How financial services companies can take advantage of ESG.
The future of finance lies beyond the monetary performance of investments. Committing to sustainability means considering the environmental, social, and governance-related (ESG) impact of investment decisions.
We have discussed the importance of those factors recently, but as governments and other industries are acknowledging the dangers of climate change and committing to sustainability goals, demand for sustainable finance products is growing rapidly. At the same time, the sector is under pressure to account for its own contribution to climate change.
Fuelled by these developments, more organizations are recognizing the importance of environmental, social, and governance (ESG) as part of their risk management strategy. Here’s a look at five examples.
Sustainability and ESG at-a-glance
To take advantage of the opportunities arising from this shift in focus, financial services companies need to understand their role in climate change. It may not always be obvious, but through day-to-day operations, all companies contribute to greenhouse gas (GHG) emissions.
Within the sector, most GHG emissions are so-called Scope 3 indirect emissions. They include employee travel but also relate to the ESG impact of financial products. The United Nations Task Force on Climate-Related Financial Disclosures (TCFD) and the Partnership for Carbon Accounting Financials (PCAF) devolved from it have developed guidance for reporting emissions related to six asset classes:
- Project finance
- Commercial real estate
- Listed equity and corporate bonds
- Business loans and unlisted equity
- Motor vehicle loans
Leading financial organizations have taken steps to integrate these measures into their business practices.
Example #1: Executive compensation
UK-based Barclays bank set a goal to be carbon-neutral by 2050. This ambition is now reflected in the pay package of executive directors. The bank’s performance concerning climate goals is directly connected to leaders’ long-term incentive plans. To accommodate the change, other measures, such as risk and strategic non-financial measures, have been adjusted.
Other businesses have tied their performance against operational carbon emissions targets to their executive compensation schemes.
Example #2: Deploying capital judiciously
In 2020, Goldman Sachs set a goal to support sustainable finance, investing and advisory activities with $750 billion by 2030. During the first year of this period, the company exceeded its expected annual investment and contributed more than $150 billion.
Wells Fargo reports a total investment of just under $9 million to help communities cope with and prepare for severe weather or climate-related events.
Example #3: Aligning revenue generation with low-carbon activities
Investment bankers UBS noted strong momentum in their sustainable finance activities throughout 2020. The bank’s core sustainable investments grew by more than 60%. As a result, these investments are now accounting for nearly 20% of all client invested assets.
Example #4: Evaluating the climate change risk of real assets
Climate change risks within the sector extend to physical properties.
HSBC recently identified 97 properties and sites that are critical to uninterrupted business operations. Within less than 30 years, 15 of those sites may be at risk from physical hazards caused by climate change. The bank is now preparing to address those risks, should there be a temperature increase of 3 °C.
Flooding is one of the biggest dangers in relation to climate change. Therefore, it is critical for banks and other lenders to understand their exposure to mortgage loans within 100-year flood zones.
Example #5: Mitigating transition risks
Transitioning to net-zero business practices will not happen overnight. The process carries risks related to credit exposure to carbon-related assets and real-estate collateral. Evaluating these now will help institutions reduce their exposure.
ING is reporting €4 million of outstanding upstream exposure to oil and gas production. Spanish banking giant BBVA is monitoring transition-sensitive and carbon-related wholesale exposure to help mitigate risks deriving from this and reduce it further.
The financial sector has a great influence on the development of sustainable products, policies, and practices. Understanding a company’s own impact and taking steps to reduce its carbon footprint by integrating ESG considerations into daily business practices is the first step toward a carbon-neutral future.