LP-830: ESG Risk Management

Abstract

This LP establishes the framework for identifying, assessing, mitigating, and monitoring Environmental, Social, and Governance (ESG) risks facing Lux Network. It aligns with TCFD recommendations for climate risk and extends to cover broader ESG risk categories.

Motivation

ESG risks can materialize as operational, financial, and reputational damage. Without proactive management:

1. Physical climate risks threaten validator infrastructure and network availability
2. Transition risks from policy changes could increase operating costs
3. Social risks from community exclusion or governance failures erode trust
4. Regulatory risks from non-compliance could restrict market access

This LP establishes the systematic processes needed to identify, assess, and mitigate ESG risks before they materialize. By aligning with TCFD, we meet the disclosure expectations of institutional stakeholders and regulators.

Risk Governance

Oversight Structure

Body	ESG Risk Responsibility
Board of Directors	Ultimate oversight, risk appetite approval
ESG Committee	Policy review, material risk decisions
Sustainability Lead	Day-to-day risk management, reporting
Working Groups	Topic-specific risk monitoring

Risk Appetite Statement

Lux Network has low tolerance for:

• Reputational damage from ESG failures
• Regulatory non-compliance
• Material environmental harm
• Human rights violations in value chain

Lux Network accepts moderate risk for:

• Operational efficiency trade-offs for sustainability
• Higher costs for green energy procurement
• Slower growth to maintain governance standards

Risk Categories

Environmental Risks

Physical Climate Risks

Risk	Type	Time Horizon	Impact
Data center disruption from extreme weather	Acute	Short-term	Availability
Rising cooling costs	Chronic	Medium-term	Costs
Sea level rise affecting infrastructure	Chronic	Long-term	Infrastructure

Mitigation:

• Geographic distribution requirements for validators
• Data center resilience standards
• Business continuity planning

Transition Risks

Risk	Type	Impact
Carbon pricing/taxes	Policy	Increased costs
Renewable energy mandates	Policy	Compliance costs
Energy efficiency regulations	Policy	Upgrade costs
Investor/user expectations	Market	Reputation
Shift to green competitors	Market	Competitiveness

Mitigation:

• Proactive renewable energy adoption (LP-810)
• Science-based targets
• Transparent carbon reporting (LP-801)

Technology Risks

Risk	Impact
Consensus efficiency breakthroughs elsewhere	Competitive disadvantage
Energy measurement inaccuracy	Reporting errors
Green technology costs	Higher than projected

Mitigation:

• Continuous protocol optimization
• Multiple data sources for energy estimates
• Conservative cost projections

Social Risks

Community & Inclusion

Risk	Impact	Likelihood
Geographic concentration	Centralization concerns	Medium
Developer community decline	Ecosystem weakness	Low
Accessibility barriers	Exclusion	Medium
Misinformation campaigns	Reputation	Medium

Mitigation:

• Validator distribution requirements
• Developer grants program
• Multilingual documentation
• Communications response plan

Security & Safety

Risk	Impact	Likelihood
Smart contract vulnerabilities	User losses	Medium
Protocol-level security incident	Network trust	Low
Ecosystem project failures	Reputation	Medium

Mitigation:

• Mandatory audits for core contracts
• Bug bounty program
• Ecosystem project standards
• Incident response procedures

Governance Risks

Decentralization Risks

Risk	Impact	Monitoring
Validator concentration	Censorship risk	Nakamoto coefficient
Token concentration	Governance capture	Gini coefficient
Insider influence	Unfair outcomes	Conflict policies

Mitigation:

• Stake distribution monitoring
• Validator cap policies
• Conflict of interest policies
• Transparent governance processes

Regulatory Risks

Risk	Jurisdiction	Impact
Token classification changes	Global	Legal/compliance
DeFi regulations	EU, US	Protocol restrictions
Privacy regulations	EU (GDPR)	Data handling
ESG disclosure mandates	EU (CSRD)	Reporting burden

Mitigation:

• Regulatory monitoring
• Proactive engagement with regulators
• Conservative compliance posture
• Flexible governance structures

