Banks have many questions about ESG

Their concerns include how to measure and disclose, and how to achieve alignment of purpose across the enterprise.

Environmental, social and governance—ESG for short—has been a consideration for investors for some years, and now its importance is rising in banking as well.

On the E side of ESG, banks are increasing their public commitments to reducing the financing of greenhouse gas and toxic emissions through direct lending or other financial instruments.

Looking at the S, diversity, inclusion and closing the racial wealth gap are a growing focus for decisions about capital allocation, including lending. Banks are intensifying efforts to support community projects, disadvantaged social groups and underbanked customer segments.

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But while the E and the S get most of the attention, neither is likely to succeed without the G—good governance that integrates ESG targets into the business strategy.

BAI recently spoke with Amelia Pan, London-based managing director in the ESG advisory group at PJT Partners, about ESG-related trends and how banks are doing in meeting their goals.

The interview has been edited for length and clarity.

For investors, the governance part of ESG has long been of interest. Has either the environmental or social component of ESG gained that same stature yet?

I think expectations around ESG performance are now commonplace, even in the U.S. In the case of environmental, efforts to make climate reporting mandatory are gaining momentum. Public scrutiny of company decarbonization efforts has increased. On the social side of things, there are calls for companies to collect and divulge data on diversity and pay at all levels of seniority, as well as retention numbers and turnover—those issues are much more front of mind than they were before.

What are the concerns these days for your banking clients? What questions are they asking, and what answers are you giving them?

Despite increasing disclosure around ESG factors, banks continue to be challenged by a lack of robust, forward-looking data for their borrowers and their counterparties. That makes it difficult to assess and report on their own ESG framework. Another thing that we hear about from our banking clients is organizational structure and leadership buy-in. How do they structure an ESG function across an organization? How do they get buy-in and build it into the organization? And how do we align ESG across all the different parts of the bank?

Late last year, a top official said the Fed is looking at creating what sounds like environmental stress-testing for banks. How valuable do you think that kind of risk measurement would be?

I think these stress tests are a long time coming, and they are a reality that banks are going to have to acknowledge. It’s also worth noting that there are opportunities with this new awareness. Banks are looking at climate more closely now, because there’s a realization that we don’t get to a net-zero-carbon economy without finance. So, we’re seeing more dedicated climate-risk teams in banks, and they’ve been appointed at a very senior level. I think once you see innovation in that space at scale, the acceleration will be enormous.

That sounds like something that will happen longer term. But short term, what’s the incentive for a bank to be an early mover climate-wise?

Number one, there’s reputational risk, which academic studies have shown to have an impact on company valuation. But banks, specifically, are struggling to understand all of the potential unintended consequences of their shift toward more ESG-related business strategies. It’s much more complicated than just saying “we’re getting out of fossil fuels.” One way of thinking about it is to consider all stakeholders in the decision-making process. Not just shareholders, but also employees, customers, the supply chain and the communities in which they operate.

To truly embrace ESG, are we talking about a major rethinking of how banks and other companies are managed, or is this more evolutionary? And where do you start?

I think the starting point has to be that ESG initiatives need to be driven from the top. Does the board understand the external challenges that the company faces—including climate, human capital and the need for a more diverse workforce? There are some who believe that ESG is 21st-century business, so it should be part of a board’s fiduciary duties. It needs to be integrated into the business strategy, and talked about in investor meetings, and management needs to empower their team. This shift can’t be done just by a sustainability team.

Terry Badger, CFA, is the managing editor at BAI.

Learn from thought leaders and gain ESG insights in the BAI Executive Report, “Banks are embracing their ESG future.”