Losing ourselves in the Tower of (Risk) Babel
With the turn of the page to a new calendar year, we are newly and more deeply engulfed in the Tower of (Risk Assessment) Babel. Various organizations — think tanks, global business organizations, investment firms, consultancies/auditing companies, government agencies and non-governmental organizations — continually update and issue multitudes of risk assessments and guidelines for preparing them. What insights do they provide? Do they inform decision makers? Are they actionable? Do they produce meaningful results?
Four types of risk analyses are especially notable. They include:
Analyses of global risks: The granddaddy of all macro risk analyses, now in its 18th edition, is annually published by the World Economic Forum (WEF). Its 2023 Global Risks Report continues the tradition of issuing rankings from panels of risk and thematic experts to produce elegant, color-coded visuals that aggregate into a Global Risk Landscape Map. The risk map ranks the relative influences of risks across economic, environmental, geopolitical, societal and technological nodes. Literally rivers of colors swirl across the page, crossing risk node boundaries and identifying risk inter-relationships that are intended to galvanize the reader’s attention.
The global risk map is lofty in its altitude of analysis, long on assumptions and short on transparency and actionable content. This year’s ranking identifies a “cost-of-living crisis” as the highest severity global risk yet, in a parallel risk prioritization 10 years hence, this risk is nowhere to be found. What happened to it? Did policymakers suddenly develop a consensus to solve this intractable problem? Did the private sector agree to have its taxes raised to improve people’s living standards? Instead, WEF offers a panoply of drive-by risk rankings that don’t evaluate the political challenges of developing broad coalitions or the need for content tailored to actually solving problems. Instead, what is on offer is a tabletop exercise divorced from business strategy, economic conditions or political reality — the essence of glib. But, as it almost always is, the skiing was fine again this year in Davos.
Investment banks view of the future. “It’s tough to make predictions,” said that noted financial analyst Yogi Berra, “especially about the future.” Yet forecasting the future is what intrepid Wall Street analysts do as they invest and manage our money.
2022 was a bad year for these money managers as both stocks and bonds declined in the face of rising inflation, energy market disruptions, ongoing supply chain bottlenecks and post-pandemic adjustments. Caution is Wall Street’s watchword in managing risk in 2023.
Mike Wilson, chief investment officer at Morgan Stanley, sees continued volatility and advises investors to be more cautious with their money by increasing their bond portfolios. Another unit of Morgan Stanley, the Institute for Sustainable Investing, adopts a more positive outlook. While acknowledging overall market volatility, it notes that “sustainable investing continues to gain momentum” beginning in 2022, “reflecting a more positive trend than the broader U.S. fund universe.” Will the real Morgan Stanley please stand up?
Goldman Sachs, meanwhile, is very skittish on navigating the ESG debate. In its predictions for sustainable investing for 2023, it urges analysts and investors to “focus on the linkages between ESG and financial fundamentals … in order to stay connected to the real economy.” In other words, Goldman wants us to take a narrower view of the scope of ESG and not wander into controversial debates that produce “Fear of Misaligned Exposure (FOME)” — yes, Goldman really does use that terminology.
Materiality and other assessments. Life used to be so simple back in the 1990s and the earlier part of this century. Borrowing from financial community practices, sustainability professionals identified and ranked environmental risks thought to be material to a company. Summarized in a single-page matrix chart, the materiality results were passed on to C-suite executives, outside directors and stakeholders to demonstrate a company’s conscientiousness of concern and management’s awareness of literally dozens of issues. Over time, the matrix expanded beyond the traditional core of environmental sustainability to encompass issues such as diversity and inclusion, innovation and cybersecurity.
Meanwhile, a separate reporting matrix related to climate evolved in the form of the Task Force on Climate-related Financial Disclosures (TCFD) that presented a distinctive set of risks and opportunities. New risk metrics (both physical and transition-based) and more expansive reporting of business opportunities and financial impact assessments populate the TCFD template. Adding further complexity are the voluntary reporting frameworks from the Greenhouse Gas Protocol, the International Sustainability Standards Board and the International Financial Reporting Standards Foundation. In addition, multiplying reporting requirements are being developed by the European Union and the U.S. Securities and Exchange Commission.
These proliferating risk reporting standards yield a declining value to business and society. Most reporting metrics backcast our understanding of risk rather than pointing us in the direction of solving critically emerging problems. For example, threats to democracy are nowhere to be found in reporting standards, and only recently have threats to biodiversity and nature begun to appear in corporate metrics. Some assessments are data-driven, while others are not. Both quantitative and qualitative methods are applied, each with differing methodologies. And proponents of differing reporting schemes continue to compete with each for influence, publicity and/or profit.
Government risk assessments. It is a primary responsibility of government to assess risks and mitigate them through regulations and standards. Over many decades, federal, state and local governments in the U.S. have developed thousands of environmental health-related risk assessments for individual pollutants and manufactured chemicals ranging from dioxins to formaldehyde to PFAS. Many governments in Europe and Japan, and global organizations such as the International Agency for Research on Cancer issue and periodically update risk assessments and classify chemicals’ degree of harm.
Government risk assessments are based on scientific information, yet large data gaps require public health officials to make professional judgements about the nature and magnitude of risks. This renders the risk assessment process highly contentious as agencies seek to control pollutant exposures from regulated entities.
Compounding this challenge is the bureaucratic nature of updating risk assessments to reflect the latest scientific information. Risk assessment methods used by government agencies have generally not incorporated innovations in data acquisition and management that have emerged in such fields as artificial intelligence, crowdsourcing, machine learning and other applications stemming from the increased digitization of data across a range of technologies. As important social concerns build over environmental justice, new chemical exposures and intensifying climate change, government risk assessments continue to assemble old wine in old bottles rather than meet the needs of a changing economy and society.
Searching for fit and purpose
These differing types of risk assessments, each with separate goals and methodologies, provide partial raw material for a variety of applications, including profiles of ESG risk, corporate sustainability commitments and reports, and regulatory policies.
A basic assumption in these approaches to risk assessment is that the problems they address can be resolved primarily by better information and technocratic solutions. This assumption suffers from three major flaws.
First, the information provided is neither clear nor sufficiently relevant for senior business management and policymakers to make decisions as varied as capital allocations or determinations of health, safety and equity. Second, existing risk assessments favor complexity over simplicity, thereby complicating communication and public trust. Third, technocratic methods and solutions designed by experts embody their own set of values that do not recognize nor are compatible with broader civil society values. Instead, as if driven by a centrifugal force, new reporting schemes continue to originate, thereby expanding the Tower of (Risk Assessment) Babel into ever larger dimensions.
Business executives, policymakers and the public can be forgiven if their response is to tune out the noise while awaiting simpler, more practical alternatives.