These are the areas to look out for in the financial services value chain to keep a check on the sustainability parameters:
- Know Your Customer (KYC) & Due Diligence: FIs should set up policies that address the requirements for assessing the potential E&S risks associated with their business. For example: Is the customer’s business directly related to renewable energy such as solar panel manufacturing or a coal electricity generation plant? Also, capture the details of the business partners/or undertaking to avoid any business relationship with firms that are not ESG compliant. Flag the customer accordingly and use this opportunity to offer targeting offerings and products. Reward them for being socially responsible and making a positive impact. Also, periodic due diligence is important to ensure there is no change in the status quo and ESG inputs provided during onboarding.
- Payments: Payments provide a very important source of information regarding the commitment of an organization towards the ESG standards. For example, payments to firms that are causing environmental concerns can be flagged and alternatives provided for transitioning to more ESG-compliant resources/firms. Having in place a rewards structure to encourage clients to adopt sustainable resources would also be very beneficial.
- Risk assessment: Adequately factor in climate-related risks for present valuations. Long-term investors need adequate information on how organizations are preparing for a lower-carbon economy. With this, creditors and investors are increasingly demanding access to risk information that is consistent, comparable, reliable and clear.
- Building, monitoring and increasing the use of green resources: To set a good precedent, sustainability is best showcased when it starts at home. FIs should leverage solutions to control and monitor the humidity and CO2 concentrations, brightness in rooms, appropriate temperature maintenance, proper waste management infrastructure, rainwater harvesting and water recycling, sensors to control the doors and windows, solar energy usage. All these initiatives will ensure you’re a step closer towards being a sustainable financial institution.
- Products on offer: New product policies are needed to assess the E&S risk exposure and its management. FIs should start creating financial products that fulfil the criteria for a sustainable future. It could be in the form of green bonds, social bonds, Green Trade Finance.
For example: Swiss impact asset manager responsAbility, the Swedish International Development Agency SIDA and Danske Bank have joined forces to launch a novel social bond. Through the Social Bond, USD 177.5 million will flow to capital-constrained companies in developing countries. The selected companies' business models are characterized by their products and services achieving a measurable positive social impact. Another example of product innovation is the Green Guarantee Facility by Société Générale. In 2021, SocGen provided this facility to Elecnor, allowing the Spanish energy infrastructure group to use it for eligible green projects that benefit the environment and are socially responsible.
- News on open channels: FIs should spread awareness in the open channels for the measures they are taking towards ESG as a responsible institution. It would bring in a new dimension of competitiveness. For example, to support a sustainable economy, Dutch ING group decided to end financing new coal-fired power plants and coal mines and to continue to reduce its coal portfolio. At the same time, it has invested billions of Euros in projects that create a green future, such as wind farms, solar energy, and geothermal power production. Powerful messages on such initiatives can have a ripple effect on other FIs and industries.
- Supply Chain Finance (SCF) and Trade Finance (TF): SCF and TF have a complex value chain because of the sheer involvement of multiple parties. Therefore it becomes very important that banks have clear visibility of the parties involved in the entire value chain in terms of the nature of business to get enough insights about the ESG responsibility they are adhering to.
- Providing insights to customers about their carbon footprint: Although today’s conscious consumers are driven by environmental concerns when making purchases, they often struggle to understand their carbon footprint. After all, consumers can have only so much visibility over the impact of their purchases. However, FIs can give customers more insights into how their spending habits are affecting the environment (Source). For example, Swedish company Doconomy has rolled out a free and easy-to-use mobile banking service that lets users track, understand and reduce their CO2 footprints through carbon offsetting. The firm’s aim is to inspire a change in behavior and a reduction in unsustainable consumption and carbon emissions. Doconomy has also worked with Gemalto to provide customers with an eco-friendly debit card made from a sustainable plastic substitute, connected to a mobile app that allows users to measure their carbon footprint from every purchase.
- Corporate governance: Corporate governance to include ESG-related risks and risk management practices will help increase transparency within organizations.
- Leveraging the opportunities that digital technologies offer for sustainable finance: Digital technologies can provide essential solutions for citizens, investors and small and medium-sized enterprises (SMEs) to transition to sustainability. One such step is by the European Commission, which recognizes digital power and will enable and encourage innovative solutions to help SMEs use digital sustainable finance tools and to support retail investor understanding of the sustainability impact of financial products. The EU Taxonomy Climate Delegated Act already establishes the technical screening criteria for data centers and digital solutions that substantially contribute to the EU Taxonomy objectives and should be expanded to include more activities for developing sustainable digital solutions and using sustainable crypto-assets (Source).
- Increasing insurance coverage: The financial system can better protect the economy and society against certain climate-related and natural disaster risks. The Commission will initiate a Climate Resilience Dialog between insurers, re-insurers, public authorities and other stakeholders to exchange best practices and identify ways to address the climate protection gap, either through recommendations or through voluntary commitments.
- Improving transparency of credit ratings and rating outlooks: This can be achieved by including the relevant ESG factors in credit ratings and credit outlooks, while ensuring methodological transparency.
- Integrate ESG issues into underwriting, risk management and monitoring and capital adequacy decision-making processes, including research, models, analytics, tools and metrics.
Thus it becomes clear: It will be difficult for FIs to maintain a sustainable outlook without a real policy and governance in place. Sustainability cannot be relegated to being a mandatory chapter in the annual CSR report, where there is intent, but no clear action. It has embedded its root at the highest levels and gained a much broader purpose, of which The Paris Climate Agreement is an example.
This agreement, in particular, includes the commitment to align financial flows with a pathway towards low-carbon and climate-resilient development. Another way to consider this is by looking at two contrasting assessments done by the United Nations Environment Program Finance Initiative (UNEPFI):
- First, the negative impact: Conservative estimates see unabated climate change leading to global costs equivalent to losing between 5% and 20% of global gross domestic product (GDP) each year, now and forever (Source).
- Second, the opportunities it unfolds for us: The transition to low-carbon and climate-resilient economies requires additional investment at the order of magnitude of at least USD 60 trillion, from now until 2050; and that investment will require financing which, in part, will have to be provided by financial institutions: USD 35 trillion to decarbonize, through renewable energy and energy efficiency, the world’s energy system; another USD 15 trillion to adapt manmade infrastructure to changing meteorological conditions; and another 2 USD trillion to reorganize global land use in ways that meet growing demands for agricultural commodities while stopping tropical deforestation (Source).
FIs implement their sustainable goals and responsibilities both in their internal operations (in terms of how they manage their physical locations, human capital, costs, opportunities, risks exposures) and their activities relating to external interactions with their clients and the types of services they support and the funding/credit they provide.