Recognising shifting social expectations is the key to de-risking a modern business
10 October 2022
10 October 2022
When it comes to risk - Ashurst has observed an emerging concept industry-wide in which the social risks of today become the legal and operational risks of the future.
In today’s world of business - environmental, social, and governance (ESG) criteria are increasingly used to screen companies based on their corporate policies and to encourage them to act responsibly. These criteria have everything to do with what stakeholders ‘expect’ from modern companies and smart businesses are quickly realising that meeting them is the fastest route to earning their social licence to operate. These expectations will often become the legal issue of tomorrow and paying close attention to them has become a governance imperative when it comes to avoiding risk.
In August this year, the Central Sulawesi government (Indonesia) granted PT Trio Kencana a license to start digging for minerals, including gold, in the Kasimbar and South Tinombo districts. They had promised “environmental protection, community service, and transparency”, but it was unclear to local residents how these commitments were being kept. Concerned about the possibility that their land would be confiscated and the fact that three mining pits had flooded rice fields nearby, protests soon turned violent and resulted in loss of life and, ultimately, massive reputational damage.
In this case - there was no ‘legal’ reason not to expand mining operations; but what PT Trio Kencana failed to do is to grasp the ‘social’ risk of proceeding. They had attached more gravitas to the ‘sign-off’ than the ‘social licence’ to proceed. Even if a company holds appropriate legal permission, operations can be placed at risk if local communities resist them.
Long before ‘Responsible lending’ was part and parcel of the financial landscape, the public had begun to signal that they felt uncomfortable with lenders loaning money to those who wouldn’t be able to service the debt and would eventually need to sell their underlying assets. Since then, the law has changed and no lending can take place without ensuring a borrower has appropriate capacity to comfortably repay a loan.
Companies who had already taken a responsible approach to lending even though it wasn’t what they were legally required to do (yet), would have fared far better when new legislation was brought in. Their systems, processes and procedures would have been future-proofed to transition seamlessly into a new way of operating.
It’s a very extreme example - but following the GFC and its ramifications, Patrick Watson of Mauldin Economics wrote a piece about the unlikely scenario of a ‘break-up of the USA’ and what that would mean from an investment perspective
“In the mid-1980s, people in the Soviet Union thought their government was, if not ideal, at least secure. Ten years later, it was gone. Former Soviet republics like Ukraine became independent countries. Everything changed,” he wrote.
He went on to say: “Just as engineers plan for once-in-a-thousand-years storms when they design bridges, investors should think about remote scenarios. We can’t rule out a scenario in which the US breaks up into smaller sovereign countries, as happened with the Soviet Union, Yugoslavia, and elsewhere. I’ve tried to imagine, from a practical perspective, what that would mean for investors. Investors succeed by either drawing income from some kind of asset they own, or by purchasing an asset and then selling it at a higher price. The asset can be anything: buildings, raw land, stocks, loans, gold, or other commodities. But you need to own it or at least control it.Ownership rights mean little without a government to protect them and courts to settle disputes. The US presently has both. What if it suddenly doesn’t?”
In all of these cases, an ability to see ‘over the horizon’ or ‘scan the horizon for risk’ would have been hugely advantageous. i.e. an ability to translate what the community expects - which might not (yet) be a legal requirement - into the possibility of that same expectation becoming the legal issue of tomorrow as a direct result of the power of democracy.
Strategic decisions; and even ‘how we do things around here’ are never made in isolation of the societal and democratic influences of the context in which they are made. These influences, when ignored, can come back to haunt even those with the best of intentions.
Today, institutional risk management is all about thinking about the scenarios with very low probability - but should they happen - the consequences would be so devastating that they warrant planning for. This involves questioning your assumptions - what happens when the things you believe will always be true, suddenly aren’t?
Smarter companies determined not to be caught out or caught short are becoming adept at turning the biggest societal risks of today into scenario plans that will help prepare them for a changing future.
They’re asking themselves “Are we clear about the assumptions we are making when it comes to achieving our objectives?” In particular:
Once you’re sure you’ve uncovered and interrogated the assumptions you’ve made - the next step is to document and monitor those assumptions closely. When you see the assumption change, that’s your cue to reflect on your business practices and manage the legal and operational risks that a change in these assumptions might present. (i.e. Is it still ok to grant loans based on underlying assets? Is legal permission enough to proceed with expanding operations into a sensitive community prior to thorough consultation?)
A robust framework around the assumptions that play into critical business decisions is key. Alongside this, it’s prudent to document what ‘acceptable’ business practice means to you in a clear framework, including sign-offs; and what might trigger changes to the framework.
The tail risk of failing to interrogate what may have been true yesterday is often significant.
Recently, social media platforms took a decision to start editorialising posts for safety. Censoring potentially harmful content (such as terrorism) was a noble idea; but when the company started to take a position on certan posts (such as leaving Trump’s infamous ‘looting’ post up), they failed to recognise that in doing so, the public might begin see them as a ‘media outlet’ as opposed to just a platform - potentially opening them up to regulation. The debate has since shifted to whether social media needs its own regulator in general.
Importantly, changing societal and regulatory conditions often impact very minor areas of a business. At the time, the changes might seem small, but bit by bit they often add up to massive change (and massive risk) that can quickly overtake a business.
Don’t be caught short. Being a gun at assumptions oversight will pay massive dividends. Change is here to stay and harnessing the power of evolving social expectation is key to helping you de-risk your business. This is what will separate those who are able to survive through change; from those who are able to use it as a tool to thrive.
Authors: Philip Hardy (Partner, Risk Advisory) ; Rob Hanley (Partner, Legal Governance Advisory)
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