What Is the Board’s Role in Addressing Systemic Risks?

The turbulent events of the past few weeks and months have brought home a stark reality: Ignoring a risk will not make it go away. This is true of the public-health and economic crises brought on by the pandemic. It is true of systemic racism in our societies. And it is true about climate change.

What is also clear is that such risks do not function in isolation. While each on its own has significant impact, what makes these risks truly systemic is how they are linked together and how they amplify each other. Climate change and habitat loss are fueling modern pandemics. COVID-19 is killing Black Americans at twice the rate of white Americans. Communities of color are disproportionately affected by climate change.

For our societies to address and stamp out these pervasive issues, everyone has a role to play and a responsibility. Individuals need to get involved. Companies need to contribute to reshaping the status quo. Action is needed at the level of our capital market systems.

A report recently published by Ceres pushes for this action. In it, Ceres lays out how climate change poses a systemic risk to financial markets and calls on US financial regulators to take steps to protect the stability and the competitiveness of our markets.

For directors, there are two main takeaways from this report.

First, recognize that US regulators and their lack of action around climate change are outliers compared to other, international bodies. The global regulatory community, including central banks and securities regulators in China, Europe, UK, and South America, are tackling climate risk. A 2019 survey of 33 central banks and supervisory authorities that represent 77 percent of global gross domestic product found that 70 percent of them saw climate change “as a major threat to financial stability.” More than half are already addressing this threat to their financial systems through regulation and oversight, including by running climate stress tests on national banks, mandating climate risk disclosure, and linking multi-billion dollar pandemic recovery packages to specific climate goals.

Second, consider why global regulators are acting so boldly and quickly. They are determined to ensure that their financial markets navigate the inevitable transition to a low-carbon economy in a planned way, rather than having it happen abruptly and destructively. The investor-led Inevitable Policy Response project describes how, as financial realities of climate change become more apparent, governments will have no choice but to act decisively to reduce their carbon footprints.

Given this, what can boards do to help their companies understand and prepare for systemic risks—and the fundamental changes that addressing them requires? Running the Risk: How Corporate Boards Can Oversee Environmental, Social and Governance (ESG) Issues, another recent report Ceres wrote specifically from the board angle, outlines some practical steps.

1) Identify systemic risks. Do the work to identify how these and other megatrends and the disruptive risks they present affect you. Just as important, do the work to consider how your company’s actions may exacerbate these risks. This comes down to ensuring that your enterprise risk management system honestly identifies and evaluates ESG risks. Traditionally, companies have treated ESG issues as separate reputational risks. The simultaneous occurrence of the pandemic, climate change, and social upheaval around systemic racism shows that that’s just not the case. As systemic risks, their impact is rippling throughout our entire economy, from the functioning of supply chains to the retention of high-value employees.     

2) Assess how best to prioritize issues. Once companies identify the risks that do or will affect them, management should conduct a risk assessment to help boards understand how urgently they need to act on specific issues, the actions they need to take, and the level of investment required. Proactive attention to these issues will help companies move away from a crisis mentality and increase their resiliency.

3) Address the risks. Boards have a key role to play in ensuring that the companies they oversee are implementing, reinforcing, and evolving the strategies needed to manage the systemic risks they face and the changes needed to address them. Around climate change specifically, this includes working with regulators and legislators to affirm that addressing and combatting climate change is included in their mandate and to support much-needed policy shifts.

Systemic risks will not wait for humanity—or corporate America—to find a convenient time to deal with them. The longer it takes to acknowledge, prepare for, and address such risks, the more unmanageable they become. Boards can help the companies they oversee manage them now, or find themselves unable to when the risks explode with a force that cannot be controlled.