Sustainable Finance: How to rebuild trust and thrive in a sustainability driven context

The COVID-19 pandemic continues to pose a significant threat to the livelihoods of millions of individuals and organizations across the globe. With more European governments re-imposing new social measures to stem the rapid infection rates, many fear that this could extinguish any hope of a swift economic recovery. According to the latest figures from the International Monetary Fund (IMF), global GDP might shrink by as much as 4% this year. As a result, many financial institutions in Europe and the US have started to stockpile large sums of loan’s provision to withstand the deteriorating economic outlook. In the first half of the year, the fifteen largest US banks and 32 largest European banks have booked more than $139bn in bad loan provision.    

While stakeholders across the board, ranging from governmental to financial institutions, are pre-occupied with the current crisis, other challenges are looming on the horizon. With similar characteristics, environmental and societal risks demonstrate a high probability of occurrence, posing significant danger for the future. Stakeholders are calling for a response to the pandemic which rebuilds the world differently, with environmental, societal, and governance issues at its core.

Examples of green and sustainable initiatives are growing everywhere. For instance, the European institutions are pushing for a new “European Green Deal”, and the German government has issued its first-ever green bond. Meanwhile, we see an increased customer appetite for sustainably marketed financial products, with the inflow into European sustainable funds reaching $61.3Bn in the second quarter of 2020.

However, despite national, supranational or even private efforts, more seems needed.

Limiting climate breakdown and reversing global inequalities calls for significantly more investments across the board.

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The importance of the private sector is emphasized by the European Commission in the European Green Deal, “the private sector will be key to financing the green transition”.

Opportunity to play a key role in transitioning to a more sustainable economy and society

By facilitating the global flow of money and reducing risk throughout the global economy, financial institutions are a crucial cornerstone in the transition to a more sustainable economy and society. Supporting this transition can take many forms.

• As liquidity providers, banks can support the Environmental, Societal & Governance (ESG) agenda by channeling credit extensions towards investments with clear environmental or societal benefits.
• As capital allocators, asset managers can continue to innovate within their investment strategies to improve investment mandates in line with investor’s increased sensitivity towards ESG issues and the UN SDG framework.
• As risk managers, insurers have a deep expertise in understanding, quantifying and preventing climate change risks while also endorsing the role of financial shock absorbers in times of disaster and can be actors in the transition to a low carbon economy.
• Furthermore, Market Infrastructure Providers are well positioned to improve the breadth and depth of ESG specific data, thus improving the opportunities described above.

Financial institutions must “walk the talk” in 4 dimensions

While the hurdles for a sustainable recovery and a financial market centered around ESG issues might seem daunting, the stewards of capital have the opportunity to build a trusted relationship with their stakeholders and continue to rebuild the industry’s reputation, which took a major hit during the 2008 recession.

However, trust requires a foundation of tangible results and transparency. With 6 out of 10 investors regarding ESG capabilities as increasingly important throughout the investment manager selection process, and regulators bringing to life a wide range of regulations and standards aimed at combatting greenwashing, financial institutions can no longer hope to thrive in a sustainability driven context without truly demonstrating impact. Financial Institutions willing to consider sustainable finance products as a core pillar of their future growth must adopt a new approach across the entire organization.

1. Anchor sustainability at the heart of the organization. This requires more than just words. According to Accenture’s and the UN CEO Study’s 2019 research The Decade to Deliver: A Call to Business Action, 99% of CEOs across various industries recognize the importance of responsible business practices, but only one in two is implementing them. With only one decade to deliver on the most pressing environmental, social and economic challenges of our time, business leaders in the financial services industry need to practice what they preach by integrating their SDG Ambition across their people, processes and technology to achieve the UN 2030 Sustainable Development Agenda. Many of today’s business challenges are human challenges; not only is the workforce changing but so is the technology and the skills needed to support the evolution of more sustainable operations in financial services industry. It is therefore no surprise that 40% of CEOs in the financial sector believe that the absence of talents with a blended financial and sustainability expertise represents a barrier which prevents them from implementing a strategic company-wide approach to sustainability (23% cross-industry average). With Millennial investors increasingly worried about the impact of their investments, financial services leaders need to walk the talk by first putting their own house in order before bringing their business purpose to life through their brand.

2. Gear up for unprecedented transparency and increased scrutiny on climate risk related controls. With research showing strong flows towards sustainable funds, an ever increasing proportion of the global AUM considered as sustainable and without any consensus on key definitions related to sustainability driven financial products, regulators have kicked into high gear to safeguard financial stability and guide the green transition. With a regulatory roadmap focused on disclosure requirements, such as the EU taxonomy for sustainable activities, and increased emphasis on identifying and addressing climate risks, such as the Task Force on Climate-related Financial Disclosures (TCFD), most financial institutions should gear up for unprecedented transparency and increased scrutiny on climate risk related controls.

3. Deliver on the promise of true sustainability. The financial services industry continues to embrace the value of ESG-driven decision making for their portfolios, as shown by the 72% of European Institutional investors who believe in the potential of ESG-integrated portfolio’s to generate long term alpha. Such continued faith in responsible financial products, combined with increasing market scrutiny, has created an environment where financial players need to overhaul their operations to thrive. While financial institutions are beginning to see their future operations centered around ESG factors, only a small subset is confident in their current ability to integrate ESG capabilities throughout their processes, tools and governance structures.  Effectively delivering on the promise of true sustainability, by applying the same level of precision on ESG metrics as for financial indicators, requires financial institutions to overcome any lack of confidence by tackling a set of challenges, centered around the sustainability-driven operating model of the impacted capabilities, a data model capable of dealing with a whole host of new and often inconsistent data points, and building further on these to cultivate customer intimacy, head on.

4. Push the frontiers of sustainability. With ever-rising demand for responsible products, financial institutions have further strengthened their reliance on sustainability data throughout their investment decision making processes. Differentiating themselves means working with the right technology and partners to gather data and develop insights. Advanced analytics and Artificial Intelligence will help to push the frontiers of sustainability by cultivating true ESG knowledge. Taming the increasing complexity of the available data and new tooling requires a new approach to the finance workforce that harmonizes the human and machine relationship.

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This article has been co-written by Seyha Nop, Jonas Van De Wygaert, and Maxime Tsvirko.