Anyone serious about sustainable finance should consider the invasion of Ukraine as a wake-up call, says Evgueni Ivantsov.
Russian president Vladimir Putin’s military aggression against the sovereignty of independent and democratic Ukraine has dramatically changed the geopolitical risk landscape. What risk management and ESG lessons can we draw from the war in Ukraine, and the hesitation of some European countries to impose severe sanctions due to the potential implications for their economies and businesses?
A more fundamental question might be: is it justifiable to develop business ties with autocratic states, where basic citizen freedoms and human rights are suppressed and the rule of law neglected? This question is not just about the moral choice of business leaders but is a crucial risk management and ESG decision. If business leaders decide to conduct business with autocratic regimes, they need to consider several issues.
The first is idiosyncratic risk, as CEOs could expose their companies to the risk of becoming dependent on markets that are intrinsically volatile, unpredictable and unstable. Second, they need to consider the systemic risk of their choices. Doing business with autocratic regimes inevitably makes autocrats richer, more powerful and more dangerous, amplifying not only the political risk for people living under these regimes but also geopolitical risk for everyone else.
The amplification of geopolitical risk should also be considered as a form of negative externality directly linked to ESG principles. Usually, we talk about negative externalities with regards to environmental issues (for example, air and water pollution). But in this case we are dealing with another form of externality: where a company profits at the expense of negative geopolitical consequences for society.
Many financial institutions have considered it perfectly acceptable to work with autocratic states as long as there is no breach of international sanctions and anti-money laundering requirements. However, ESG factors give us a new and rather different perspective, as the ‘S’ and the ‘G’, the social and governance components of the principles, are meant to measure and evaluate business ethics and the way in which companies create value for society. Enriching autocratic regimes and creating negative geopolitical externalities is, therefore, unlikely to be consistent with ESG requirements.
The war in Ukraine will have many risk implications for the financial services industry, in both the short and the long term. For financial institutions, these will mainly be non-financial – namely, compliance and reputational risks. The recent imposition of sanctions against beneficiaries of Putin’s regime, for example, created a much wider compliance scope for banks to deal with.
Sanctions mean bad news for the banks and other financial institutions that benefited for years from Russian money that originated from questionable sources. Now these organisations are exposed to significant compliance risks if they don’t fully comply with the new financial sanctions against Russian banks, companies, politicians and individuals. As a result, the reputational risk of retaining business ties with Putin’s regime will likely significantly outweigh any potential penalties by the regulators.
Social responsibility has become an important business paradigm. Chief risk officers and ESG professionals have a crucial duty of clearly articulating the risks of dealing with autocratic regimes every time their companies review their risk appetite and ESG strategy, because these choices can have potentially serious implications for both the financial performance of the company and for the wider society in general.
Evgueni Ivantsov is chairman of the European Risk Management Council