The case for sustainabe finance
An economy that is increasingly structured on the basis of sustainability benchmarks, requires a financial sector in which the same standards form an integral part of strategy and operation. Simply complying with the legal requirements when it comes to sustainable finance is not a tenable strategy for financial institutions in the longer term. Customers, investors, regulators, politicians and society expect and demand more when it comes to sustainability. Banks, insurers, pension funds and asset managers will have to embed ESG aspects in their products, services, processes, systems, strategy and culture. Only in this way can they continue to be assured of a licence to operate, maintain a viable revenue model and contribute to a further restoration of confidence in the financial sector.
Financial sector key to systemic change
The EU Action Plan: Financing Sustainable Growth gives banks, insurers, pension funds and asset managers an essential role in the required reallocation of capital. Although most attention has so far been paid to the climate and energy objectives, the Action Plan explicitly includes much more. Social aspects (working conditions, privacy and data security) and governance aspects (behaviour with regard to competition, taxes and remuneration) of companies must also be taken into account in the investment decisions of financial institutions.
Four levels of leadership in sustainable finance
Financial institutions are increasingly aware of their role in the transition to a climate neutral, green, circular, inclusive and competitive economy. There is a growing awareness that sustainability can also be profitable in a strictly commercial sense. The new measures, their scope, impact and compelling nature, and the speed with which they are being implemented, make sustainability a strategic priority. Financial institutions cannot escape the issue of how to implement sustainable finance. An initial focal point is the way in which they wish and are able to distinguish themselves from their peers. Is compliance with legislation good enough when it comes to sustainability, or is the ultimate goal that investment choices lead to positive changes in society? We distinguish four levels of leadership that financial institutions can adopt compliance, active management, active engagement and frontrunner.
Frontrunners in sustainable finance distinguish themselves in three areas
Sustainable finance offers financial institutions opportunities to distinguish themselves when it comes to products and services, risk management and reporting and disclosures.
- Products and services
In the first instance, compliance relates only to the investment aspect, in order to redirect capital flows towards sustainable investments and therefore sustainable and inclusive growth. Frontrunners not only take ESG criteria into account in their investment decisions, but also apply them to loans and services, for which regulation is expected only in several years' time. - Risk management
The aim of regulation is to make financial risks arising from climate change, resource depletion and environmental and social degradation transparent and manageable. Frontrunners are learning from the coronavirus crisis and have insight into the extent to which their customers, suppliers and the value chains in which they operate are fully ESG-proof. In their risk management, they not only consider the risks, but also the positive impact of the investments and actively monitor and report on them, both internally and externally. - Reporting and disclosures
Regulation aims to promote transparency and long-term thinking in financial and economic activities. An institution that is solely compliant will report to a minimum extent on sustainability, while a frontrunner will also provide insight into its progress in terms of commitments and the impact of its investments.
From compliance to frontrunner
The extent to which financial institutions are able to distinguish between compliance and frontrunner is not an easy matter. Sustainable finance touches on almost all aspects of financial institutions, and the development to frontrunner will therefore involve having to progress through various stages and being embedded in every fibre of the institutions. Being 'simply' compliant already involves a considerable effort. The active management and integration of ESG elements throughout the institution's operations is of an entirely different order for a several reasons:
- ESG is technically very complex, both substantively and from the point of data availability. Whereas these substantive criteria used to belong to the domain of a small group of specialists, they will now have to be given a broad significance within the organisation.
- The legal side of ESG is complex, partly due to a lack of standardisation and the fact that various measures are still subject to consultation. This makes rolling out ESG in the organisation a major challenge..
- On the operational side, none of a financial institution's core processes are likely to have been designed with ESG elements in mind. As a result, data collection and management, metrics, process descriptions, governance, etc. are not yet ESG-proof. A redesign of these core processes is required to get these aspects in order.
Financial institutions that manage to start integrating ESG elements into their core processes soon distinguish themselves from their competitors. Financial institutions that integrate ESG into their entire operations are assured of a licence to operate and the trust of customers, investors and a society that expects more and more in this respect.
Would you like to know more about which approach best suits your organisation? And what the quickest route to achieving the desired sustainable finance ambition is? Get in touch with us. We will be happy to talk to you.
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