THE CASE FOR ESCG IN BANKING (Term Paper Sample)

Business Case for Sustainability The Strategic Issue We are at a point where the financial sector can no longer ignore issues surrounding sustainability, climate change, and environmental, social, and governance (ESG). The conservative model of banking considered sustainability as an ethical and social responsibility activity. However, we are at a point where these issues are no longer an ethical concern but an economic and existential concern. Financial institutions must identify and evaluate the sustainability and ESG-related risks and opportunities and holistically embed them into their risk management framework.[Spielberg, H., Monteforte, M. & Quick, M. ESG Risks in Banks: Effective Strategies to Use Opportunities and Mitigate Risks. KPMG. https://home.kpmg/xx/en/home/insights/2021/05/esg-risks-in-banks.html] Financial institutions are under increasing regulatory and social pressure to embrace ESG and climate change in their business models. A key driver of the regulatory pressure is enacting the 2015 Paris Agreement, passed by 196 countries globally. The Paris Agreement aims to lower global carbon emissions and limit the rise in global atmospheric pressure to 1.5oC. The European Union has committed to transitioning to a carbon-neutral economy by 2050. Achieving this goal demands massive investments, to the tune of €350 billion annually in new projects.[Financial Conduct Authority. (2021, November). A Strategy for Positive Change: Our ESG Priorities. Corporate Documents. https://www.fca.org.uk/publications/corporate-documents/strategy-positive-change-our-esg-priorities] [Bischof, R., Bourdier, N, Gassmann, P, Wackerbeck, P., & Marek, S. European Bank Transformation: Why Banks can no longer ignore ESG. StrategyandPWC. https://www.strategyand.pwc.com/de/en/industries/financial-services/transforming-eu-banks/esg.html] Sustainability Regulations/Mandates in The U.K. and USA In the U.K, the Financial Conduct Authority (FCA) set out its ESG strategy. It acknowledges that the financial sector has a key role in achieving a sustainable long-term future. The U.K government published its Green Finance Strategy in 2019. Its first objective is “Greening finance by supporting the financial services sector to align with the U.K.’s net-zero commitment, the need to adapt to climate change, and the U.K.’s commitment to nature’s recovery.” The aim is to ensure that finance incorporates financial risks and opportunities presented by climate change and other environmental challenges. The FCA has initially identified dive themes to guide ESG reporting: (1) transparency on climate change and sustainability along the value chain, (2) building trust in ESG products, products, and the ecosystem, and (3) tools such as collaborations with others, (4), transition to support the role of finance to deliver the transition to a sustainable economy, and (5) to develop a structure to integrate ESG into the FCA activities.[Green Finance Strategy: Transforming Finance for a Greener Future. (2019, July). HM Government] The FCA also recommended that financial services providers make climate-related disclosures using the TaskForce on Climate Related-Disclosures (TFCD). The TFCD requires an entity to disclose climate-related risks, their impact on the company's financial performance, and any climate-related opportunities that may appear to the organization. The TFCD recommendations are now mandatory for the top-tier listed banks in the U.K, which has helped improve disclosure. Banks should adopt the TFCD recommendations on an explain or comply basis and indicate that they have complied with the TFCD recommendations on their annual reports.[Sidley. (2022, January). New UK FCA Rules on Climate-Related Disclosures — Ten Key Points for Asset Managers. https://www.sidley.com/en/insights/newsupdates/2022/01/new-uk-fca-rules-on-climaterelated-disclosures-ten-key-points-for-asset-managers] [Recommendations of the Task Force on Climate-Related Financial Disclosures. (217, June). Final Report. Task Force on Climate-Related Financial Disclosures] In the United States (U.S), the ESG policies are still in their infancy, with the U.S Federal Reserve bank indicating its interest in climate change risk. Currently, there are no regulations or mandates applicable to the banking sector. The rulemaking in the U.S regarding ESG climate-related disclosures is slow, and the financial service providers make voluntary disclosures. Due to the lack of a standardized framework to guide ESG and climate-related disclosures, several U.S banks and insurance companies have faced allegations of greenwashing. In March 2022, the SEC also proposed rule changes requiring registrants to include certain climate-related disclosures in their registration statements and periodic report, including information about climate-related risks reasonably likely to have a material impact on business and financial condition. It also proposes the companies disclose certain climate financial statemen metrics in a note to the audited financial statements.