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Urgency for ESG Compliance in Financial Institutions

Environment matters. And climate change is a reality that all of us are facing. While people worldwide have been made aware in repeated numerous ways of what they can do to reduce individual carbon footprint, the concept of environmental, social, and governance (ESG) in the corporate world has seen wider acceptance and adoption only in recent years. Weaving ESG-compliant norms and practices that focus on fostering an economic environment that works for both the people and the planet, into the enterprise strategy is now non-negotiable and, in many cases, a regulatory requirement. And perhaps, no other industry is better placed to drive focus on sustainability than the financial sector.

The COVID-19 pandemic upended and reshaped the global economic and social landscape in a matter of weeks. And the ensuing economic turmoil, social strife, and continued focus on climate change-led challenges have placed an increased and urgent need for ESG-aligned action. Financial institutions, too, are facing increased pressure to adhere to ESG standards. A 2020 Goldman Sachs finding suggests that the year coronavirus upended the world, $47 billion was channeled into investments with a greater focus on ESG features. This figure was 2X the amount of the previous five years combined. Nasdaq also found that ESG-integrated strategy assets were valued at $8.2 trillion by the end of 2020, 34% higher than the end of 2018.

Policy and People are Driving the ESG Agenda

The heightened awareness of global issues, including climate change, sustainability, and social inequality, is placing higher importance on not just developing more sustainable financial products, but also ensuring brand and business success. Besides, the ESG agenda is becoming a keen factor for regulatory compliance as well. The Paris Climate Protection Agreement, the United Nation’s Sustainable Development Goals (SDGs), and the EU’s Sustainable Finance Action Plan aim to include more sustainable and socially conscious policies and practices into the DNA of organizations and realign capital toward sustainable investments.

The Net-Zero Banking Alliance goes further. It brings together global banks representing about 40% of global banking assets in a sweeping demonstration of their commitment to net-zero emissions by 2050. The Alliance is focused on “Reinforcing, accelerating, and supporting the implementation of decarbonization strategies, providing an internationally coherent framework and guidelines for operating, supported by peer-learning from pioneering banks. It recognizes the vital role of banks in supporting the global transition of the real economy to net-zero emissions.”

Customer Support for ESG Compliant Businesses

Interestingly, the focus on embracing ESG is not driven by policy alone. The modern customer demands that the organizations they engage with, including banks and financial institutions, behave in visibly responsible ways for the environment and society. A PwC report finds that customers quickly change loyalties in favor of businesses they perceive to display environmental and social responsibility in their actions. According to the report, 83% of consumers believed that companies should be actively involved in creating ESG best practices, 86% preferred to work for companies that showed higher ESG compliance, and 76% of consumers reported they would cut relationships with enterprises that treated employees, communities, or the environment unfairly.

What Can Financial Institutions Do to Meet ESG Demands?

A recent IDC survey found that ESG was in the top three priorities for financial organizations in 2022. And several large global banking institutions are actively adopting ESG initiatives. For instance, TD Bank has linked the compensation for senior executives to its ESG performance. Well Fargo has entered into a 20- year agreement with a Florida-based company for renewable energy. The trend is clear, and industry reports suggest that over 80% of banks prioritize ESG and sustainability. Moreover, financial institutions also focus on investing in and serving companies that are more net-zero-compliant. As an example, JPMorgan Chase’s ‘Green Economy’ specialized team provides dedicated services and expertise to companies that make and deliver sustainable goods and services or focus on environmental conservation.

As understood from the examples above, the ESG agenda in the financial industry is two-pronged. On the one hand, financial firms are looking to embrace ESG-compliant policies and practices into their operations; on the other hand, they are engaging with and investing in companies that show greater adherence to ESG practices and reporting. The common factor between the two is technology. From automating processes to embracing digital transformation at scale, financial institutions are discovering how technology is central to ensuring ESG compliance.

ESG reporting and auditing: The Center for Audit Quality’s study of ESG data for S&P 500 companies found that 95% of them had detailed ESG information publicly available. The report also suggests that ESG reporting had seen a dramatic increase after the pandemic struck. In 2019 roughly 37% of S&P 500 companies published ESG data, and this number increased to 54% for the period ending 2020. Clearly, there is a heightened focus today on prioritizing corporate risk policies and strategies toward a sustainable future. While ESG reporting guidelines have been around for some time, organizations must design a robust tech framework to support their ESG reporting and ambitions. From developing an effective, standardized data strategy to automating processes for more efficient performance, CIOs have a seat at the table when it comes to formulating the enterprise ESG strategy.

Automating green finance: Automation has proved to be highly critical for financial institutions in monitoring and reporting on ESG-related risks across their investment and customer portfolio and the firm’s performance against its targets for ESG. This includes tracking progress on environmental targets such as carbon emissions and sustainable procurement, fostering workplace diversity, and following industry-best labor practices. By focusing on green finance, financial institutions proactively identify an investment-worthy organization in the ESG industry and those in other sectors who follow their ESG commitments with absolute rigor. And technology enables this by making it easy to process and analyze large amounts of data for critical insights.

AI to apply ESG standards: By applying artificial intelligence and machine learning algorithms to massive unstructured data sets, companies can identify, extract, and quantify ESG information quickly and efficiently and automate the traditionally manual data research and extraction process. An AI-based model analyzing ESG compliance helps develop a streamlined and standardized framework and presents the findings in an easily digestible visual format

The Road Ahead

Implementing an ESG strategy is a complex undertaking that must be supported by solid and disparate skills and technology, including risk management, data analytics, and automation. It is expected that by 2025, about 50% of all US-managed assets will be ESG-compliant. And while the concept of ESG may be a social issue, financial institutions will be critical in driving cross-industry adherence. However, limited transparency and massive unstructured data may prove to be a challenge for financial organizations to measure ESG data.

By applying the right technology and tools, financial organizations can proactively measure and analyze unstructured data, automate manual research and extraction processes, develop a standardized framework for evaluating enterprise ESG impact, and predict trends impacting their financial performance. How fast this can happen remains to be seen.

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