions, investors are demanding entities disclose their transition pathway. A recent PWC survey found that private equity investors identified net zero, climate risk, and carbon footprint, as three of 5 the most significant gaps between individual ESG concerns and action being taken to mitigate these. [6] In the realm of debt-capital markets, lenders are becoming more considerate of the long-term sustainability commitment of their borrowers. Growing numbers of banks are developing their own Sustainability Linked Debts (SLLs and SLBs) products to track the long-term sustainability performance of their clients.

Dealing with long-term risks requires a company to define long-term success and understand how movements in the ESG landscape can affect this success. Identifying and assessing ESG risks calls for a company to adopt the sustainability lens to thoroughly assess its business, and to consider all plausible short- and long-term risk events that may pose threats or opportunities to the company’s future.

Integrating ESG Risks: A Vital Step in Comprehensive Risk Management for Sustainable Business Success

A necessary next step is the integration of ESG risks into the company’s overall risk management approach. According to the World Business Council for Sustainable Development, while 57% of companies have aligned sustainability-related risks to traditional business risks to some extent, only 8% have achieved full alignment.

Recently, critics have suggested the reason for the failure of the Silicon Valley Bank (SVB) is because it overlooked its own business to focus on improving ESG performance.[7] But shouldn’t it be that way around? ESG should not be “something extra or unrelated”, it should be well-integrated into a business. In fact, one could propose that the reason for SVB’s collapse is it approached ESG in a detached way. Having an important role, such as a Chief Risk Officer, vacant for over 8 months, is definitely a significant internal control risk in terms of governance.

This is where companies can step up: by evaluating the interaction of risks in double materiality, companies can obtain a broader perspective to inform their strategy development, thereby enhancing their preparedness and resilience to sustain their business in the long term.

Integrating ESG risk throughout the operation of a company requires inter-departmental collaboration. Individuals should provide their professional insights to drive long-term sustainability changes in the company. Keeping up-to-date with the rapidly changing sustainability agenda is easy accessible through various knowledge hubs, such as the Chartered Banker Institute's Centre for Responsible Banking.[8] To take a step further, individuals can even achieve professional qualifications specific to ESG strategy in the sector, such as the Institute’s Certificate in Climate Risk.[9]

2022 was a great example of how unexpected events can cause disturbances on a global scale, with effects rippling through individual businesses. Being prepared for these changes requires strategic planning, and that starts by acknowledging and appreciating the long-term risks that your business may face. A company with a view of the wider picture will be able to protect its business from shocks and disruptions, create long-term value, and be at the forefront of sustainable development.

 

Bon Cheung, Research Assistant of Civic Exchange, one of the first batch of candidates in Hong Kong who passed the Certificate in Green and Sustainable Finance from the Chartered Banker Institute. With the knowledge obtained through the program, Bon has worked in various intern post related to green finance, such as sustainability consultancy firm and bank. He has also been publishing academic papers related to green finance. He is now working in Civic Exchange and leading the research related to taxonomy development and transition financing in GBA.

Cindy Tanaka, Alumna of Hong Kong University of Science and Technology, currently works as an analyst in the sustainability consulting field in Hong Kong. With her strong interest in green and sustainable finance, she hopes to contribute to the Chartered Banker Institute by sharing her thoughts and opinions on current green and sustainable finance trends.