Highlight & stories

02 February 2023, by Emmanuel Rondeau

There has been a global acceleration in the demand for sustainable finance. COP 26 in Glasgow and COP 27 in Sharm El-Sheikh have received universal coverage. But the pressure is not just from NGOs and the media. Governments and Central Banks are trying to meet net zero pledges and Nationally Determined Contributions on greenhouse gases. Regulators are also putting pressure on financial institutions to better identify their ESG risks and to embed those factors into their risk framework.

A two-pronged threat: the rise of double-materiality

Based on the concept of double materiality, the financial firms must now account both for their own impact on sustainability and their contribution to the Sustainable Development Goals – including climate change – as well as for the impact of ESG risk on their lending or investment portfolios. This is not just about risk management. It is also about competitive positioning in a trillion-dollar market.

But the more they progress into this new world of sustainable finance, the more challenges banks, insurance companies, asset managers and asset owners face.

A web of complexity

The first challenge is that they need data that measures and tracks their non-financial performance. They have to populate their models with new types of technical data, e.g. data on climate risk, such as physical risks or Scope 3 emissions. The difficulty is not just in selecting third party data providers and adjusting models, but also in the complexity of securing the proper assurance framework in line with The Basel Committee on Banking Supervision (BCBS) 239 principles.

Second, firms have to review and implement revised policies to integrate ESG factors into everything they do. This will not be an overnight shift. Where to start? And how to ensure consistency across policies and controls in the transition phase?

Third, firms will want to act quickly on new products to contribute to the transition and to benefit from the business opportunities. But recent greenwashing scandals are increasing legal and reputational risks. Fines have been imposed on the likes of BNY Mellon and Goldman Sachs. The broader story with DWS in Germany, which is under investigation by the German authorities and has been sued by a consumer group for greenwashing, could lead to new legal precedents. At a time when standards are still in flux, with the first International Sustainability Standards Board (ISSB) principles to be released this year, finding the appropriate framework to ensure that ‘green’ products are really ‘green’ is a work in progress. As an illustration, the European green taxonomy, one of the most advanced in the world, has already published more than two thousand pages on only one of the six environmental objectives!

The avalanche of recommendations and lack of settled standards leads to communication and reporting issues. Even if some frameworks are already in place, such as the Basel Pillar 3 disclosure requirements for banking, or the TCFD recommendations for reporting climate risk, they are still in their early days. Hundreds of pages are now published on sustainability and ESG every year, but they are hard to compare, still lack proper assurance process and have limited audit review.

These are only some of the complexities that the whole industry is facing when trying to address the sustainability challenge and to cope with new ESG and climate regulations.

There is plenty of pressure on firms to find their way to contribute to the sustainability agenda – but there are no easy answers when it comes to how to do that.