• Reynir Atlason, Director of Sustainability at Creditinfo Group


• 27.11.2023 01:00 pm
#finance #management

From climate change to social inequality and governance failure, Environmental, Social, and Governance (ESG) concerns have never been more important. In recent years, these matters have increasingly influenced how businesses operate, as consumers and investors alike expect a certain level of transparency on a business’ broader societal and environmental impact. 

With the cumulative green bond issuance from 2007 to 2021 surpassing $1.5 trillion, and a massive growth in ESG-labelled funds, investor demand for sustainable options has undoubtedly grown. Although the global bond issuance has slowed down this year, it is still predicted that the global sustainable bond issuance in 2023 will reach between $900 billion and $1 trillion. Therefore, ESG consideration should be front of mind for banks and financial institutions. 

Where have demands for ESG considerations come from?

As the financial risks of climate change have become more evident, demand for more dependable business practices has emerged. The negative impact of climate change such as social unrest and resource scarcity, can negatively impact financial markets. It’s therefore in the best interest of financial services to integrate such impact into risk models along with the required compliance with regulations. 

The finance industry, like many other sectors, is now subject to more stringent regulatory demands regarding sustainability and corporate responsibility. Meeting sustainability demands has now become a regulatory requirement that requires transparency on a new level and has become a key business consideration for the financial sector worldwide.

For example, the European Union has introduced regulations such as the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation, which require banks to disclose ESG-related information and align their investments with environmental objectives. Regular ESG data reporting has, therefore, become standard practice to measure ESG impact quantifiably. The SFDR data produced by financial institutions will furthermore better allow researchers to study the actual impact of the ESG considerations. Better, more transparent and standardized ESG data is a welcoming addition to the research environment.

Why are ESG considerations important? 

While financial institutions must be more transparent on ESG matters due to regulatory demand, it is important to highlight the other benefits of incorporating ESG initiatives. 

1. Financial benefits

While ESG data collection and reporting is the first step of a company’s ESG journey, it does not necessarily lead to financial improvement alone. However, studies show that strong ESG performance positively correlates with higher equity returns. 

Millennial investors are on the rise and a recent Morgan Stanley study suggests that 88% of millennials are interested in investing in funds that address climate change. Banks and financial institutions that integrate ESG principles into their strategies, therefore, will attract a wider range of investors prioritising sustainability and social responsibility. Green bond issuance helps banks access these responsible investors, and with the continued growth of green bond issuance this year, it is a responsible and profitable route to take. 

2. Risk management

With the physical risks posed by climate change-related natural disasters and social and governance risks that stem from issues such as human rights abuses, financial institutions can better prepare and protect their financial performance by integrating considerations from the start.

Regulatory frameworks have already begun to notice this. The European Banking Authority, for example, now requires banks to disclose data points regarding ESG risks in their risk reports. This type of regulation is likely to become more common, and preparing for this is critical. 

3. Driving innovation for sustainability

ESG prioritisation will also help drive innovation and the development of new services and products that can address environmental and social challenges. For example, issuing green bonds can help finance renewable energy projects or other environmentally beneficial initiatives. Or, by focusing on the ‘S’ of ESG, banks and financial institutions can focus on driving financial inclusion among underserved communities and promoting social equality and mobility. 

By considering ESG matters, banks and financial institutions can support the transition to a low-carbon economy and promote social inclusion, helping to establish a more sustainable and equitable future. 

How can data and technology create a more sustainable industry?

One of the primary problems when it comes to promoting sustainability practices is ‘greenwashing,’ which refers to organisations providing misleading information or giving the impression that they are addressing or doing more for ESG concerns than they actually are. Some companies issue broad statements on sustainability as a way to distract from the fact that their organisation lacks sufficient evidence to support their claims. 

Emerging technologies along with a growing population of professionals with interdisciplinary backgrounds, which involve finance and natural sciences, solves many of these concerns, allowing banks to measure and track their ESG performance quickly and accurately. ESG performance can be proven through various data sources, ranging from the more obvious annual reports to alternative sources, including legal records and sources from the media. Technology is the key to automating these processes with data coming from vast and disparate sources.

Looking forward

The growing awareness of ESG issues has transformed how investors and businesses approach decision-making, demanding a more sustainable and responsible approach to finance. ESG factors are not mere buzzwords or fleeting trends; they represent fundamental business drivers. By integrating ESG principles into their investment strategies, financial institutions can mitigate risk, identify new opportunities, and enhance their reputation, ultimately leading to more robust financial performance.

The finance industry has a unique opportunity to play a pivotal role in addressing our planet's sustainability challenges. By embracing ESG principles, financial institutions can steer capital towards sustainable endeavours, foster innovation, and promote a more responsible and ethical business landscape.