The pressure is on to provide sustainable finance but the risks are high

Recent scandals are increasing legal and reputational challenges for companies

Financial companies must account for their effect on sustainability and their contribution to Sustainable Development Goals, including climate change. AP

There has been a global acceleration in the demand for sustainable finance.

Cop26 in Glasgow and Cop27 in Sharm El Sheikh received universal coverage. But the pressure is not only from non-governmental organisations 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 (environmental, social and governance) risks and embed those factors into their framework.

Two-pronged threat

Based on the concept of double materiality, financial companies must now account both for their effect 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 only 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 owners face.

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, for example on climate risk, such as physical risks or Scope 3 emissions.

The difficulty is not only 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, companies 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, companies will want to act quickly on new products to contribute to the transition and 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 2,000 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 (Task Force on Climate-related Financial Disclosures) 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 processes and have limited audit review.

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

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

Emmanuel Rondeau is a visiting professor and senior advisor for banking studies at the London Institute of Banking and Finance Mena