Sustainable Finance Director, Mike Jennings, explains the nine key areas a bank should consider while building an Environment, Social and Governance (ESG) programme.
When building a comprehensive bank-wide ESG and Responsible Investment programme, management will have to deal with a minimum of nine priority areas, dependent on the business of the banking entity and its operations. This is a sizable number of matters to be considered and handled by management that will require coordination with key departments across the business.
It’s common for banks to address ESG challenges from different angles. Recently, we’ve noticed banks beginning their ESG journey predominantly with a focus on the risk and regulatory angle. Others have started with business and commercial topics, such as the issuance of green bonds or the development of sustainability linked loan products. But wherever a bank starts, the C-suite will need to deal with all nine areas.
There are many factors driving banks and wider companies to implement ESG and sustainability programmes, some of which include:
- Increasing regulation and legal requirements for non-financial reporting
- Heightened customer expectations that products and services will include sustainability aspects and that companies will adhere to ESG principles in governance and action
- Significant governmental support for ESG programmes, including grants and incentives from the EU through transition funds and national programmes
- Changing expectations of investors who are now looking at a wider range of aspects of company management and operations than just the profit margin
- The rapidly increasing sustainable finance market with green bonds and sustainability-linked loans becoming available for mainstream financing purposes.
There are a minimum of five key types of stakeholders in the ESG process:
- Shareholders – with their expectations communicated to management (and many shareholders are becoming much more vocal in expecting ESG performance from their investments)
- Numerous regulators – responsible for individual rules and regulations (European Central Bank, European Commission, European Banking Authority etc.)
- Employees and employee representatives – looking at work-life balance, diversity, equality, inclusion, and similar topics
- Customers – in order to better understand customer expectations and what is important to them in terms of company governance, environmental risks, diversity and human resources activities, products and other matters
- Society – many institutions are already partnering with and/or sponsoring social welfare programmes and activities in their communities
A key step in any ESG programme is to understand the expectations of these diverse groups of stakeholders at the start of the process, so that the programme can focus on dealing with issues that really matter to stakeholders. This will require involvement from senior management, HR and compliance, investor relations and marketing to help discuss with each of these parties.
Stakeholder engagement is a fundamental part of a materiality assessment, which is a process to identify and prioritise ESG issues and concerns that are the most critical to an organisation and its stakeholders. This enables an organisation to understand their current state and determine future actions.
Some banks are actively implementing changes to be a first mover and market leader in their business areas.
There are a minimum of 5 key types of stakeholders in the ESG process:
- Numerous regulators
- Employees and employee representatives
2. Strategic Ambition
Based on numerous recent discussions with banks, there are varying approaches to ESG management.
Some banks are actively implementing changes to be a first mover and market leader in their business areas. Others, predominantly those smaller in size, are taking a more “wait-and-see” approach, to observe what competitors are doing and how the market develops. In the middle, we see banks with focused investments in specific opportunities but without the expectation that they will be market leaders in all areas. Based on discussions with stakeholders, each bank will have to find its own path.
3. Customers and Segments
The key here is to look at where the customer portfolio is now and how it will develop in the next ten years. Consider how customer expectations will change and where there will be significant government funding through structural funds. So far, a large proportion of the EU Green Deal financing focuses on green investments and technological projects. A bank that can position itself to secure funds and clients in these areas will be ready to achieve faster growth in the ESG marketplace.
A significant discussion topic in smaller portfolios and countries relates to how and whether a financial institution should reduce its loan footprint with “brown” industries as this will have a significant impact on fee and interest income as alternative borrowers are rare. This could also have powerful social impacts as “brown” industries are the main employers in some areas. In general, there must be some balance between moving to loans that finance cleaner industries and supporting existing industries to improve their carbon footprint.
A main consideration of any ESG programme is how to commercialise its impact.
