Financial Institutions: Articles

March 2024

ESG explained and its influence on Financial Institutions

Environmental, Social and Governance (ESG) is a framework to set a standard for a company’s business practices on sustainability and ethical issues. ESG has been a discussion point for a very long time but with the accelerating effects of global warming, this has been a priority in the early 2000’s.

Companies are working to identify the ESG parts of their protocols and ensure that necessary steps are taken to manage and mitigate any impacts of a poor ESG performance. An ESG score is an objective evaluation of a company, a fund, or a security’s performance measured against ESG criteria.

Environmental

In recent years, we have a much better understanding on how the world needs to reduce global emissions and this has enabled companies and investors to improve their ESG rating. Carbon dioxide emissions, primarily from the combustion of fossil fuels have risen dramatically since the start of the industrial revolution. The UK is committed to reaching net zero by 2050 and this has led to a push for renewable solutions and investment in clean energy.

How does this impact Financial Institutions?

Traditionally, ESG data wasn’t widely considered in an investment decision, but the framework now provides capability for investments to be screened and evaluated based on more than just their financial performance. This is known as ESG investing and it can help investors avoid companies that are engaged in risky or unethical practices. Investors regularly use this data to decide whether or not to invest in a company and are looking to put more money into companies with stronger ESG performance. Investors are conscious that they have a moral responsibility and will look to avoid companies with a poor ESG performance.

Companies understand that they need to focus on their ESG rating and as a result, greenwashing can be an issue. This is when companies deceptively use green marketing to persuade the public or investors that their company policies are environmentally friendly.

According to the Corporate Governance Institute, an ESG framework provides concrete metrics that help differentiate between business that are genuinely committed to sustainable goals and those that are simply greenwashing. Interestingly, a correlation has been noted between the size of the banking institution and ESG practices, with larger banks also having higher ESG scores. This may be because they have more funds to leverage to create a more sustainable future.

Social

The Social aspect of ESG focuses on inequality, working conditions, human rights, product safety, community relations, supply chain transparency and more.

How does this impact Financial Institutions?

There is a growing recognition that non-financial factors influence financial performance, and more and more investors require that products align with their values.

Companies with strong ethical and governance practices will likely suffer fewer regulatory fines, and the financial services sector is already highly regulated.

Companies who recruit people from a range of ethnic and social backgrounds will score high in this area of ESG. Research has shown that Inclusion and Diversity programmes will make employees feel more appreciated and involved and result in a more loyal, hardworking and dedicated.

In addition, companies are encouraged to spend more time volunteering to give back to the community. Volunteering will also improve a company’s ESG rating and according to ESGmark, corporate volunteering can boost employees’ happiness levels, with some studies showing that 80% of employees felt happier from volunteering activities. It can also help with an employee’s sense of purpose, which makes them four times more engaged at work than those who do not feel purpose through their job.

Not only does it help with existing employee engagement, but also with future recruitment. In the UK, 44% of people prioritised meaningful work over a high salary, so being able to show positive impact through corporate volunteering can help attract talent.

Governance

The Governance aspect of ESG focuses on corporate policies, stakeholder rights and responsibilities as well as how the corporation is managed. Companies are encouraged to establish clear roles for the board of directors and company managers.

How does this impact Financial Institutions?

The Corporate Governance Institute explains that ESG has become progressively more important in the financial services sector because of the connection between ESG factors and financial performance.

S&P Global research on governance factors has shown that companies that rank well below average on good governance characteristics are particularly prone to mismanagement and risk their ability to capitalise on business opportunities over time. S&P Global assesses companies’ governance performance by assessing four factors: structure and oversight, code and values, transparency and reporting, and cyber risk and systems.

Gender diversity and equity is another high-profile governance issue, with many institutional shareholders demanding better representation of women on corporate boards and in executive ranks, and equal compensation and mobility for women and people of colour. More companies are emphasising the financial benefit of creating inclusive workplaces in an effort to increase diversity and inclusivity. S&P Global Market Intelligence research revealed that firms with more women on their boards of directors and in C-suite positions had greater financial performance than less diverse companies.

A successful company will ensure that ESG is a priority throughout the day-to-day operations, as evidence continues to show that it will improve a company’s overall performance.

Sources

https://corporatefinanceinstitute.com/resources/esg/esg-score/

https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp#:~:text=Environmental%2C%20social%2C%20and%20governance%20(ESG)%20investing%20is%20used,products%20that%20employ%20ESG%20principles

https://en.wikipedia.org/wiki/Greenwashing#:~:text=Greenwashing%20(a%20compound%20word%20modeled,and%20policies%20are%20environmentally%20friendly

A guide to ESG in the finance sector

The benefits of corporate volunteering — ESGmark

What is the “G” in ESG? | S&P Global (spglobal.com)