For financial services firms, including ESG goals within a risk management approach is critical to future-proofing the entire organization.
Traditionally, risks managed in financial services have revolved around making and losing money, managing expectations and planning for contingencies. However, more recently risk management in the industry has evolved to include more holistic considerations. Some of the most impactful aspects are founded on the combination of environmental, social and governance issues, commonly known as ESG.
Making the transition to ESG-driven strategies opens new opportunities for organizations to connect with their stakeholders and eventually build new revenue streams.
What does ESG stand for?
The three components of ESG – environmental, social and governance – allow companies and their stakeholders to measure how businesses are impacting both society and the world. The performance of financial services used to be measured only based on monetary returns delivered; this is no longer enough.
This change in how performance and value are evaluated in the financial sector has not happened overnight. What started as investor activism is now so much more. The momentum is closely connected to some of the biggest issues facing global economies, including climate change and persistent inequality. If anything, the challenges associated with the Covid-19 pandemic and the Great Resignation have made it more obvious that businesses don’t operate in a vacuum, they must cater alike to investors, employees, customers and the communities they serve.
To be sustainable in the long term, business performance assessments require more than simply looking at the bottom line. This is true for any industry, and financial services can benefit the most from making changes.
The World Economic Forum (WEF) recommends that any company’s ESG metrics should align with the sustainable development goals set out by the United Nations. Let’s take a closer look at what that means in practical terms for the financial services sector.
At a glance, it may seem like financial services businesses have a small environmental footprint. After all, the industry doesn’t have manufacturing processes that use raw materials and result in waste products.
But there’s more to ESG than an organization’s direct carbon footprint. Powerful servers, computers and other office equipment require electricity. As financial services companies offer more sophisticated, cloud-based products, their carbon footprint may increase due to additional server and energy capacity requirements.
Aside from energy consumption, additional environmental factors that financial service organizations influence include the climate change-causing activities of industry, transportation and agriculture investments. Green loans or green bonds and renewable energy equity financing can drive investment opportunities. Lending decisions can look at the percentage of a mortgage portfolio within flood zones.
Let’s not forget the financial services workforce. Until the beginning of the pandemic, thousands of employees commuted by car to their workplaces daily. These emissions were temporarily reduced by working remotely. But many of those commutes have increased again as staff return to offices. And even if organizations continue to offer hybrid or remote working, empty office spaces are equally wasteful.
Considering the environmental influence of the sector is a complex undertaking.
How does a financial services business affect its community? From leadership, ethics and business strategies, to relationships with partners, vendors and clients, to the firm’s workforce, and extending to the community where the business is based – all are impacted by its actions. A company needs to ensure its people reflect good values, such as ethics and compliance behaviors defined in a Code of Conduct – during and after business hours.
Most recently, the health and well-being of employees in the workplace have been the subject of countless headlines across all industries. Protecting staff and clients from Covid-19 has been a priority for small and large employers. Financial services was no exception.
The social factors of ESG goals also include policies regarding equal pay, diversity and inclusion. Companies that want to be recognized as leaders in their field need to consider reviewing their policies in this regard. Offering development opportunities or upskilling teams is another part of a company’s social impact on its community. Supportive management and positive employee relationships increase retention and productivity.
Ensuring a happy and healthy workforce increases productivity, efficiency and profitability. Stakeholder management is a critical process to ensure your company’s values align with what is important to employees, customers, regulators, and all who may engage with your business directly and indirectly.
Governance relates to how a company is run. This area includes company policies and decision-making processes. Executive compensation levels and the composition of a company’s board are an equal part of assessing governance as demonstrating the transparency and accountability of the business.
In the case of financial services, complying with regulations by relevant federal agencies is one of the most critical aspects of governance. Depending on the type of business, in the U.S. these agencies include the Federal Reserve Board (FRB), the Federal Deposit Insurance Corp. (FDIC), and the Securities and Exchange Commission (SEC). While individual responsibilities vary, the agencies are tasked with protecting consumers, investors, and other stakeholders.
Establishing good governance means creating strong, trustworthy, and responsible financial services companies, and is a strong contributor to ESG goals.
How can businesses build on ESG to thrive?
ESG risks can affect financial services businesses directly, such as a flood or fire that makes offices inaccessible or a long-term power outage in a server room that impacts uptime. But the sector is also at risk from indirect consequences. The Great Resignation has shown that skilled employees have a voice and options. A strong ESG position is one way to build a company culture staff will want to stay with.