4. Products and Services
A main consideration of any ESG programme is how to commercialise its impact. In recent years, we have seen more sustainability-linked loans being provided by banks, and more green bonds being issued. Headlines seem to focus on larger sustainability-linked loans, but many financial institutions have also been innovative in the areas of consumer loans, car loans, mortgages etc.
One specific area that is often discussed is the advisory model for banks, i.e., how to help corporates and SMEs to secure governmental funding for green projects and how to help finance those projects. Many corporates and SMEs do not have a clear picture of the options available and a financial institution that can help them secure funds can significantly improve its customer loyalty.
ESG is not just environmental risk management. It also encompasses social and governance angles, which require financial institutions to deal with a multitude of other laws and regulations.
5. Risk and Regulation
Until now, much of financial institutions effort has been focused on risk management topics and regulatory changes. Several regulators have sent out surveys to financial institutions on preparedness for dealing with climate and environmental risk in their risk processes, such as EBA, who included environmental risk in its loan origination and monitoring regulation and the ECB with the 2021 questionnaire to systemic banks on climate and environmental risk. The European Commission has also been involved in these communications in relation to SFDR, Taxonomy and the corporate sustainability reporting directive.
And yet, ESG is not just environmental risk management. It also encompasses social and governance angles, which require financial institutions to deal with a multitude of other laws and regulations. Obviously, financial institutions are used to the weight of regulation already, but it should not be forgotten that topics such as AML, labour laws, human trafficking laws, supplier due diligence, cybersecurity etc. must also be addressed within an ESG programme.
ESG is having a direct impact on how consumers and investors view a company’s brand.
6. Competitor activity
When advising clients, we recommend that they understand the competitive situation in their industry and geography concerning sustainability and other key ESG topics. It is crucial to understand what other players in the market are doing and how they are positioning themselves both internally and, more crucially, within the marketplace. ESG is having a direct impact on how consumers and investors view a company’s brand. Companies need to take these aspects into consideration when building their plan.
7. Data and Management Information
Finding a baseline for ESG performance and monitoring improvement against KPIs over time can be a challenge for many financial institutions. Banks are used to reporting a significant quantity of financial information to regulators (FINREP, COREP for example) and to auditors, but much of the required information for ESG is non-financial and has not been captured well (if at all) in the past.
Demonstrating reductions in carbon emissions is important and mapping out planned reductions across scope 1, 2 and 3 greenhouse gas emissions is key. As opposed to some other industries, most of a financial institution’s emissions will lie in scope 3 through their investments and loans (some estimates put this at over 90% of the total GHG emissions of a bank) and also their use of the cloud and professional services. So, without forgetting scope 1 and 2, and other operational emissions, financial institutions will have to put resources into working with their clients to obtain the information they need on financed emissions.
Improved brand perception is a key benefit that financial institutions notice when they have an ESG agenda in place.
8. Brand, Communications and Reporting
Improved brand perception is a key benefit that financial institutions notice when they have an ESG agenda in place and they can reap the rewards of better commercial opportunities, risk reduction and customer loyalty. However, the ambition of a financial institution needs to balance the benefits from brand uplift, cost efficiency, risk mitigation and greater revenue from being more ambitious on ESG matters versus the consequent internal costs and time involved of taking that more ambitious approach.
Many global banks are already issuing sustainability statements and reports (some for several years now), and smaller institutions will need to step up and emulate that level of reporting if they want to be taken seriously. One issue in reporting on ESG is that there are many different frameworks (TCFD, GRI, and SASB) and banks need to work out which one, or a mix, is best suited to them.
An ESG programme is transversal across the business, bringing in many of the key departments and relying on good co-ordination between people and activities.
As you can see from the above eight areas, an ESG programme is transversal across the business, bringing in many of the key departments and relying on good co-ordination between people and activities.
Depending on the size and business focus of a financial institution, at some point you will need a strong programme office (transformation office) to organise and run the changes. Luckily, many financial institutions have project management offices and change management teams that can take over some of this responsibility.