ESG (Environmental, Social, and Governance) in Financial Services – Thematic Research

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The global pandemic has arguably done more for ESG awareness than it did for digital adoption. A dual health and economic crisis, in which the fate of individuals was dependent on how other people behaved, created a heightened sense of togetherness. This was visible not only in terms of virus transmission but economically, as banks realized that only by helping customers survive the crisis could they help themselves repair balance sheets. However, ESG remains highly problematic from a strategy and execution perspective. It is an initiative as complex and all-encompassing as the entire digital transformation project itself. In the context of bank financing, institutions can have very different starting points, with portfolios exposed to various risks, making it difficult to determine a baseline for success.

What are the main trends shaping the ESG theme in the financial services sector?

Technology trends

ESG-focused robo platforms use machine learning (ML) algorithms to guide investors towards suitable investments, typically exchange-traded funds (ETFs) that bundle securities into themed and lower-risk instruments in which risk is hedged across a portfolio. Sustainable ETFs have grown in popularity due to specialist robo-advisors, such as EarthSimple10, that deal exclusively in sustainable ETFs. By making it easier for individuals to invest in accordance with their values and preferences, the total amount of capital available for sustainable development goals (SDGs) may increase significantly.

Banks and technology vendors are re-purposing digital money management (DMM) capabilities to optimize financial wellness goals and ESG impact. DMM vendor Meniga now offers climate change impact insight. Doconomy in Sweden, a partner of Mastercard, helps users track and measure the CO2 emissions associated with their purchases – enabling them to limit the climate impact of their spending through climate savings, climate compensation, sustainable investments, and climate refunds from partner brands. Just as we had traceability in supply chains for fair trade, we are now moving toward traceability in money.

Given the pace and scale of ESG-led change, banks are strategically deploying fintech eco-systems to drive sustainability in their products and operations. This overall category of fintech is often referred to as Sustainable Digital Finance (SDF). It subsumes mobile payments platforms, crowdfunding, big data, artificial intelligence (AI), blockchain, digital tokens, and the internet of things (IoT), to help providers, directly and indirectly, support the targets set in the UN’s SDGs.

Macroeconomic trends

The COVID-19 pandemic has changed what matters to customers. The experience of a dual health and economic crisis, in which the fate of individuals was dependent on how other people behaved, created a heightened sense of togetherness. In particular, the size of the economic disruption reminded retail banks that they were “in this together” with their customers. Resorting to fees or penalties would have pushed even more customers into the red and devastated loan loss provisions further. Instead, enlightened self-interest – buttressed by government regulation – saw banks focus on helping their customers improve financial resilience, perhaps for the first time.

Perhaps the biggest single driver of sustainability is not the need for action now but a generation that will soon represent 75% of all accounts and purchases and receive an estimated $30 trillion wealth transfer from Baby Boomers over the next 30 years. These individuals are more interested in purpose than profits, or so they say on their placards and banners. Younger customers are not just demanding cheaper, faster, and more convenient ways of managing their finances (i.e., what powered the fintech revolution) – they also care about a company’s moral, social, and political values and want brands they affiliate with to align with their own beliefs.

Banking has a greater need for reputational rehabilitation than almost any industry, bar perhaps defense. But, unlike defense, banks must achieve that rehabilitation while under attack from new entrants. Sticking points include the industry’s role in causing the global financial crisis through a bonus culture that rewarded greed and its ability to privatize gains and socialize losses with bailout packages but no meaningful change (or at least, that is the perception of many observers and consumers).

What are the ESG challenges in the financial services sector?

Environmental challenges

Most banks have significant books of business wrapped up in loans and instruments to ‘brown’ assets. As long as those brown assets continue to generate profits for the bank, bank executives will need to balance their duty to finance the ESG transition against their fiduciary duties to shareholders. There are also various unintended social consequences to environmental moves. Declining to renew loans on existing coal mines, for example, may improve a bank’s carbon disclosures, but it could lead to significant social implications as mines close and unemployment grows (which, in turn, would have a massive impact on that market’s retail lending and potential impairments). Having the experience, insight, and data to map all those potential consequences is proving to be a challenge.