[Engler, H. (2021). US financial firms should prepare for ESG regulations, with sustainability a key focus. Thomas Reuters Regulatory Intelligence. https://www.thomsonreuters.com/en-us/posts/news-and-media/esg-regulations-financial-firms/] [The Securities Exchange Commission. (2022, March). SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors. https://www.sec.gov/news/press-release/2022-46] The SEC acknowledges that investors demand transparent information about an entity’s ESG performance, and some firms exaggerate their ESG credentials in investment products to attract investors. The SEC has recently introduced two measures to crack down on exaggerated ESG claims in response to this. The SEC proposes to require an entity using terms such as ESG, sustainable, and low-carbon to disclose the marketing of the ESG funds, how it incorporates the ESG into investing, and the voting of these funds in the annual general meeting.[Temple-West, P. & Palma, S. (2022, May). SEC prepares to crack down on misleading ESG investment claims. Financial Times. https://www.ft.com/content/6fefdb2c-f72e-4e52-b95b-c0727aeb1a94] Insurance companies are also demonstrating a deep interest in ESG factors, and they take these factors into account when deciding whether to cover a client. ESG and climate-related risks include physical risks, and insurers face numerous risks, such as increased natural catastrophes linked to climate change. In response, the U.K Prudential Regulation Authority (UK PRA) is requiring insurers to pressure test their U.K-based portfolios under different global-warming scenarios. The UK PRA expects that insurers and reinsurers understand the financial risks from climate change and how it affects their business model. Specifically, insurers must develop scenario analysis and stress testing and use all availae data to correctly identify short and long-term financial risks to business models from climate change. Also, insurers must define a credible plan or policies to mitigate and manage exposure to the financial risks from climate change.[Debevoise & Plimpton. (2021, January). ESG in the Insurance Sector: Growth,Opportunities and Risks. Debevoise in Depth] The Demand for ESG Investments The demand for ESG investments has risen rapidly, and they have become prominent with the onset of the COVID 19 crisis. The COVID 19 crisis revealed the need for businesses and governments to focus on ESG issues to strengthen the resilience of companies and societies, which accelerated interest in ESG-focused investments. Estimates indicated that in 2025, global ESG assets will exceed $53 billion by 2025, representing a third of total assets under management and demonstrating that ESG investments are no longer a niche for financial institutions. Research suggests that demand for ESG products by investors is motivated by three factors: (1) the institutional investors believe that ESG factors have a material effect on investment risks and returns, (2) some investors seek to combine non-financial objectives such as environmental concerns without hurting financial goals, and (3), some investors are open to sacrificing financial returns to support social or environmental objectives.[Wu, J. & Juvyns, V. (2020, May). COVID-19 Shows ESG Matters more than Ever. On the Minds of Investors. J.P. Morgan Asset Management. COVID-19 shows ESG matters more than ever | J.P. Morgan Asset Management (jpmorgan.com)] [Bloomberg Professional Services. (2021, February). ESG assets may hit $53 trillion by 2025, a third of global AUM. Bloomberg Intelligence. ESG assets may hit $53 trillion by 2025, a third of global AUM | Bloomberg Professional Services] Sustainability Reporting Disclosures Furthermore, the accounting standard setters acknowledge that organizations need to disclose the material impacts of climate-related risks on their financial performance. The International Accounting Standards Board (IASB) formed the International Sustainability Standards Board (ISSB). The role of the ISSB is to develop a global framework to guide sustainability-related reporting by firms. Europe is at the forefront of publishing standards to guide disclosures on ESG risks. The European Banking Authority has published its final draft on Pillar 3 disclosures on ESG risks. The aim is to set guidelines on banks’ disclosures of transition and physical risks and quantitative disclosures on the institution's action to mitigate and support their counterparties in the transition to a carbon-neutral economy and adapting to climate change. This demonstrates that investors and capital markets demand transparent, reliable, and comparable reporting on the firm’s sustainability and ESG-related activities.[IFRS Foundation Trustees Feedback Statement. (2021, April). Consultation Paper on Sustainability Reporting. https://www.ifrs....