With governments and citizen activists demanding advancements in sustainable business, ESG initiatives are moving to the forefront of today’s market economy. In this environment, it is crucial for U.S. financial institutions to effectively manage ESG-related risks and capture ESG-centric opportunities as we see numerous examples in various domains of the financial services and insurance industries.

As part of a highly regulated industry, banks have been dealing with governance issues for a while. In recent years, the banking sector focused on social issues in response to the Community Reinvestment Act, putting particular emphasis on diversity, equity, and inclusion. The new frontier and where banks are turning their attention now is to the “E” in ESG — environmental — as they begin to understand their role in becoming carbon neutral and the impact of environmental considerations on risk within their lending and investment portfolios.

In April 2021, the Prince of Wales joined 40 banks worldwide in a working group called the Sustainable Markets Initiative’s Financial Services Taskforce. Their goal was to understand how the banking industry impacts global sustainability efforts. Out of this working group came the Net-Zero Banking Alliance,¹ an agreement by banks to align lending and investment strategies using existing and new technologies and policies with net-zero emissions by 2030. This agreement not only targets the industry's own carbon emissions, but also allocates lending and investment funds to organizations involved in the reduction of carbon emissions.

Finance for a sustainable future has been an integral part of the growth path for many banks for some time. Although the volume of ESG-related announcements from banks before the COVID pandemic was quite large, the industry is seeing an uptick in ESG commitments, especially since the advent of the Biden Administration. Goldman Sachs, for example, announced they will spend US$750 billion on sustainable finance over the next decade and Bank of America has pledged US$300 billion to sustainable investments.² Bank and fund managers are moving toward ESG-informed investing. For instance, the sustainable investing framework shown below combines the various paths investors can take to act on their ESG objectives, which asset managers are considering and promoting with their clients.

Retail banks are developing products and services aimed at Millennials with a focus on sustainability. The new products include green home-improvement loans, carbon neutral banking and sustainable Exchange-Traded Funds (ETFs). Commercial banks are creating new products and testing new lending models. For example, the UK firm Britvic recently refinanced its GBP400 million (US$520 million) loan facility with several commercial banks through a sustainability-linked deal that offers the company lower rates if they meet their various ESG targets.³ BlackRock announced that nearly all the $7 trillion assets they have under management will be subject to ESG considerations.

Sustainable ESG framework for investors:

More customers are changing loyalties and choosing to do business with organizations whose strategies and policies address environmental and social responsibility. The Thinking Ahead Institute’s⁴ World’s Largest Asset Managers report suggests that 58% of employees consider company’s social and environmental commitments when deciding where to work, and employees are three times more likely to stay at a purpose-driven organization.

Additionally, stakeholders are demanding accountability and transparency on financial exposure to risks, opportunities, governance, and fiduciary duty related to human capital. For example, 51% of S&P 500 companies utilized ESG metrics to reward executives in their annual incentives as they entered 2021. Among companies that use ESG metrics in executive incentives, the most prevalent category for North America and Europe is people and HR, which includes metrics such as succession planning, talent development, DEI, employee engagement and culture, according to Willis Towers Watson (WTW) research.⁵

Example of Transmission Channel Framework:

The Federal Reserve plays a crucial role in setting the U.S. ESG agenda by establishing and assessing ESG metrics for the institutions that they oversee. This is especially true for climate-related changes, driving financial stability risks which can emerge as either shocks or vulnerabilities into their framework, represented on the financial stability reports.⁶ For example, climate change can lead to a further rise in sea levels and increase in storm surge. These effects, in turn, can lead to increased inundation of coastal land parcels, which could either damage existing structures on those parcels, or require investment and adaptation for their continued productive use. As these climate changes continue, the expected value of coastal real estate may decrease—which may, in turn, pose risks to real estate loans, mortgage-backed securities, the profitability of firms using the inundated property, and the finances of state and local governments facing declining property tax revenues and rising remediation costs.

Conclusion

As the regulatory environment is changing, the stakes are getting higher. The financial services industry is now seeing capital allocated based on ESG information and ratings to a much greater degree. ESG is becoming the “industry standard” as consumers gravitate towards brands that address ESG issues in ways that align with their own values. As ESG reporting continues to evolve, firms that innovate more quickly will race ahead.

Recommendations for financial organizations to advance the ESG agenda and stay abreast of the curve include:

• Ensure the firm is prepared to manage all aspects of the ESG challenge and has a strategic approach to Green, Social and Sustainability to promote ESG benefits to their investors
  
• Align to an ESG ratings provider or an ESG data aggregator organization so that the company’s ESG performance can be measured and tracked relative to other firms
  
• Consider the attributes of ESG data, which are hard to track and still evolving, in your company's data management standards and methods, especially when supplemented by third party data
  
• Create transparency for improved ESG data management; encourage the better use of ESG global data assets for sustainability which in turn will lead to better financial and societal outcomes
  
• Create education programs to inform their stakeholders internally and externally about ESG and how it is going to impact “Business as Usual”

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 1.  https://www.unepfi.org/net-zero-banking/
 2.  https://www.cnbc.com/2020/01/24/climate-crisis-investors-putting-money-towards-sustainable-future.html
 3.  https://www.globalcapital.com/article/b1kcxskd4hxrqz/britvic-opens-lid-on-sustainability-financing
 4. Thinking Ahead Institute - The World's Largest Asset Managers
 5.  Willis Tower Watson - Executive Compensation and ESG
 6.  Climate Changes and Financial Stability Federal Reserve Note