Managing ESG Risks

With more and more regulatory pressure driving banks to manage climate risk, a green agenda is becoming a commercial imperative. But what are these specialized skills that are needed to successfully implement a climate-driven initiative? There is a lot of confusion when it comes to risks analysis and banking. ESG issues, or environmental, social and governance, refer to three central factors when it comes to measuring the sustainability and social impact of an investment into a company or business. They are non-financial metrics that are used within an analytical process to identify the materials risks and growth opportunities. 

Environmental considers how a company is being a steward to nature. Social examines how a company manages its relationships with its employees, suppliers, customers and communities in which it operates. Governance is about a company’s leadership, looking to anti-corruption measures, internal controls, and its duty to shareholders and shareholders’ rights. ESG issues have risen within the last few years due to an emphasis by investor concerns as well as pressure on the financial industry. It has accelerated in the regulatory space partly due to the new administration putting climate change as one of its priorities. 

So what does these emerging risks mean for banks? ESG risk affects the entire financial industry. It will require banks to manage new forms of risk while adhering to emerging regulatory disclosure requirements regarding their businesses. This will require enhanced internal oversight and governance in response to a rapidly evolving regulatory environment. Specifically for banks, it will require a focus on managing climate risks. But there are major uncertainties when it comes to what will ultimately be required of community banks when it comes to setting aside capital for identifying, managing and mitigating these risks. 

The U.S. Climate Finance Working Group has been responding to requests for information on how climate change and natural disasters could pose threats to the financial service industry. It is a collaborative effort to create a framework to identify, evaluate and mitigate the risks of climate change on the financial system more broadly. Its principles offer a framework for policymakers to come to a common understanding regarding these emerging risks. But many key questions remain. 

How can financial firms prepare for future ESG regulations? How should ESG efforts and resources align with a bank’s business purpose, strategy and long-term goals? Is there transparency and accountability? Implementation of an ESG Management System may be a solution to these questions. An ESG Management System would need to be practical and easy-to-use, while providing ESG reporting that identifies a baseline of ESG parameters. It would need to allow for continuous monitoring of ESG parameters while interfacing with investment and regulatory processes.  

It is important to remember that ESG is an advanced and elevated push-and-pull—community banks are going to be asked at some point about their ESG performance, especially when it comes to investors, regulators, depositors and customer care. The reputational risks, coupled with enhanced Anti-Money Laundering risks bring about a stewardship requirement currently unparalleled in the financial industry today.