Operational Risks

Risk	Impact	Likelihood
Key person dependency	Continuity	Medium
Documentation gaps	Knowledge loss	Medium
Third-party failures	Service disruption	Medium

Mitigation:

• Succession planning
• Documentation standards
• Vendor diversification
• SLA monitoring

Risk Assessment Process

Identification

Sources:

• Quarterly horizon scanning
• Stakeholder feedback
• Industry reports and news
• Regulatory updates
• Incident post-mortems

Process:

1. Working group identifies potential risks
2. Categorize by E, S, or G
3. Initial severity assessment
4. Escalate material risks to ESG Committee

Assessment

Likelihood Scale

Score	Likelihood	Description
1	Rare	<10% probability in 5 years
2	Unlikely	10-30% probability
3	Possible	30-60% probability
4	Likely	60-90% probability
5	Almost certain	>90% probability

Impact Scale

Score	Impact	Description
1	Minimal	<$100K or minor reputation
2	Minor	$100K-$1M or localized impact
3	Moderate	$1M-$10M or significant reputation
4	Major	$10M-$100M or major reputation
5	Severe	>$100M or existential

Risk Matrix

	Minimal (1)	Minor (2)	Moderate (3)	Major (4)	Severe (5)
Almost Certain (5)	Medium	High	High	Critical	Critical
Likely (4)	Low	Medium	High	High	Critical
Possible (3)	Low	Medium	Medium	High	High
Unlikely (2)	Low	Low	Medium	Medium	High
Rare (1)	Low	Low	Low	Medium	Medium

Treatment

Risk Level	Response	Approval
Critical	Immediate mitigation required	Board
High	Mitigation plan within 30 days	ESG Committee
Medium	Mitigation plan within 90 days	Sustainability Lead
Low	Monitor and review quarterly	Working Group

Monitoring

• Risk register: Maintained and reviewed monthly
• KRIs: Key Risk Indicators tracked for top risks
• Reporting: Quarterly to ESG Committee, annually to Board

Climate Scenario Analysis

Scenarios Analyzed

Per TCFD recommendations:

Orderly Transition (1.5°C)

• Aggressive climate policy
• High carbon prices ($150/tCO2 by 2030)
• Rapid renewable energy deployment
• Strong regulatory requirements

Impact on Lux: Moderate transition costs, competitive advantage from early green positioning

Disorderly Transition (2°C)

• Delayed but abrupt climate action
• Carbon price volatility
• Technology disruptions
• Stranded asset risks

Impact on Lux: Higher short-term costs, potential validator disruption

Hot House World (4°C)

• Limited climate policy
• Severe physical risks
• Extreme weather events
• Economic instability

Impact on Lux: Significant physical risks to infrastructure, economic disruption

Scenario Outputs

Scenario	Physical Risk	Transition Risk	Overall
1.5°C	Low	Moderate	Moderate
2°C	Moderate	High	High
4°C	High	Low	High

Incident Management

ESG Incident Categories

Category	Examples
Environmental	Significant carbon footprint error, greenwashing accusation
Social	Security breach, community harm, discrimination
Governance	Conflict of interest, regulatory violation

Response Process

1. Detection: Identify through monitoring, reports, or external notification
2. Assessment: Evaluate severity and escalate appropriately
3. Response: Activate response plan, communicate with stakeholders
4. Resolution: Implement fixes, document actions
5. Review: Post-incident review, update risk register

Communication Protocol

Severity	Internal Notification	External Communication
Critical	Immediate (all leadership)	Within 24 hours
High	Same day	Within 72 hours
Medium	Within 48 hours	If required
Low	Weekly summary	Not required

Related LPs

• LP-800: ESG Principles and Commitments
• LP-840: Impact Disclosure & Anti-Greenwashing Policy
• LP-850: ESG Standards Alignment Matrix
• LP-860: Evidence Locker Index

Changelog

Version	Date	Changes
1.0	2025-12-17	Initial draft

Copyright

Copyright and related rights waived via CC0.