The financial services sector has a vital role in the global effort to reduce greenhouse gas emissions and limit the impact of climate change. Without it channelling private investment into projects supporting a more resource-efficient, resilient, and sustainable global economy, meeting the ambitious targets set out by the Paris Agreement will be even more complex than it already is.
As the urgency of climate change initiatives accelerates, Grant Thornton International is making significant investments in assisting our diverse clients to incorporate ESG into business model transformations.
The financial services sector has become a particular focus for governments and regulators across the globe because of its role in the world economy. Mandatory regulatory changes to deliver sustainable banking will have significant impact on banks' business models.
“There are several careful balancing acts for businesses, policymakers, and the financial sector to traverse on the road to net zero. Among the most pressing is the role that legislation should play in requiring the private sector to do more.”
The EU Green Deal and the package of supportive regulations, including the taxonomy regulation, represents a big shift away from asking business for voluntary ESG compliance, to legally requiring it.
These changes are only the beginning. The taxonomy is one of several measures set to be introduced by the EU, supporting initiatives like the Sustainable Finance Disclosure Regulation (SDFR). Governments all over the world are formalising their climate commitments and alignment with the UN’s Sustainability Development Goals (SDGs). Reacting to regulatory requirements means going beyond developing policies and systems to meet current requirements. You must embed sustainability in every element of your operations and relationships with customers, clients, and regulators, and stay abreast of changes.
In this new legislative landscape, effectively disclosing ESG performance and progress is no longer a goal, but a starting point. The primary objective of incoming requirements like the SFDR and taxonomy is to create harmonised rules where previously there has been a multitude of different approaches. This will promote better transparency on the ESG impact and performance of investments.
Banks will be required to disclose, both at the company and product level, their approach to integrating sustainability risks and impacts into their processes and financial products. Catherine adds “going beyond compliance and integrating sustainability into their strategic decision making has potentially huge benefits for banks. It will enable them to better identify and mitigate risks, create unique points of differentiation and offers a competitive advantage.”
Collecting accurate and clean data on the environmental performance and impact of investments is vital if you're going to keep up with ever more stringent legislation around disclosure. This, however, means overcoming some significant hurdles.
“There is currently a substantial gap between the requirements and the reporting data due to the lack of common reporting standards and publicly available data,” says Fani Xylouri, sustainability services manager for Grant Thornton Luxembourg.
“However, with time it's expected that harmonised frameworks will be widely available. Until then, financial professionals will have to rely on the most commonly accepted indicators and accessible qualitative information.”
For Emma Verheijke, partner, sustainability advisory, Grant Thornton Netherlands, this is a clear area that you need to focus on over the short to medium term: “Banks need to improve their data and measurements on the ESG performance and impact of their portfolios. Where data is currently not available from data suppliers like MSCI, companies should explore developing data strategies to measure or model the impact themselves.”
Collecting data is only one part of the equation though. Making that data transparently available to a wide range of audiences is likely to be challenging from an organisational perspective too. “Internally, banks need to incorporate the management of ESG risks into their communication processes, including the regular reporting to the management body,” says Fani. “Externally, it is essential that disclosures for investors give them the whole picture, including investment strategy, rating systems and metrics, as well as performance in the short, medium and long term.”
As well as being able to accurately assess materials and performance in relation to ESG factors, you need to try and embed sustainability thinking throughout every part of your organisation. One of the most effective ways to do this is to make ESG factors part of performance reviews.
“This helps ensure the board and management are fully on board, with sustainability integrated into all business lines and communicated to internal, as well as external, stakeholders,” says Karin Björk, sustainable finance lead, Grant Thornton Sweden. “Tactically, this needs to be underpinned by clear targets with underlying KPIs tailored to the whole operation, as well as the different levels of the bank. Without this, it will be much harder to measure sustainability performance over time.”
Being able to do this effectively means creating the right information flows across different teams and management levels. “Putting the right procedures and systems in place is critical,” says Emma. “It ensures that sustainability information is systematically disclosed and that it is always available for strategic decision making.”
Integrating sustainability and strategy is an opportunity for you to create a competitive advantage. Catherine adds, “customers, investors and policymakers increasingly want to see climate impact factored into transaction and acquisition information. Although regulation changes are necessitating a change in approach, there is significant scope for banks to go further.”
“Important considerations here are banks’ corporate client base and what risk exposure does it have through its lending portfolio,” says Karin. “If the portfolio is exposed to companies who are themselves failing to manage their sustainability-related risks, it can lead to substantial losses. This also relates to how banks integrate sustainability into product development. Failure to offer attractive products such as sustainability-related bonds, loans, and investment products, means that corporate and institutional investors might take their business elsewhere.”
Understanding and having oversight over value chains will be important. Every company is affected differently, but also has a unique impact. For Karin, the key is “performing materiality analysis based on sector-specific sustainability issues, as well as the individual company’s exposure and management of financial and governance, social, and environmental aspects. Without a solid overview of the risks and opportunities they are facing in the ESG space, banks will struggle to keep up with regulatory requirements.”
A good starting point for sustainability analysis is the four areas of the global compact: environment, human rights, labour rights and anti-corruption. Additionally, there are a wide variety of methods and frameworks that form an excellent starting point for specific focus areas such as GRI and SASB (Sustainability Accounting Standards Board – now Value Reporting Foundation) and the Task Force on Climate-related Disclosure (TCFD).
The scale and pace of change required can be overwhelming, but it’s critical that you start, and build on your progress. Systems need to be agile enough to adapt to ongoing regulatory requirements, as well as provide investors and corporate clients with close to real-time data on investment performance and impact. Integrating sustainability into strategy is a journey, not a destination.
In the UK we also have a significant presence in the financial services sector and in particular an extensive portfolio of ESG services.
To know more about sustainable banking and how our ESG services can support you, contact Rashim Arora.