Facing a Black Swan and preparing for Grey Swans

By: Rekha Menon-Varma

The black swan: COVID-19 impact on environmental and social risks:

More than the event itself, the extent and severity of COVID-19 have been unprecedented in the consumer and industrial sectors and pointing towards a black swan. Forced shutdowns and production and travel restrictions have left companies scrambling for raw materials and operational continuity. Containment and employee safety considerations have necessitated remote working or, at the very least, social distancing for essential operations. How do these developments affect existing environmental, economic and social risks? Regulatory compliance forms the foundation of ESG (environmental, social and governance) risks.

In March 2020, EPA announced an ‘enforcement discretion policy’ which relaxed penalties for noncompliance with routine monitoring and reporting activities that are the result of COVID-19. It is understandable to see the difficulty in carrying out inspections with travel restrictions and remoteworking. On the other hand, one could expect the lack of monitoring to potentially result in undetected operating deviations that could, in turn, increase emissions and pollution, thus contributing to ESG risks.

More broadly, a macro-level contributor to the risk relates to variations in how different countries will react to the situation. Will they relax regulatory requirements in light of the need to rapidly ramp up
production and reopen the economy? If so, what criteria do global corporations need to keep in mind while sourcing from, or producing in, those locations, as a way to manage ESG risk?

Sustainability of the operations and of the business itself, while adhering to overarching company standards and best practices globally should be the key consideration.

Emissions:
Significant reductions in emissions have been reported due to the production shutdowns. It is not surprising to see drops in NO2 emissions (surrogate for production/ output) and coal consumption in China. A fall of ~6% in CO2 levels, as reported by WMO (World Meteorological Organization) and the UN should be considered a ‘short-term good news.’

Latest data from WMO indicated that carbon dioxide (CO2) levels and other greenhouse gases in the atmosphere rose to new records last year.
As yet undetermined, and a key environmental component, is whether we are going to see steeper increases and worse numbers when countries reopen their economic activities and ramp up production.
Global coal production is still expected to remain at 2019 levels or even grow slightly. There is potential for Scope 3 emissions, related to the supply chain, to also remain at 2019 levels and not reduce in 2020.

Economic shifts and realigned priorities:
Besides the extreme supply chain woes, companies were faced with operational shutdowns, employee illnesses and community spread in the first quarter. Increasing unemployment and falling consumer
confidence will have a huge impact on product demand across sectors. We can expect a renewed focus on strengthening balance sheets and effectively addressing financial constraints. The focus for the remainder of 2020 could become basic – source, produce and deliver. This also extrapolates to limiting new investments and re prioritizing organizational initiatives.
Given the short-term operating reality, what will become of active sustainability initiatives? It will be business as usual for companies who consider sustainability a way of working and have integrated it into
their operations. However, it is possible that sustainability and ‘beyond compliance’ initiatives may become a lower priority for some companies, at least in the short-term. From a global perspective, this could result in more violations in the areas of fraud, ethics, human rights and data security.
How does an Organization begin to protect its business and operations from such events and associated impacts, under different scenarios? A structured program/process, that is agnostic to the event itself and based on tracking of data on lagging, current and leading indicators, is essential.

Section 2: What about the next major event?
A set of ‘grey swan’ events that we know about – extreme weather, climate action failures and natural disasters – rank among the highest in global risks, both in likelihood or probability, as reported by the World Economic Forum in 2020. Are we prepared for one or more of these extreme events? The business and ESG impacts of such events could perceivably also be as broad-based as that of COVID-19. Continuation of organizational (and country) focus on emission control and resource efficiency come
into play here. One impact scenario could be production concentration in a natural disaster-prone area. In this case, companies will have to evaluate higher inventory levels, alternate manufacturing and overall
preparedness. Another scenario could be related to supplier concentration; for instance, major suppliers located in a water-stressed region. Under this scenario, companies will need to prepare long term contingency plans for additional suppliers or newer processes. In these scenarios, companies will
have to find an optimum between reliability and cost considerations. An Organizational focus around resource use, that hinges on collecting data around key performance metrics and other indicators, would be key for managing associated risks. We will be discussing this in more detail in the next blog!

In Conclusion:
While it is difficult to predict the occurrence or extent of black and grey swan events, Companies can assess the potential implications of such events and develop contingency plans for the same. In order
to do this, it is vital that Companies implement ongoing, dynamic monitoring and analysis of various leading indicators, both from a business risk and ESG/sustainability perspective. The volume and variety
of data can be daunting, and the scope of this activity extends beyond a specific department or region. Significant cross-functional efforts will be needed to address, prepare and succeed. Here at Vertaeon,
we continuously strive to enhance risk analytics spanning 100s of company and macro variables, and to synthesize actionable strategies and mitigation plans for business continuity across the organization.

Rekha Menon-Varma (WG06) is Managing Partner at Vertaeon LLC. She is a frequent speaker at national conferences on enterprise risk and integration of sustainability indicators. Rekha serves on the alumni advisory board of Wharton IGEL.

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