Globally sustainability is seen to be rising up the agenda as we begin to navigate ourselves through the post-pandemic world attempting to implement a ‘green recovery’. With sustainability pledges from organisations being announced almost weekly, this month our Woodhurst discusses delved in to environmental, social and governance (ESG) issues in financial services, and whether we are truly moving towards sustainable finance.

Is the financial services sector playing its part to reach the 2050 net-zero target?

Commitments from banks to align their operations with the net zero 2050 target are becoming more prevalent, yet the detail remains to be seen as to how this will be implemented and achieved. Predominantly it has been pension funds that have been making the biggest progress but as they can take a long term view this is not surprising.

For the incumbents, change objectives are usually specific to the C-suite and delivered across their time in role, how do you define a roadmap to achieve a goal that spans multiple leaders and decades? Targets and pledges need to be broken down and must be followed by a credible phase out plan and a fully embedded approach to managing climate risks. It seems the intention and goodwill of organisations is there but given the myriad of buzz words being used interchangeably, a lack of definitions and regulations, there is a long way to go.

How many frameworks is too many?

Sustainable Financial Disclosure Regulation (SFDR) main provisions set by European regulators came into effect in March, requiring some transparency on sustainability disclosure for financial market participants and advisors, at both an entity and product level. Whilst this is a significant step in the right direction SFDR does not force disclosure but rather comply or explain why not.

In a powerplay since leaving the European Union, the UK has instead decided to implement their own framework to help aid their greener economic recovery. The ambition set out in November 2020, if achieved, would be the first country to make TCFD (Task Force on Climate-related Financial Disclosures) aligned disclosures fully mandatory by 2025 going beyond the ‘comply or explain’ approach. Having taken a bold stance, it seemed strange the proposed Financial Services Bill just once month prior (October 2020) made no reference to climate change. Opposition and peers proposed changes and eventually amendments to the Bill agreed in The Commons and the Chancellor has since announced further progress:

• Provisions in law that regulators must take the UK’s net zero target into consideration when making any future changes to prudential rules.
• New remits for the FCA and PRA that will require them to consider climate change commitments across the whole of their remit and in all future decisions and planning.
• A future consultation process addressing climate change across the whole of the regulatory framework.

These changes give the UK a significant opportunity to use the framework to address climate change at the highest levels within FS and for regulators to drive alignment to net-zero. There is, of course, still much more to be done and the bill is potentially a missed opportunity to review the climate change risks applied to fossil fuel exposures in capital requirements as proposed by Lord Oates.

Whilst the UK lays the foundations for another framework, is this truly what is best for environmental, social and governance practices or just another move to compete to be the ESG pioneer. Financial Services is a global industry and with so many frameworks (GRI, SASB, TCFD, Net Zero Investment Framework, PRI, to name a few) there needs to be cohesion at the highest level.

ESG Data Challenges

Good quality data is the lifeblood of any framework or practice but the lack of standardisation and transparency in ESG reporting presents critical challenges for asset managers. Currently the primary source of data is the information companies chose to report, this self-assessment underpins the value chain of data and poses reliability questions for anyone who uses it to make an ‘informed’ decision.

An alternative to conducting due diligence yourself is to use a data provider, there are a vast number of ESG data providers each with their own mechanism for scoring. By choosing a data provider you are aligning to their values and methods of materiality, data acquisition, aggregation and weighting, in doing so will affect the portfolio scoring and how ‘good’ your ESG is.

Determining ESG scores to this point is predominantly done using historical data, the key pivoting point will be accurately predicting for future investments and portfolios. Organisations that are taking advantage of AI capabilities to consume unstructured data could lead the way in defining transparent and fair models for the industry.

Power to the consumer

It is clear is that whilst government and regulatory bodies are starting to enforce change, many organisations had a different driving force, their consumers. If it isn’t Seaspiracy, Life on our Planet or Richard Curtis telling us ‘it’s pensions actually’, advances in technology and social media means that movements are captivating and resonating with all generations more than ever.

If we stop investing in bad ESG profiles will that make the planet more sustainable, or are there benefits of continuing to invest in high risk scored organisations if they are developing more sustainable practices, e.g. the major oil companies investing in renewable energy. Ethical questions like this are personal to each individual, and as consumers become more aware of the implications of their choices, they are looking for answers to inform their decisions.

Fintechs are trying to educate and give consumers options to improve their own personal ESG impacts: 

• Tred App: connect your accounts and every time you spend it will calculate the carbon footprint of the transaction, providing bespoke offsetting plans based on your emissions.
• Yayzy for Business: uses APIs to helps banks and FinTech’s deliver personalised carbon insights to their customers and inspire action. Can be deployed on-premise
• Sugi: provides the consumer with the carbon impact of your current investments
• Pensionbee: offers two different ESG pension plans ‘Fossil Fuel Free Plan’ and ‘Future World Plan’

If alignment on robust frameworks can be met (which is no mean feat) then the fintech potential using open finance would put even more power in the consumers to drive forward change.