Banks are key decision-makers that influence the entire economy with their funding decisions. If banks choose to cut off financing to a particular company or industry, they will struggle immensely. This makes banks responsible for ensuring that their investments promote positive values. Oil and gas companies have high capital and operational expenses. To meet these financial demands, they turn to banks for financing, which banks are happy to do as they can provide very large loans with very little risk.

Social challenges

Banks must have good visibility over the practices of the companies that they invest in, especially when those companies sit outside of the bank’s home country, where regulations may differ, and oversight may be more restricted. This is to ensure that human rights are not abused due to a bank’s investment. One of the most common areas in which human rights violations occur is the use of child or forced labor in manufacturing processes. It is the responsibility of banks to undertake extensive due diligence on their investment holdings to ensure that no human rights violations are taking place across any part of that firm’s value chain. This may even extend to external firms that provide inputs for companies and have no direct relationship with the bank.

Discriminatory practices also manifest in credit risk methodologies built up over decades that consider these same groups (women, ethnic groups etc.) as higher risks, as historically they have earned less across their lifetime or not worked at all. Such financial exclusion also plays out for SMEs, particularly rural SMEs in developing markets, which are typically much harder to assess from a credit perspective using traditional data points and techniques. Including these groups is not just ethical but is mandated by regulation in many markets (such as the Financial Services Charter in South Africa, or financial inclusion as part of the UN’s Millennium Development Goals) – but it is also a clear commercial opportunity.

Governance challenges

Following a string of scandals and the 2008 financial crisis, the public has a very negative view of banks and their corporate culture and structure. Banks have long had unjustifiable remuneration for top-level executives, although this is one of the main drivers incentivizing people to enter the industry. These pay packages and bonuses are not necessarily tied to output, as we saw following the 2008 financial crisis when banks almost single-handedly tanked the global economy, yet many bankers still received their bonuses.

Regulators still want more clawbacks, which allow bonuses to be recouped if investments go sour or wrongdoing is later discovered. EU banks live under a tougher regime after Brussels-based lawmakers banned bonuses of more than twice fixed salaries starting in 2016. However, success has been mixed. For example, Barclays has reasonable ESG credentials but was desperate to avoid a state bailout so it could continue paying huge bonuses to staff, according to board minutes recorded during the financial crisis. Bosses feared ministers would restrain pay, fueling an exodus of top staff.

Which are the leading companies focusing on ESG theme in financial services sector?

Major financial services companies focused on ESG include TriodosBank, ING, USSA, Navy Federal, Citigroup and Goldman Sachs.

Market report scope

Outlook Year 2021
Companies Mentioned Bank of America, Barclays, BBVA, BlackRock, Citibank, Citigroup, Deutsche Bank, Goldman Sachs, HSBC, J.P. Morgan, JPMorgan Chase, Morgan Stanley, Santander, Tandem, USAA, Wells Fargo, and Wirecard

This report provides an in-depth analysis of the following:

  • Several tech trends are shaping ESG in the financial services industry, including artificial intelligence, cloud, and robo-advice.
  • Customers are increasingly expecting their financial services providers to display sustainable credentials.
  • Companies must take a holistic approach to sustainability that addresses all three of its major aspects: environmental, social, and governance. GlobalData’s ESG Framework helps clients build trust with society and set them on a path forward toward sustainable success for their companies and the planet.

Reasons to Buy

  • This report is crucial to understand how ESG is changing and will continue to change the financial services industry. It will allow you to identify trends and track competitor activity in the ESG theme.
  • Benchmark your ESG strategy against competitors in the sector via access to several examples of successful sustainability initiatives across each of the E, S, and G categories.
  • Identify areas in which to prioritize ESG investment using our comprehensive analysis of the most important ESG challenges facing the financial services industry and best practice approaches to mitigate these risks. Staying abreast of emerging ESG trends in the sector will help improve your sustainability credentials.

Bank of America
Barclays
BBVA
BlackRock
Citibank
Citigroup
Deutsche Bank
Goldman Sachs
HSBC
J.P. Morgan
JPMorgan Chase
Morgan Stanley
Santander
Tandem
USAA
Wells Fargo
Wirecard


Table of Contents

Executive summary

GlobalData’s ESG framework

Trends

The ESG action feedback loop

ESG challenges in financial services

Case studies

ESG timeline

Companies

Sector scorecard

Glossary

Further reading

| Our thematic research methodology

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