Operationalising ESG: Context, Strategy & Culture
In this joint collaboration with Aurora, we set the context for the challenge of operationalising ESG within financial institutions, and discuss why it needs to be led from the top and engrained into company culture to achieve success.
Operationalising ESG: what is it and where do you start?
ESG is now a major force in financial services, with its criticality only set to increase as more jurisdictions adopt regulations and standards. With the implementation of SFDR and CSRD, the EU has led the charge in making ESG considerations a key part of Client Lifecycle Management. 97% of banking executives say that sustainable digitisation is key to success – but what does ESG mean to your organisation? With so many standards available from TCFD to UNGC to ISSB and beyond, how does a financial institution design and operate an ESG process that delivers compliance without impacting the end customer experience?
Why operationalising ESG is important
Recent polling shows that six in 10 (59%) of financial institutions are unsure if their organisation is equipped to meet ESG requirements . With a spate of fines and incidents of greenwashing, this is a major point of exposure for financial institutions. More and more, consumers and employees expect the firms they do business with to embody ESG values – the reputational impact of positive ESG activity delivers dividends for financial institutions. But ESG is not just a cost; it can also be a revenue driver. With capital requirements leniency (such as Article 501a) and the opportunity to offer new, sustainability-focused products, ESG can attract forward-thinking customers treating it as a priority.
In this first of two articles, we explain how you can ensure your organisation is not left behind as ESG comes into force. We’ll discuss how a strategic approach can deliver for you and your clients, and what you need to consider from a people, policy, and process perspective.
What does it mean to be compliant with ESG?
This varies per jurisdiction and per financial institution, as each has their own risk appetite, regulatory environment, and view of the market. But the fundamentals are the same; regulatory obligations such as the EU’s SFDR and CSRD are coupled with the application of due diligence standards to understand the client profile.
Meeting regulatory obligations is not easy, but it is straightforward; the legislative text is black and white, and applicable scoping is clear. However, with over 400 standards available, how does an FI decide what standard to adopt, and how to implement it. There has been a level of maturation in the space, with key standards TCFD and the upcoming ISSB being widely adopted by jurisdictions (such as the UK and Thailand) and firms. That said, standards are guidelines and not binding; each FI must forge their own policy according to their risk appetite and market perspective.
Make it central to your strategy and culture.
To operationalise ESG successfully, there needs to be a recognition that ESG must extend beyond just regulatory compliance. Instead, a genuine shift in corporate mindset needs to occur to incorporate ESG into the culture of financial institutions and avoid corporate hypocrisy visible to both customers and employees. There is a strong link between employee perception of corporate hypocrisy and work engagement, where if an employee views inconsistencies between their company’s actions and their communication, there is a decrease in the dedication to their work. This disengagement is likely to filter through to negatively impact customer trust, attraction and retention. As a result, integrating ESG into the corporate culture and business model is critical to its successful operationalisation and can generate added financial value. Internal communications should clearly define their commitments, goals, and path to achieving them, whilst external communications should be transparent and unambiguous.
FIs must also assess the industries they want to continue servicing in a new ESG context. There is a growing need to phase out industries which pose a significant environmental or ethical risk. For example, HSBC created a target of Net Zero by 2050, and HSBC Asset Management have committed to phasing out the financing of coal-fired power and thermal coal mining by 2030 within the EU and OECD. This move away from servicing non-renewable energy firms that don’t take sufficient action to reduce carbon emissions is a major step by a Tier 1 bank. Other FIs have joined HSBC in their commitment to phasing out financing of coal by signing the Powering Past Coal Alliance at the COP26 summit. This could be the first step for FIs to shift away from financing polluting industries.
A recent report confirmed that in 2019 the largest global banks invested over USD 2.6 trillion in sectors that are primary drivers of biodiversity destruction . Industries such as metal and mineral mining could be next to be phased out as public pressure grows for FIs to take accountability for environmental damage caused by their lending. FIs that focus early on environmentally friendly industries will reduce reputational risk, service a growing customer demand, and gain a competitive advantage. Formal regulations may emerge in the coming years, but the creation of internal policies and procedures around servicing environmentally harmful industries would enable FIs to get ahead of the curve.