Several scandals have rocked the financial services sector in recent years, causing significant brand damage. With global social discontent on the rise, governance-related themes such as ESG have never been more important.
ESG has grown in importance in the financial services business, and institutions can utilise ESG criteria alongside other financial measures to make investment decisions.
Because of the link between ESG variables and financial performance, ESG has become increasingly relevant in the financial services sector.
Businesses that have good ethical and governance standards are likely to face fewer regulatory fines, and the financial services industry is already heavily regulated. Furthermore, today's investors expect more financial products to match with their values and views, which has aided in the development of ESG-related indicators.
In the financial services business, for example, the European Union has recently adopted legislation that compel asset managers and investors to declare how they will integrate ESG issues into their decision-making. In short, there is a rising realisation that non-financial elements influence financial performance, and investors are increasingly demanding that products reflect their beliefs.
ESG is measured using a variety of measures, which vary based on the industry, company, or asset under consideration. However, the following are some of the most popular approaches employed in the financial sector:-
ESG ratings: These ratings assess ESG performance by considering aspects like as carbon emissions, diversity, and executive compensation, among others.
ESG indexes: can be used as benchmarks for ESG investing and to create new investment products.
ESG integration: entails combining ESG factors into financial analyses, which may involve the use of specialised modelling.
Impact investing: The goal of impact investing is to identify assets and enterprises that have a beneficial social and environmental impact as well as high financial returns.
As a result, there are numerous techniques for measuring ESG in the financial services sector.
Investor demand: As previously noted, investors are increasingly demanding that investment products reflect their beliefs, and ESG standards can help in this regard. As a result, financial services firms that employ ESG standards are well positioned to attract investors.
Risk: By using ESG standards, businesses can reduce their exposure to risks such as reputational harm and climate change.
Regulation: As the industry becomes more regulated, organisations can employ ESG criteria to ensure they stay on the right side of the law and avoid costly penalties.
Reputation and branding: By proving their commitment to ESG-related criteria, financial services organisations can boost market trust in their brand.
The economy is increasingly deviating from established frameworks and becoming more consumer-driven. The issue is to create a system that aids in the transition to a new type of economy, and the financial services industry will play an important part in this. Working with various stakeholder groups, today's financial services business has the opportunity to explore divergent collaborations in addressing social concerns and rebuilding trust in institutions. People in charge of governance in this area can play a critical role in assisting individuals and businesses in transitioning to new job positions.
In short, the financial services sector can add value in the ESG space by facilitating value exchange, controlling risk, allowing for greater value-based investment, and providing the stability and trust required to fuel economic growth.
Climate change has received a lot of attention in the banking sector when it comes to ESG.
The European Central Bank has acknowledged that the links between social variables and financial consequences can be more difficult to quantify than climate change. Some organisations may be forced to provide data on board diversity and employee treatment, but this may only apply to major corporations. As a result, the EU has acknowledged the need for greater data when assessing the impact of social criteria.
The creation of such guidelines has grown even more important as the issuance of social bonds has increased.
The governance pillar of ESG is one of the better established areas, as there has been regulation in place for several years. Corruption, board independence, and ethics are examples of measurement criteria. Transparency and tax tactics can also be addressed in this area. The European Commission's Corporate Sustainability Due Diligence Directive seeks to strengthen sustainability in governance and value chains. This will push businesses to address human rights issues throughout their operations and supply chain.
All of this poses a challenge for financial services firms in terms of upskilling employees to comply with new social performance rules and implementing systems capable of capturing the data required to measure this.
Companies should concentrate on the European Sustainability Standards and become familiar with the infrastructure and skill sets that may be required to ensure compliance.
By implementing green initiatives, banks may differentiate themselves from the competition and position themselves to help assist the transition to a more sustainable economy.
ESG measures assist distinguish between businesses that are genuinely devoted to sustainable aims and those who are simply greenwashing. Surprisingly, there is a correlation between the size of the banking institution and ESG policies, with larger banks having higher ESG scores. This could be because they have more resources to invest in creating a more sustainable future.
To improve ESG, those in the banking sector can first obtain an ESG certificate, such as the Diploma in ESG, and then build a more systematic approach to this issue, which must originate from the top down. They should establish short-, medium-, and long-term goals and assess where they stand in relation to those goals. Second, they must guarantee that all actions are conveyed to all stakeholders. The SEC is becoming more interested in the ESG field in the United States, as it is becoming increasingly relevant to investors.
Investors are looking for long-term financial goods, but although this gives opportunity, it also presents hazards.
Greenwashing, which involves deceiving consumers or investors about a company's environmental credentials, is one area where institutions should exercise caution.
Companies will very certainly face increased regulation as a result of this, and they must be careful to disclose information in a clear and non-misleading manner. Financial services organisations must also be able to follow the requirements for corporate disclosures.
Governance is an area where there may be some risk, and organisations should ensure that clear systems are in place to limit this risk.
When an ESG-related risk is identified, it can be reported to senior management and the board. Furthermore, there may be future needs to publish more information about climate-related governance and risk management. Overall, businesses must consider the reputational risk that may develop as a result of failing to address ESG-related concerns. Breach may result in fines and regulatory scrutiny.
To keep ahead of these risks, organisations must be rigorous in mapping the ESG landscape and engaging with other stakeholders. They should make certain that proper training is provided, as well as that suitable governance and whistleblower measures are in place. If complaints or concerns are presented, protocols should be in place to ensure that they are taken seriously and investigated properly.
You can learn more about the subject by opting for the ESG Expert Certification course from Directors’ Institute - World Council of Directors.