Of late there has been a growing interest around ESG.
ESG, as we all now know, covers all environmental, social, and governance issues inherent to a firm’s day-to-day activities. For some, ESG is mistaken as or synonymous with Climate risk which is only one of the elements that ESG tries to address. The reason for these blurred lines is the ever-increasing threats of Climate Risk which is also one of the critical factors bringing ESG to the forefront.
But ESG is much more. Any beyond CSR as well.
CSR which is a more familiar concept and has been prevalent for quite some time now is focused more on external activities and association with the community. ESG goes beyond community and has relatively more interest coming from regulators and investors. In my personal view, ESG is not an add-on activity but a part of the DNA of the institution – its objectives, its activities, the sectors that it funds in case of financial institutions, supply chain, practices with employees such as diversity, inclusion, working conditions, board diversity and independence, corporate behaviour, internal controls, transparency, shareholder rights, etc.
Unlike a thought process where CSR may have been viewed as a portion of revenues that were being allocated, ESG is viewed or needs to be viewed as a tool that can help improve financial performance and something that is essential for long-term viability and success.
ESG is not a tick box.
It’s not a few pages in an annual report to please internal or external stakeholders. I, therefore, see it as being very similar to the culture in an institution. It has to be the backbone of the institution and the philosophy with which every choice or decision is being made. It needs to be part of the mindset and not sit merely in any mission or vision. And this is why I strongly see the similarity of ESG with Culture. And that’s why integrating ESG with the enterprise risk management (ERM) or organization’s ecosystem becomes paramount and ever so critical in the case of Banks as a custodian of public funds has several different stakeholders.
For a Bank or financial institution, ignoring ESG today can attract higher costs, result in non-compliance with the regulators, limit the accessibility of funds from investors, and negatively impact its reputation or brand which can have an exponential impact or at times cause irreparable damage.
So ESG is highly critical for sustainability.
Various external stakeholders are nowadays evaluating financial institutions on several aspects associated with ESG and making their decision accordingly. Hence the need for integrating ESG into the Bank’s ERM framework. ESG is a business risk in itself. While Banks traditionally manage most of the risks associated with ESG, it’s become pertinent to have a formal ESG program. It has to be integrated into its thought process – right from the strategy, business objectives, and risk appetite. The more aligned the ERM framework is to ESG, the more it can use ESG principles to add value. ESG compliance should not be viewed as a challenge but as an opportunity to make the business more sustainable while addressing the growing demands of various stakeholders.
Getting this into action is the critical part.
Such integration into the Bank’s risk appetite starts from the Board and the Senior management. There needs to be collective responsibility at the top. To ensure the execution, the necessary skills and expertise are essential across business groups. The framework must be also formalized through policies and programs. Additionally, risk management and financial disclosures and reporting need to cover the various aspects of ESG. Banks can also create scorecards to track their ESG score and continuously monitor their progress on each of the sub-components of ESG. This ensures that there are corrective actions taken where needed and the steps are being taken in the right direction.
ESG Scores are being evaluated externally as well
External rating agencies for one have started incorporating ESG as one of the factors while scoring or evaluating corporates and financial institutions and in fact, have started issuance of ESG Ratings as well. Sophisticated investors have also started assessing ESG as part of their decision. ESG-specific indices are also monitoring the performance of entities in this regard.
So, few basic steps to get this integration right
- Banks must align their business strategy with ESG. This will help discover what could be the critical ESG risks for the Bank.
- These ESG risks must be dovetailed into the Risk Appetite Statement.
- All of this must be supported by Board and management oversight as well as the requisite policies and processes.
- Followed by a continuous monitoring mechanism to keep track of the compliance as well as to suggest corrective action where any of the ESG principles might be getting compromised.
ESG thus needs to be an Eternal Sustainable Goal of any financial institution or firm.
Blog Author: Tarun Sethi, Head Risk – Wholesale, Yes Bank Limited
“The views expressed in this article are personal and not representative of the Bank’s views”