Risky Business - An Environmentalist Viewpoint
Presentation to Swiss Re Annual Client Conference
by Duncan McLaren, 13th
October 2000
Introduction
| The environmental impacts of business | Environmental
risk | Risk management and precaution |
Risk and innovation | Who
bears the risks? | A 'stakeholder'
approach | Implications for the insurance
sector
Introduction
This paper briefly explores the issues of sustainable business and
environmental risk from the perspective of Friends of the Earth, one
of the UK's leading public interest pressure groups, and part of the
world's largest network of environmental groups represented in 68 countries
spanning all continents. The paper offers proposals for reforms to the
market and regulatory framework to internalise environmental risk within
corporations, and concludes with some brief suggestions for the response
of the insurance sector to these issues.
The environmental impacts of business
Businesses play a fundamental role in generating (and potentially in
solving) environmental problems. The vast majority of energy and materials
consumed in the modern world are used by businesses, or by consumers
of the products of businesses. In a capitalist market economy this may
be inevitable, but it means that business activities lie at the heart
of environmental degradation worldwide.
For example, only a tiny fraction of greenhouse gas emissions (responsible
for the threat of climate destabilisation) results from individual activities
which business does not mediate. Some people still gather and burn their
own fuel-wood, but no-one extracts and refines gasoline for their own
use. Businesses prospect for, develop and exploit oil and other mineral
reserves. Businesses operate logging operations, businesses gather and
supply drinking water, and businesses grow, distribute and market the
vast majority of food we eat. All of these processes have environmental
impacts resulting from resource exploitation, pollution and waste.
Businesses do not only respond to consumer demand for services and
products, they also engage in a mutual process of demand creation and
stimulation. As a result overall consumption has grown much more rapidly
than population levels, resulting in severe environmental problems.
Throughout the world, businesses, meeting the demands of the relatively
wealthy 'consumer class', have gained control of environmental resources
- minerals, forests, land, water - and depleted them in quantity or
quality. In turn this has exacerbated by the pressures placed on remaining
subsistence resources by the much more numerous - but low consuming
- 'subsistence class'. The overall effect has been that environmental
resource use now exceeds sustainable levels for most resources - for
example global use of the atmosphere as a sink for greenhouse gas emissions
exceeds the level commensurate with climate stability by at least a
factor of two.
Environmental risk
The environmental impacts of business are not entirely predictable,
and thus we have to deal with risk. Much risk arises from lack of knowledge.
Despite decades, and in some disciplines, centuries of research, we
still know very little about environmental systems and how they respond
to disturbance by human activities. For example, the rapid depletion
of the ozone layer by CFCs and other ozone depleting substances was
a major surprise to the chemical industry. And even where we can broadly
predict the large scale consequences of an action, we often know less
about the specific effects. For example the cumulative loss of primary
forests leads to reduced biological diversity and species extinction,
but we cannot tell exactly which, if any, species will be lost as a
result of logging a specific area. For many pollutants, we know too
little about the receiving environments, or interactive effects in the
real world.
These factors can be of particular significance for human health. Humans
vary widely (by more than 100-fold) in their reaction to exposure to
individual toxic chemicals. In the real world we are increasingly exposed
(albeit rarely at obviously acute levels) to a cocktail of chemicals
in our drinking water, food, and environment. Measuring and managing
risk in such circumstances is a major challenge. The effect of an additional
chemical in a product such as tin-can lining, or an increase in certain
emissions may be negligible - or it may trigger severe hormone disrupting
impacts on human reproduction for many thousands of people. As human
genetic science improves, many more people will be able to pinpoint
the chemicals responsible for their illnesses.
We also know little about the resilience of environmental systems.
Whilst many systems have proved remarkably resilient to disruption,
others have revealed the existence of critical catastrophic thresholds
- such as the sudden appearance of the ozone hole, or forest die-back
after persistent exposure to acid rain. We simply do not know whether
there are further or similar thresholds in various bio-geo-chemical
cycles - which, for example, might trigger ocean-scale algal blooms
from our interference with nutrient cycles. Nor do we know the effects
of the subtle alteration of the Earth's angle of rotation caused by
impounding trillions of tonnes of water behind large dams. Nor of continuing
acidification, widespread dispersal of bio-accumulative and persistent
chemicals or genetic pollution from deliberate or accidental release
of genetically modified organisms.
