5 Key ESG Considerations for Financial Institutions in 2023

April 3, 2023

Daragh Tracey

How will developments from 2022, like COP27, inform ESG regulation in the future?

Regulators are under increasing pressure to improve sustainability performance in the financial sector by enhancing market transparency and discipline, as well as by translating sustainability considerations into risk management practices and supervision at financial institutions.

This was a key focus of Egypt’s COP27 climate conference in November of 2022 – below we will detail what this landmark summit means for financial institutions.

5 Key Takeaways for Financial Institutions:

1. Loss and Damage Fund to Be Set Up for Poorer Countries Impacted by Climate Issues

This is really the big success story for the developing world. The agreement starts the process of creating an ongoing loss and damage fund to support poorer countries ravaged by climate impacts, primarily from devastating weather events such as flooding in Pakistan and overheating in sub-Saharan Africa.

The deal was historic for poorer nations. which bear the brunt of the impact of climate related disasters, despite being responsible for a minority of climate emissions worldwide. Wealthier nations – which produce the lion’s share of emissions – have resisted the call for financial assistance for over 30 years.

Given that the sums of money involved will be in the tens of billions, and that the funds will be routed across the globe, the impact on the financial system will be huge. How that plays out for financial institutions and wider market participants will be a key area to watch over the coming years.

2. 197 Countries Agreed to Winding Down on the Use of Coal

Rising inflation rates and slowing economic growth has completely shifted the energy landscape in the last few years, with the international community turning against fossil fuels following the Glasgow Climate Pact in 2021.

For the first time in history, COP27 saw 197 countries agree to the phase down use of coal. And this year with the Ukraine invasion, we have seen how fragile nature and natural gas oil supplies are. However, despite this achievement COP27 was widely seen as a disappointment for fossil fuel reduction ambitions, with the major producer countries shying away from targets and only Portugal and the US State of Washington upgraded to become ‘core members’ of the Beyond Oil and Gas Alliance (BOGA).

Fossils fuels and the green transition are key considerations for the finance industry, being as they are key component of the green taxonomy and factoring heavily in Scope 2 and Scope 3 emissions data. The financial system is both the engine of change and a force for inertia when it comes to the sustainability, so the actions of FIs and their clients will be crucial.

3. Countries and Institutions Pledged Support for the Article 6 Initiative of the Paris Agreement

Japan's environmental minister launched the implementation partnership for Article 6 of the Paris Agreement at COP27, attracting pledges from 40 countries and 23 institutions. Article 6 governs cooperative mechanisms for countries to transfer carbon credits and meet the targets set out in their NDCs (Nationally Determined Contributions).

This initiative aims to advance the implementation of high integrity carbon markets and serve as an information and support platform for Article 6 and its initiatives.
Financial institutions should know for ESG reporting that, under Article 6:

When engaging in the cooperative approaches, parties must promote sustainable development, environmental integrity, and transparency
International cooperation is voluntary
Double counting of emission reductions is prohibited
Financial assistance for developing countries partaking in the mechanism is provided for

4. Biodiversity is Key for Tackling the Climate Crisis – But No Hard Targets

For years, the biodiversity crisis and the climate crisis have been treated as separate issues. One of the things to note about COP27 is that the importance of the links between the two issues was recognized – namely that there is no viable route to limiting global warming to 1.5 degrees Celsius without urgently protecting and restoring nature.

Unfortunately, little was done and discussions failed to mention the COP15 biodiversity summit taking place in December 2022 in Montreal, which again gathers countries to protect the world's declining wildlife and degraded ecosystems.

5. Consumers and Investors Expect Improved Sustainability Levels and Social Responsibility

Social and environmental considerations and brand purpose are key for financial firms as investors and consumers increasingly expect businesses to take meaningful action on sustainability and corporate responsibility. This is permeated across the provision of financial services, where customers expect their financial institutions to be seen as green banks and offer green products.

Institutional investment decisions are being made with these considerations front of mind, with over three quarters integrating ESG data into their investment strategy, elevating the role and significance of ESG reporting in consumer products even further.

It is critical to call out that there are now 300 financial institutions who have signed up to the Principles of Responsible Banking - so what was once was the exception is now the norm. At Fenergo, as a third-party service provider, we're aligned in supporting our clients in meeting this mandate.

Learn more about Fenergo's ESG Solution.

Conclusion:

Following COP26 in 2021, and COP27 in 2022, the next major milestone is the finalisation of the ISSB recommendations around sustainability and climate-related disclosures, now that they're going out for public consultation again early in 2023 and seeking a huge amount of industry feedback.

Fenergo is actively monitoring this space to best interpret what those requirements will mean for financial institutions. Coupled with the renewed energy from the initiatives and decisions of COP27, financial institutions must be ready for ESG to move to the next step and begin to demonstrate meaningful progress on their ESG ambitions and net zero targets.