The benefits of an often-overlooked, yet highly effective risk management strategy.
Much of my work focuses on helping clients manage the risks of sustainable innovation. This can be done by leveraging various strategies. One key strategy is attempting to get and stay ahead of future regulation.
But what does that mean?
It generally means avoiding the costs of late-in-the-game compliance and adding value by capturing market and other opportunities created by regulatory activity. These costs and missed opportunities are very real business risks that can and should be managed.
The first step to implementing this strategy is learning how to identify the “guideposts” or indicators that suggest future regulation.
Guideposts that suggest future regulation
Climate change is a good, if obvious, example of a guidepost.
President Biden has made it clear that climate will be a priority during his Administration. And nearly every industry — from textiles to architecture — contributes to climate change (in one way or another) and, as a result, nearly every industry will be impacted by regulation intended to mitigate climate change impacts. If you are not paying attention to this clear indicator from the Executive, and taking at least some steps toward mitigating your business’s contributions, you are putting your business at risk.
Proclamations from government and other regulatory entities are also important guideposts, because once a city, state or other government entity commits to a certain climate benchmark, such as climate neutral by 2030, they have to regulate to achieve that goal or benchmark.
Another guidepost is when industry leaders take strong, public positions on certain issues. For example, asset management firm BlackRock gained significant attention in 2020 by taking very public positions with respect to sustainable investing and incorporation of Environmental, Social and Governance (ESG) risk analysis, in a series of letters to clients and CEOs. BlackRock has continued to take this position in 2021. And the Securities and Exchange Commission’s recent appointment of a new senior policy advisor, whose work will focus on climate and ESG issues, bolsters this cue from the private sector that ESG will be subject to increased regulation.
A final example is automotive industry leader General Motors committing to sell only Zero-Emission vehicles by 2035. The following quote from a recent New York Times article captures the significance of this Zero-Emission pledge:
Leaders could point to G.M.’s decision as evidence that even big businesses have decided that it is time for the world to begin to transition away from fossil fuels that have powered the global economy for more than a century.
Businesses can look to industry leaders and bold, public proclamations as key guideposts that regulation is forthcoming, particularly from companies in the business of identifying and managing risk — like financial institutions and insurance companies. With these regulatory guideposts in mind, it is important to start implementing strategies to manage these risks and minimize the associated costs.
So how do we manage the risks of future regulation?
With respect to sustainability, most companies don’t know what they don’t know, which reinforces the importance of tracking data and simply starting somewhere. Government and other regulatory entities will often take this “start with data” approach, which is why it is important for businesses to do the same.
If we use the built environment as an example, buildings are one of the most significant contributors to climate change emissions. As a result, many state and local governments have appropriately focused regulation on building energy use, by following a pathway that begins with a guidepost followed by data collection.
If we use the City of Seattle (and state of Washington) as an example, the pathway looks like this:
City makes bold climate proclamations, and identifies largest contributors to climate change emissions, in this example, large, existing commercial buildings.
City first requires owners of these buildings to track and share data on their (fossil fuel-based) energy usage.¹
City then requires building owners to identify and make low to no cost improvements to existing buildings.
State of Washington (with authority over buildings in the City of Seattle) enacts the Clean Buildings Act, which, among other things, requires buildings to meet specific energy use targets (EUI).²
If we put this pathway in a more visual form, it would look like this:
Example regulatory pathway that can inform risk management strategies.
The point is that businesses can manage the risk of future regulation by taking voluntary measures that track this expected pathway. This means at least tracking data and preferably implementing basic, low to no cost sustainability strategies — before they are required.
While this example comes from buildings, we expect regulation of other industries to follow a similar pathway.
There are two sides to this conversation: while there are costs associated with regulatory compliance, including labor, equipment and reporting costs, there are also benefits associated with staying ahead of the regulatory curve.
The benefits of staying ahead of the regulatory curve
Generally speaking, it costs less to stay at pace than to try to catch up. The analogy of a set of stairs can be helpful: it costs less to take one stair at a time than to jump up several stairs.
In the below example, the steps represent increasingly stringent reductions in energy use. It is easier (i.e. costs less) to go from step A to B, B to C, and C to D than it is to jump from A to D.
Example of steadily increasing regulatory requirements.
Waiting until the last minute to comply with regulation (having to jump from A to D) also exposes business to other risks. If we continue with our example of buildings in Washington state, in order to comply with the Clean Buildings Act, many owners will need to enlist the help of outside consultants and other support specialists. For owners who wait until the last minute, these supporting consultant firms could easily become overwhelmed and lack the capacity to meet crunched deadlines. Missed deadlines can expose owners to a variety of risks, including penalties and other costs.
And these penalties can be significant — for the Clean Buildings Act, up to $5,000 plus $1 per gross square foot, per year. For a 50,000 square foot building, that’s an unacceptable level of avoidable exposure.
Continuing with our example, the Clean Buildings Act also contains an early adoption incentive for certain buildings. Building owners that comply with the regulation early can receive a one-time incentive payment. However, this incentive is capped at $75M total. Once this pool of free money is used up, it is gone. Thus the name “early adopter.” For projects that are eligible, leaving this type of free money on the table is a significant and avoidable risk. Yet I would be incredibly surprised if there were enough early adopters to actually exhaust this incentive.
Missing these types of opportunities has traditionally been considered an acceptable business risk based on short-term thinking. However, this type of thinking no longer fits the current reality, and these types of risks need to be reframed and placed in the appropriate context.
Summary
Attempting to get and stay ahead of future regulation is an important and effective risk management strategy. Smart business owners will want to look for guideposts, expect (and plan for) a data-first pathway and take advantage of early adopter benefits. In the current climate, the “wait and see” approach is no longer a viable option.
[1] In fact, regulations related to energy benchmarking and disclosure have steadily increased over time. According to a Bloomberg report, the “square footage of commercial building space covered by such policies jumped from 9% in 2017 to 13% in 2019, covering around 11 billion square feet.”
[2] This type of legislation is commonly referred to as a Building Performance Standards (BPS).