Environmental, social and governance challenges also impact a company’s customers. Whether due to market, economic or climate influences, they may no longer be able to afford products and services or they may choose to make investments where perceived dedication to ESG goals is more important. Canceled contracts or diminished investments are only two examples of how financial services companies suffer directly.
Building ESG into company culture and brand and placing these factors at the core of everything the business does helps companies rise above the risks and turn a sincere ESG stance into competitive advantages in:
- Elevated customer trust
- Enhanced employee loyalty and engagement
- Increased brand value and recognition
- Greater agility to deal with unprecedented situations
- Long-term growth through sustainable business practices
Improved levels of customer trust
Financial services organizations are built on establishing and maintaining trust between the business and its customers. Winning trust takes time. It is a process that requires financial services businesses to be transparent in all their communications and customer interactions.
In this context, only considering current customers would be short-sighted. Developing a reputation as a trustworthy financial services provider will be noticed by those not currently using your company’s services. When these prospects are ready to purchase, your business will be front of mind because it is already known as reliable and credible.
High levels of customer trust are also essential when it comes to mitigating problematic situations.
Increased brand value and recognition
Delivering an excellent return on investment for shareholders remains important. However, building a brand that has high credibility in the wider community can increase a company’s value even more.
Becoming known as a fair employer, for example, will help any financial services company build a powerful reputation far beyond its workforce. Creating opportunities within the local community can become a differentiator between financial services companies and support the growth of your brand.
Shareholders have recognized that a company’s value encompasses more than its share price. In fact, companies that are solely focused on their bottom line whilst neglecting employee wellbeing, have seen public opinion turn against them. In some cases, declining public opinion has led to lower share prices, too.
The past two years have made it clear that companies need to be agile to be able to react quickly to economic and environmental challenges. Businesses that were able to pivot and adjust their business model to deal with lockdowns, supply chain issues and other problems managed to weather the storms.
Financial services companies have long been more likely to follow a traditional path. This rigid way of working is no longer the best strategy for growth. Changing business models and approaches now will put your business in a better position to deal with as-yet unknown challenges as the world emerges from pandemic-fueled disruptions.
Adopting ESG principles allows financial services companies to lay the foundations for long-term growth and profitability.
Granted, the priority of many businesses in the sector is to safeguard customers’ investments and deliver returns. But it is no longer acceptable to run a business without considering the effect its day-to-day practices have on future generations.
ESG offers one of the best strategies to attract the next generation of clients. According to Forbes, many millennials are “known to be increasingly interested in placing their bets on companies and investment funds with measurable ESG records.”
How to integrate ESG into your operations
Integrating ESG principles into an organization’s culture is about balancing fiscal interests with the greater good. Those two considerations can go hand in hand. According to corporate analysts, the financial services sector has been comparatively slow in adopting a wider view of success. However, experts also believe that the industry can leverage the lessons learned during the pandemic to safeguard against ESG risks.
Putting ESG factors at the heart of everything your business does is the best way to ensure you reap the benefits and safeguard against the risks. The goal is to make your organization truly customer-centric by ensuring that ESG considerations that are meaningful to shareholders, regulators, employees and your community are part of every major decision.
Financial services companies can start by analyzing customer data to gain insights into customer needs. Based on that, it is easier to create services and products to meet those needs. If your company has been following a traditional path so far, there will be a transition period to introduce ESG best practices.
Solid measurement is critical to a successful transition. Understanding how ESG-focused policies are affecting perceptions of your brand and customer decisions is impossible without data-driven insights.
Your existing workforce is instrumental to the company’s transformation. Clear communication is essential for securing your team’s commitment and support. Targeted sales incentives are one approach to this area. However, as not everyone is motivated by remuneration it is important to consider alternatives to increase motivation and morale.
Changing an organization at its core is a huge undertaking. Introducing ESG principles to the overall business strategy, policies, and processes of your financial services organization is often easier with the help of a partner. For that reason, SAI360 has expanded our risk management portfolio to encompass forward-looking solutions that address the compliance and reporting needs of ESG.
No governance, risk and compliance (GRC) strategy is complete without a solid commitment to ESG. Our innovative toolset is ready to help future-proof your financial services business operations and set you up for long-term growth.