Sustainable Finance: Choose an Integrated Approach
It goes without saying that companies must increasingly focus on environmental, social and governance (ESG) issues, with more attention to people and planet than in the past and without the once-common obsession with profit and economic and quantitative variables. The same applies to banks and other financial institutions. In this respect, they are no exception. One difference between financial institutions and the rest of the business world, however, is that public opinion expects them to be the very catalyst of the sustainable transition. Partly due to this, they have to deal with a much greater avalanche of legislation and regulations, which are also only partially crystallized. It is no coincidence that the debate around ESG is called a regulatory hype curve. Today's policies can be introduced as legislation tomorrow. Measurement issues also arise. ESG is very broad and goes beyond the impact of your own organization because of regulations that require companies to look at the entire ecosystem. Then it turns out that data are limited, and standards are lacking.
Three motives
The ever more stringent - often stated in general terms and interpreted differently per country and sector - ESG laws and regulations put enormous pressure on financial institutions. It is understandable that these institutions devote many people and resources only to be and to remain compliant. But this is not the only motive; there certainly are two more.
Firstly, financial institutions take ESG measures to manage a variety of other risks, in addition to the risks posed by violation of laws and regulations. Consider the credit risks banks face on their outstanding loans. There is an increasing risk that customers who do not join the sustainability transition will run into trouble and be unable to meet their debts. Or what about the risk of reputational damage? Financial institutions that do something that does not please NGOs, consumers and other stakeholders risk losing their license to operate. Here too, financial institutions differ from many other companies. They traditionally always had a social role and are visible in the public debate - they have to meet high expectations.
The upside of 'should'
Secondly, ESG measures can of course also have an upside. Forerunners in ESG quickly gain reputational advantages, for example in the labor market: they succeed best in attracting and retaining good and loyal staff and emerge as winners in the war for talent. They can also benefit commercially from ESG measures. A bank that advises companies on how to become more sustainable, how to price the climate risks they face and is willing to finance plans to go green adds value. An added value that few other parties can provide - so in that respect, too, the financial sector occupies an exceptional position.
Fragmentation is wasteful
To some extent, financial institutions are guided by all three motives in their ESG policy. Because they have to (laws and regulations), because they want to limit the disadvantages (risk management) and because they want to benefit (reputational gain and commercial advantages). Yet the emphasis is quite often on compliance issues, and measures just to comply with all the laws and regulations on ESG get the upper hand. Given the urgency, it is no wonder they are regulatory driven. In addition, many financial institutions use sustainability in their marketing statements too loosely, without embedding it in strategy and strategy execution. This kind of 'empty' marketing eventually results in the opposite effect on reputation, when society eventually notices the discrepancy between marketing statements and the actual operations.
The call for ethics and ‘accountability’ is greater than ever. Only, risk management and commercial policy risk being developed separately because compliance absorbs so much energy. Too often there is no integrated policy. People in departments may work hard, but cooperation is limited. Much time and effort is wasted because of this fragmented approach. Energy is wasted. We should be able to do better.
Integral sustainable finance
Ideally, financial institutions take an integral approach to becoming sustainable. They have a holistic view of how they want to incorporate their sustainable finance activities into their organization. Their strategy as well as the activities derived from it are based on this ; when they take ESG measures, the impact on the entire value chain is taken into account. Sustainable finance would then have a far-reaching impact on the business - and operating model, on risk management, on commercial strategy, on operations and on overall business operations. It can then even provide a competitive advantage.
Such an integrated approach starts with formulating a strategy and a clear positioning on sustainability. As mentioned, ESG is broad, so focus on a set of clearly stated goals. Many companies choose to focus on countering CO2 emissions. This is not necessarily what is needed. ESG is much broader than just countering climate risks, although that is the most pressing issue and best quantified (with carbon accounting). Alternative positioning can actually make it more recognizable. A next step is then an integrated approach across all divisions and the overall value chain.
An example. A bank bases its strategy on some of the SDGs, including affordable renewable energy (SDG 7). In doing so, a bank that provides a "green" loan must inform itself on the relevant risks involved and has to report on it according to certain rules. This can only be done on the basis of diverse, often non-financial, information about the client, in this case about its dependence on fossil fuels. It would be beneficial if the bank already at the customer’s onboarding, take this into account - and request data necessary for proper risk management and reporting. This then should subsequently be monitored. And all of the above should be done as efficiently as possible.
Success Factors
This integrated approach to sustainable finance is only possible if a few conditions are met. An important success factor is the availability of the right data. Moreover, the organization must mobilize the data quickly and be able to move toward insights and targeted actions.
As mentioned, financial institutions often need to collect new data in order to implement ESG measures. That is often difficult enough, and in addition that data is often collected and processed separately by different departments, whereas here too, an integrated approach delivers optimally. It provides one version of the truth; you avoid ending up with incomplete, inconsistent, corrupt or duplicated data. Speed also benefits. This integrated approach became easier thanks to the digital transformation already underway and the rise of the cloud and cloud technologies.
But for an integral sustainable finance approach to succeed, culture, leadership and the right attitude of top management are essential. That management must, in defining and monitoring the strategy, categorically support making the company sustainable. This strategy can then be implemented in a coordinated way at all levels of the organization. The various departments should be given the leading role - they, after all, have the greatest expertise in their field. However, this must be done according to a coordinated execution plan, carried out under the guidance of top management. They are, ultimately, principally responsible for the commercial propositions, operating model and risk management of their company and for the cooperation and knowledge exchange between the different departments. Only top management can ensure the correct culture, strongly focused on organizational learning and a willingness to embark on the journey of sustainable transformation.
Essay by Jeroen Bos, Partner Financial Services at Valcon, and Ivar Kunst-Palmieri, Senior Manager Financial Services at Valcon. Published in Management Scope 01 2023.