Increasingly, environmental, social, and governance (ESG) initiatives have become a strategic priority for financial institutions. The recent UK Finance COO Forum explored how these initiatives are developing across the financial services sector. Among the insights gleaned from the forum is that most institutions are taking a measured approach to ESG strategy as they acquaint themselves with ESG risks and assume responsibility for setting ESG standards.
While the concept of ESG was established in 1960s as a model for socially responsible investing, ESG as a broader corporate strategy did not gain prominence until the 2000s. The terms ‘sustainability’ and ‘green’ are commonly used today in the corporate context, with good intentions. However, organisations across many industries have been criticised for ‘greenwashing’, or over-hyping their environmental credentials.
Recently, environmental activism has reached a flashpoint because of climate change, and the Covid-19 pandemic has amplified social inequality. The public is now demanding that governments and organisations address these issues. Consumers are directing their dollars to brands that ‘care’, job seekers are gravitating to socially conscious prospective employers, and retail investors are aligning themselves with fund managers who have ESG mandates. Meanwhile, financial institutions are making net zero commitments publicly and improving the diversity of senior management.
ESG strategies in development
According to some of the attendees at the forum, most institutions are still in the process of developing full-scale ESG strategies and have made the most headway on the environmental component. Regulators and financial institutions share concern about greenwashing, as corporate reputations could suffer if their actions don’t match their rhetoric.
Many institutions are assembling CEO- or CRO-led working groups to develop ESG proposals.
The forum focused largely on the risks of implementing ESG strategies in the absence of prescriptive regulation. While COOs at the event agreed that ESG strategies should be prioritized, they acknowledged that current regulatory expectations are vague and that they choose to tread carefully until guidance is clearer. In March 2021, the FCA outlined its ESG strategy, and in October 2021, the Financial Conduct Authority (FCA), the Prudential Regulation Authority (PRA), and The Pensions Regulator published progress reports on their efforts to manage climate risk in the financial services industry alongside updated guidance.
Many COOs are determined not only to meet the ESG expectations of regulators and the public, but also to set their own ESG agendas. In addition to advancing mainstream directives such as carbon emissions reduction and diversity, equity, and inclusion, they are motivated to underwrite specialized ESG programs that create impact beyond the industry and develop their brand.
For example, a mortgage lender may provide green mortgages (i.e. financing with preferential terms for properties that meet certain environmental standards) as a regulatory compliance measure, and also provide energy efficiency education to homeowners to raise environmental awareness on a large scale and position itself as a sustainability thought leader.
- Regulators expect financial services organizations to be ESG exemplars.
- Financial institutions understand and manage environmental risk better than social and governance risk. Many institutions do not integrate ESG risk management with broader risk management, making it difficult for them to assign accountability and model behavior for other industries.
- Financial institutions must be diligent about describing products accurately in marketing collateral and other disclosures, as regulators will closely scrutinize public information for greenwashing. Additionally, organizations should begin evaluating environmental financial crimes safeguards and compliance in light of the Financial Action Task Force’s (FATF) paper Money Laundering from Environmental Crime, published in June 2021.
- Financial institutions have been analysing their diversity and inclusion policies since the FCA published its consultation paper Diversity and inclusion on company boards and executive committees in July 2021. The regulator said it will evaluate governance of its own diversity and inclusion practices. Protiviti has learned that the industry submitted positive comments on the paper.
- Regulators have signaled that boards are accountable for establishing ESG frameworks. However, the FCA has raised concerns about organisations ‘competence washing’, or overstating their ability to understand and implement ESG practices. The FCA is expecting boards to sponsor ESG training across the organisation and to develop knowledge sufficient to challenge and enable proper oversight of ESG matters.
- Internal audit teams will need familiarity with ESG risks to adequately appraise the quality of controls. Additionally, they will play a key role in assuring the stakeholders of an organization that its ESG reporting is reliable.
- Regulatory guidance suggests that internal auditors can leverage existing compliance assessment methodologies to measure ESG compliance. In March 2021, the Institute of Internal Auditors noted, “While most regulations on ESG reporting are relatively new, the processes for evaluating the effectiveness and efficiency of any regulatory compliance regime are well-established.”
The UK Finance COO forum was held online in association with Protiviti on 3 February 2022. For more information on the event and UK Finance, please contact head of member communities Zoe Bailey at [email protected].