Risk management and precaution
Three issues essentially determine whether environmental risk is managed
appropriately in business - who bears the risk, whether the risk measurements
are accurate and whether the risk management techniques are adequate.
If the company itself does not bear the risk in some way, then however
good the risk management techniques are, the net result will be more
environmental risk than is in society's overall interest. I will return
to this key issue later, but first briefly address the two other factors.
Despite the increasing sophistication of risk management and risk insurance
tools developed mainly for financial markets, we do not have adequate
tools for environmental risk management. Techniques such as environmental
impact assessment can help identify likely impacts, but despite 15 or
more years of experience, few are rooted in empirically verified experience
from previous projects. Cost benefit analysis techniques might help
companies put a financial value on a potential impact, but the most
commonly-used contingent valuation techniques systematically undervalue
the interests of future generations, non-human species and the poor
(all groups which cannot be asked or cannot state their 'willingness
to pay' to avoid impacts). Formal risk assessment techniques are equally
suspect, and even where the base data and knowledge is technically good,
their results tend to bear little resemblance to public assessments
of risk. This is because, for example, they do not take into account
issues related to who controls risk exposure.
Recent research by the Economic and Social Research Council reviewed
the issues of risk and uncertainty. They concluded that, while risk
assessment techniques might be valid where there was some knowledge
of both the magnitude and probability of adverse environmental impacts,
such conditions did not apply in critical areas of environmental risk,
such as the potential impacts of genetically modified crops. Such circumstances
are better characterised as ones of 'ignorance', requiring very different
management tools.
The fundamental tool in the environmental armoury for such circumstances
is precaution. The precautionary principle shifts and adjusts the burden
of proof. According to the principle, for action to be taken to protect
the environment from potentially serious or irreversible damage in conditions
of uncertainty or ignorance should not require proof beyond reasonable
doubt, but merely reasonable grounds to believe that such damage could
arise. The precautionary principle is one of the key Principles agreed
by Governments at the Earth Summit in Rio in 1992. This summer the OECD
Ministerial agreed that businesses - and not just Governments - could
reasonably be expected to take a precautionary approach. The concept
- albeit circumscribed - is now included in the OECD's 'Guidelines for
Multinational Enterprises' . In making it operational, techniques such
as citizens' juries, and critical natural capital may have much to contribute,
but few companies are making use of such innovative techniques.
Risk and innovation
However, a precautionary approach to environmental risk does not mean
that companies should become generally less risk-averse. In fact, Friends
of the Earth believes that companies should increase their appetite
for certain types of risk. We know that humankind is pressing on, or
beyond environmental system limits. We also know that growing numbers
of humans demand - and deserve - a decent standard of living and quality
of life. To provide this for around ten billion humans by the middle
of this century without exceeding environmental limits requires a factor-ten
or better increase in resource productivity, as well as the targeted
elimination of environmental risks such as those posed by toxic, persistent
and bio-accumulative chemicals.
This demands nothing less than an innovation revolution - and that
cannot be delivered without taking any risk. Companies need to develop
innovative technologies, products and services and to phase out the
most damaging products and processes - taking managerial, cultural and
financial risks in the process. Many individual businesses will fail.
Some whole sectors will need to close down - although companies in those
sectors may reinvent themselves. For example, the future for the oil
sector is probably limited to a few decades at best - but some of the
companies involved could successfully make the transition to the solar
and hydrogen economy that climate protection requires. Many successful
new businesses will be started.
How will companies and entrepreneurs be persuaded to take such risks
whilst reducing environmental ones? Friends of the Earth sees only one
basic option - the introduction of a market framework that provides
the right incentives and sanctions to redirect entrepreneurial innovation
and corporate attention. Governments need to invest in economic modernisation
to guide the economy as a whole. This will involve eliminating some
subsidies (such as those for oil exploitation), introducing or redirecting
others to support more sustainable alternatives, tax shifts from human
resources to environmental resources, and a host of other measures to
help manage the transition for particular sectors and regions. In this
way the risks associated with the sustainable path can be reduced. At
the same time, as we will see, the regulatory framework can increase
the costs and risks of the current unsustainable path.
