Reorienting Organisational Strategies Towards An ESG-Integrated Financial System


It comes with little surprise that demand for ESG-integrated systems is growing. Frameworks such as the EU taxonomy not only help investors, companies, issuers and project promoters steer action towards a low-carbon, resilient and resource-efficient economy. They establish a performance threshold for economic activity that;

  • Contributes to 1 of the 6 environmental objectives, i.e., climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems,

  • Do no significant harm to the other five, and

  • Meet minimum safeguards (such as, OECD Guidelines on Multinational Enterprises, or the UN Guiding Principles on Business and Human Rights)
According to a recent Harvard Law School Forum, the EU taxonomy has had a ripple effect on the US financial sector, given that regardless of the lack of a similar regulatory framework in the US, non-EU funds may face pressure by EU-based or ESG-minded investors to disclose the percentage of investments that are aligned with the EU Taxonomy.

"For any organisation to gain mainstream investor interest, it is critical to reorient organisational strategies towards an ESG-integrated financial system."

Given the immense interconnectedness of global markets, it is only a matter of time when we see Indian investors facing similar pressures from ESG-compliant investors from the across the globe to demonstrate alignment with global ESG frameworks.

This being said, for any organisation to gain mainstream investor interest, it is critical to reorient organizational strategies towards an ESG-integrated financial system. While this does not necessarily need to be embedded in the EU taxonomy, such a system should certainly demonstrate alignment towards global ESG frameworks and ambitions.

This should revolve around 4 key aspects:

  • Commitment,
  • Controls,
  • Transparency and accountability, and
  • Innovation and capacity building


Commitment

In April 2020, German Chancellor, Angela Merkel emphasized that governments should focus on climate protection when considering fiscal stimulus packages to support an economic recovery from the coronavirus pandemic. The magnitude of the challenge of economic recovery offers critical opportunities to implement government stimulus programs that work towards accelerating progress on climate change mitigation.

The scale of this challenge also requires commitment by the private sector to integrating ESG thinking and establishing business targets on sustainable investment into organisations’ business strategies and plans. Despite misconceptions around the misalignment of ESG initiatives and profits, recent evidence has shown that investors that remained committed to ESG investment strategies, overweighed high ESG stocks, or focused on companies showcasing improvement in ESG performance, have outperformed global benchmarks for close to a decade.7

Climate change and ESG-thinking could open unforeseen opportunities to bring in sustained returns, especially with the momentum set in by the Paris Agreement, providing greater incentives to key stakeholders to commit to ESG integration.


Controls

It is important to integrate ESG risk analysis with risk management frameworks and Business Continuity Plans, in order to establish well-rounded and effective control measures. With the eventuality of a rapid tightening of norms towards building an ESG integrated financial system in the EU, it is imperative to fine tune these strategies to demonstrate effective governance and controls.

To do so, instituting adequate policies and procedures to address and manage ESG risks becomes critical. In case of banks, for example, instituting Environmental and Social frameworks to address the ESG impact of project transactions or prioritising climate risks would serve as effective control measures against potential ESG risks in its project portfolio.


Transparency and accountability

Organisations are being directed to focus on clear and candid stakeholder communication and disclosures by both policy and regulation. Measuring, analysing and disclosing the impacts of business activity on the environment and society helps address and manage stakeholder concerns about the business’ environmental and social footprint. Further, disclosures that are candid, comprehensive and practical not only augment broader financial decision making, but also enable organisations to respond to growing investor concerns on the long-term viability of business models. Ultimately, communication on ESG metrics is revelatory of an organisation’s strategies and culture, which can make up fundamental RoI (investment) drivers.

Timely and comprehensive standardisation in ESG disclosures would form the basis of an ESG integrated financial system.


Innovation and capacity development

Innovation is the key differentiator between market creators and market followers. Updated capacities and skills enable disruption and first-mover advantage to all stakeholders in the finance sector such as banks, insurers, asset managers/regulators and corporates who innovate, build capacities to capture emerging ESG opportunities in order to better understand ESG risks.

Some financial institutions are ahead of the curve and are already incorporating ESG performance in new products. Sustainable debt issuance has seen a meteoric rise in 2020, with Sustainability bonds increasing to $68.7 billion (US) in 2020, from $37.9 (US) in 2019.8

An array of green, ESG and sustainability linked financial products and services have surfaced in the recent years. For example, Green Bonds have gained global traction with annual global issuance reaching $305.3 billion (US) in 2020 pushing every global bank in the major league to design green bond products and services. The global Social Bond market has also gained momentum, especially during the pandemic. The shift in demand for social bonds in 2020 shows issuance volumes reaching $147.7 billion (US) , compared with $18 billion (US) in 2019.8

This rise in issuances is demonstrative of the diversity and scale of opportunities available for stakeholders in the finance sector to realise.

Commitment to global ESG initiatives, relevant and adequate controls to identify, assess and manage ESG risks, implementing channels to facilitate candid, comprehensive and practical disclosures, and capitalising on the immense opportunity available to stakeholders in the finance sector, all promote and support the actualisation of a successful ESG-Integrated Financial System.


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