Sustainable finance: a force for a better world
With the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow starting next week, climate change is in the forefront, and a coherent strategy on sustainability is fast becoming a necessity, rather than a choice, for financial service providers.
Insurers, banks and asset managers have an opportunity to position themselves on the right side of a powerful shift in stakeholder expectations.
Regulators, investors and consumers have a growing appetite for information on the environmental, social and corporate governance (ESG) impact of companies and investment products.
ESG issues cover a broad range from climate change, responsible governance and business practices to fair treatment of workers and gender equality in the workplace. CEOs are increasingly integrating ESG considerations into everything they do, at strategic and operational levels.
KPMG’s Survey of Sustainability Reporting 2020 found that 80 per cent of the large and mid-cap respondent companies in 52 countries report on sustainability — up from 12 per cent in the inaugural survey in 1993.
The financial services industry is a significant driver of sustainability in other industries, through the influence that comes from insuring, financing and investing decisions.
The impetus comes from the top. For example, the Financial Stability Board, an international body that promotes global financial stability through strong policymaking, views climate change as a threat to financial stability and has put forward proposals to address these concerns to national regulators.
Regulators have also put transparency requirements on banks and insurers, who in turn require transparency from corporations. The result is the growth of a global ESG ecosystem founded on common principles.
Significant potential benefits of the incorporation of ESG into corporate and investment strategies are becoming clear, as are the risks of failure to respond to the growing demand for sustainability disclosures.
Reputation: growing availability of ESG data will give stakeholders insight into whether a company is a pacesetter or a laggard in terms of being a good corporate citizen
Regulation: financial regulators around the world are paying increasing attention to ESG and the European Union plans to require disclosures by 2023
Talent: multiple surveys show that many prospective employees, particularly purpose-driven millennials, seek strong sustainability values in an employer
Business: strong commitment to ESG can attract potential consumers and investors, in turn bringing increased supply and economies of scale, reducing the cost of financing and financial services.
In order to be ESG-transparent, companies need to recognise and disclose their impact. Many will seek independent advice on understanding the implications of ESG for their business models and setting achievable ambitions.
A single global standard, either for companies or for investments, is lacking. At corporate level, frameworks include:
Global Reporting Initiative (GRI): an independent organisation that helps companies to understand and measure their impact (two-thirds of the companies who reported on sustainability in KPMG’s global survey used GRI)
Sustainability Accounting Standards Board (SASB): identifies the subset of ESG issues most relevant to financial performance
International Financial Reporting Standards (IFRS) Foundation: currently developing a sustainability reporting standard
Task Force for Climate-related Financial Disclosures (TCFD): framework to improve reporting of climate-related financial information; there is pressure for this to become a regulatory standard, which is likely to happen in larger economies in the medium term.
Sustainability is also a growing influence on the choices of investors, large and small.
Not only do they want to see their dollars deployed in a manner that has a positive impact on humanity and the world, but many believe it will deliver superior returns as investment capital and know how are attracted to the most ESG-friendly opportunities.
KPMG’s Sustainable Finance Survey found that the top driver of institutional investors’ ESG-oriented investments was the opportunity to generate alpha, as cited by 44 per cent of respondents.
Investors are seeking dependable information on the ESG merits of investment products and funds.
KPMG offers a digital solution to enable measurement of the real-world impact of an investment fund’s portfolios against six impact themes to reflect their alignment with the United Nations’ 17 Sustainable Development Goals (SDGs).
Known as the Sustainable Investment Framework Navigator, it was developed in collaboration with the University of Cambridge Institute for Sustainability Leadership.
The six themes are:
• Climate stability
• Resource security
• Healthy ecosystems
• Basic needs
• Decent work
SIFN provides meaningful insight for investment managers by processing complex information into a simple dashboard to check alignment with the SDGs.
As disclosures become more widespread, making data on sustainability more readily available, ESG investors can make ever more accurate comparisons between investments, potentially drawing more investment dollars to the segment. This virtuous circle, fuelled by transparency, points to growth in the ESG economy.
Pressure from regulators to improve sustainability reporting is happening internationally.
The EU is a leader in this respect and its Corporate Sustainability Directive will take effect in 2023, introducing a mandatory requirement for large companies to report on sustainability risks affecting them, as well as their own sustainability impacts.
The EU’s Sustainable Finance Disclosures Regulation targets financial-market participants, such as insurers, asset managers and certain funds. SFDR’s requirements are applied at entity and product levels. The focus is on investment decisions and how sustainability considerations factor into them.
EU insurance carriers and intermediaries will have to incorporate sustainability considerations into their governance structures, investment risk frameworks and conflict-of-interest policies by the third quarter of 2022.
The same time frame applies to investment product manufacturers — such as banks, insurers and fund managers — and their distributors, to incorporate sustainability factors into their target-market determinations and product information.
On the other side of the Atlantic, US regulators at both the state and federal level are mobilising to require climate and sustainability risks to be built into their regulated entities’ governance and business strategies — and both requirements and timelines are likely to broadly harmonise with developing requirements in the EU.
The momentum for sustainable finance is gathering pace and those who act sooner rather than later to build it into their planning will be best positioned to benefit.
Charles Thresh is managing director and head of advisory of KPMG in Bermuda. He can be reached at email@example.com