Who bears the risks?
The present distribution of risk has a severe distorting effect on
the operation of the market. The different risks generated by, or related
to a company are borne by groups that have very different degrees of
influence over that company. Largely, investors bear financial risk,
and in return they (at least theoretically) hold ultimate authority
- in the case of a listed company, the right to 'hire and fire' the
directors of the company. But other groups bear risks without commensurate
influence over the company. Employees bear health and safety risks,
Employees and local communities bear the risks associated with accidents
and localised pollution or resource depletion. All people, and other
species, bear the dispersed environmental risks - such as those from
persistent chemical emissions or climate change. However, these risks
are not spread entirely evenly. In the case of climate change, the poor,
the uninsured and those in low-lying areas for example, tend to bear
a greater share of the risk.
Because these environmental risks are not valued or internalised, the
incentive structure that businesses face today works systematically
to reduce financial risks and increase environmental risks. Corporate
liability for such risks offers a key mechanism to internalise them
in company decision making. In Friends of the Earth's view, to fully
internalise these risks, such liability should be retrospective, strict,
joint and several, with a burden of proof on the defendant, and legal
processes must be open to all citizens and public interest organisations
without the need to demonstrate a material interest. For these reasons
we believe that the current European White Paper falls well short of
what is needed. We also believe that there is a particularly pressing
need to move ahead on defining strict corporate liability for the potential
impacts of genetically modified crops on farmers, beekeepers and the
wider environment.
A 'stakeholder' approach
This is just one element of a stakeholder approach to sustainable business.
The stakeholder concept may no longer be flavour of the month with Tony
Blair, but it offers a good basis for a framework of company law which
would help business contribute to a sustainable society. The model suggests
that good business practice would not only respond to, and seek to create
value for investors (the financial stakeholders), but for all stakeholders
including customers, employees, local communities and the wider environment.
The central measures - reporting and accountability to all stakeholders
- could drive improved risk management too. Legal mechanisms could be
established that allow other stakeholders to challenge company directors
over decisions that impose risks upon them, stimulating the company
to provide protection from the risk or face paying compensation or damages.
Friends of the Earth is keen to explore how such an approach could
be applied in the UK - perhaps through a more ambitious approach to
the ongoing Company Law Review - and internationally, where accountability
of multinationals to local communities, employees and wider society
in host countries is even more limited than in the UK, with only a few
tortuous routes at present available for impacted groups to seek any
form of redress. More generally we believe that there is greater scope
for extending the personal, and even criminal, liability of company
directors for some of the risks imposed by companies on society.
Such liability and accountability measures would provide the other
essential steer for business - providing sanctions which increase the
risks to business of environmentally unsustainable practices.
Implications for the insurance sector
Having ranged over the territory of sustainable business and environmental
risk, I want to conclude with three suggestions for the role of the
insurance sector.
First, research - and work to minimise - the actual environmental risks
(and not just the financial exposures) that you face as insurers, such
as those for the health effects of chronic chemical pollution, which
could well generate expensive class actions against chemical companies,
or those associated with more frequent severe weather events resulting
from climate change.
Second, reinforce this understanding in how you operate as investors,
by applying ethical screening and engagement practices to your investments,
and in particular targeting equity investment in future winners - such
as renewable energy - not past dinosaurs like fossil fuels.
Finally, support regulatory change that puts liability and accountability
where it belongs - to internalise environmental risk in the corporations
responsible. This type of political responsibility will require collective
action. But otherwise, insurance industries could also be in the firing
line for the big legal class action that is coming. A class action that
will make the tobacco settlement look like fiddling small change - a
global class action against the oil, fossil fuel, and automotive industries
on climate destabilisation. These companies have known for years that
climate change is a real threat, yet they have continued to develop
exploit and market fossil fuels, and fossil fuel dependency all around
the world; worse, they have attempted to deny the scientific evidence
and consensus; and worst of all they have lobbied and used political
influence to hamper and prevent effective Government action to minimise
the threat and the damage that will result.
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