Financial institutions around the world are increasingly facing risks as a result of regulatory and reporting requirements that focus on the environmental, social, and governance (ESG) impacts of their operations.
ESG strategy is crucial
There has been new legislation on ESG issues for the financial sector in 2021, including the Sustainable Finance Disclosure Regulation in the European Union and the Executive Order on Climate-Related Financial Risk in the US.
The ESG performance of companies and institutions in the financial sector is progressively influencing investment decision making, lending criteria, and insurance considerations. Clearly, companies unable to demonstrate an ESG strategy will be putting the long-term viability and resilience of their business at risk.
While there is no definitive list of ESG risks for financial institutions to consider, they typically include a blend of the following.
Environmental
Criteria examining an organization’s impact on the planet, include:
- Calculation of a company’s total emissions, as a measure of its commitment to addressing climate change.
- An entity’s plans for transitioning to low-carbon usage to ensure energy security.
- Monitoring and disclosure of greenhouse gas (GHG) emissions.
- Establishing targets for pollution and waste practices.
- Projects they invest in or loan to and the impact of those projects.
For financial institutions, the transition to green financing is not only key to an organization’s reputation, but also emerging as a regulatory requirement globally.
Social
Criteria examining how an organization treats and values its employees and surrounding communities, include:
- Labor management policies.
- Health, safety, and wellbeing commitments.
- Impacts an organization has on the local community and whether those effects are beneficial or adverse.
- Labor standards of a company’s suppliers.
These concerns are a few of many for financial institutions, along with the need to embed diversity and inclusion policies, social equality, and customer privacy.
Governance
Governance criteria assess a company’s corporate governance practices. These focus on board structure, in particular board diversity, audit quality and transparency, and issues surrounding remuneration, such as executive pay.
Preparedness for ESG risks varies
Financial institutions currently differ vastly in their readiness for the transition to sustainability, at which point organizational agility to respond to new laws, requirements, and customer expectations is going to be key.
In a recent survey by Marsh, 80% of respondents in the financial services sector ranked climate change and ESG as either an important, or the most important, issue for their operations.
However, 42% of respondents said they have an ineffective process, or no process at all, for identifying, responding to, and implementing changes based on climate threats and ESG-related factors.
The survey also found 80% of financial companies had not yet carried out a comprehensive stress test on financial impacts from climate threats across current and future operations.
Conclusion
Organizations adopting a more proactive and methodical approach to understanding the impact ESG factors and climate change will have on their most valuable assets undoubtedly will be able to embed greater levels of resilience into their operations. As greater attention is given globally to ESG concerns, the need to act will continue to increase sharply.
Key actions to take include:
- Assess the implications of ESG for your organization by utilizing industry data, risk indices, physical climate models, and key stakeholders’ perspectives.
- Analyze and establish the means to control the physical, transition, and reputational risks associated with ESG for your organization.
- Analyze the requirement for external reporting. Many financial institutions globally are already aligning to reporting frameworks, such as the Task Force on Climate-related Financial Disclosures (TCFD) and the Global Reporting Initiative (GRI).
Acting on the above support the execution of ESG objectives in line with an organization’s risk appetite and bring practices within established environmental resource management and resilience frameworks.
If you have questions on your ESG and climate change risk, please contact your Marsh advisor.
