As environmental, social, and governance (ESG) issues receive more mainstream attention, banks are continuing to find themselves in the crosshairs. From NGOs and investors to regulators and customers – banks are continuously being pressured to do a better job on ESG. And while some of the criticism is legitimate – many banks can do more – much of it discounts the real work banks have done in this area.
As someone whose firm has been delivering ESG risk data to banks for the past 15 years, I have witnessed banks tackle these issues for a long time. Compared to many other industries, and even some other parts of the financial services sector, banks have made considerable progress integrating ESG information and practices into their operations.
When it comes to capital availability, movement, and allocation – banks play a critical role. And at large global banks with corporate and investment banking (CIB) and asset management arms, as well as large wealth and private banks – each of these divisions has a role to play in ESG. Banks also touch everything — essentially every sector in every country. From deforestation and endangered species to child labor and human trafficking, to corruption and fraud; banks are exposed to material reputational, compliance, and bottom-line financial risks stemming from almost any ESG risk facing their clients. Unsurprisingly, that has made them lightning rods for criticism.
Credit where it’s due: Responding to the criticism
Public pressure is nothing new for banks, who for a long time had to manage their reputational risks better than other industries. In 2006, UBS needed a list of 100 companies exposed to severe environmental and social risks. For this, they required a systematic methodology for identifying, assessing, and quantifying ESG risks related to companies and infrastructure projects such as mines and oil and gas platforms. This project became the catalyst for the creation of the RepRisk Platform – an online searchable due diligence database on ESG risks. In 2011, UBS became the first bank to integrate ESG risk data into their global compliance system. As a result, all of UBS’ client onboarding, periodic client reviews, transaction assessments, and even suppliers are screened on environmental and social risks.
Another example of companies responding to public pressure is Credit Suisse, who had NGO protestors outside its Zurich headquarters in 2007 accusing the bank of failing to protect indigenous people from a major timber company operating in Malaysia. This event acted as the catalyst for Credit Suisse revamping their environmental and social risk review process and becoming our second client.
Today, RepRisk serves over 80 global banks, regional banks, and development finance institutions. All of these organizations leverage RepRisk’s environmental and social risk data on public and private companies, as well as infrastructure projects, in their transaction due diligence processes. Many have also taken the next step by integrating environmental and social risk assessments into their client onboarding and KYC (know-your-client) procedures. Some others have also integrated ESG risk into their counterparty and supplier risk assessments. This why having access to timely, consistent ESG risk data can not only better inform a bank’s risk management processes across its business divisions, but it can also help ensure compliance with internal policies, external commitments, and international standards.
Over the years, major global banks have developed sector-specific policies for higher-risk sectors such as oil and gas, mining, and forestry. Most of these policies prohibited financing when the client had links to child labor or forced labor, or sector-specific activities such as illegal logging, forest burning, or illegal fishing. Over time, controversial activities such as mountaintop removal coal mining, arctic drilling, and fracking simply became too reputationally risky for many banks to engage in – essentially removing financing of such activities by large swaths of the financial sector.
On the regulatory front, banks have joined together to set global ESG standards. In 2003, 10 financial institutions came together to establish the first generation of The Equator Principles, a framework that began as a way to assess environmental and social risks associated with the financing of major infrastructure projects such as geothermal facilities in Indonesia, a power plant in Mexico, or the construction of a dam in India. Today, 123 institutions in 37 countries have adopted The Equator Principles, and its scope has broadened to include project-related corporate loans, refinancing, and acquisition financing, as well as information-sharing among members. The Equator Principles had real-world impact because they not only referred to a performance standard – defining real practices and benchmarks based on the World Bank group standards and industry guidelines – but because they required members to be fully transparent about its implementation (public “second opinion” by ESG experts). Further, in 2019, 130 banks – collectively holding USD 47 trillion in assets, or one third of the global banking sector – signed The Principles for Responsible Banking – a unique framework with six guiding principles to help the banking industry establish stronger risk management protocols, stakeholder engagement, a culture of effective governance and responsible banking, as well as greater transparency and accountability.
These are voluntary agreements and compliance varies from bank to bank and region to region. Even so, these soft law standards help to prevent a race to the bottom while simultaneously setting global standards for environmental and social issues in banking activities.
In the absence of stronger government legislation and regulation, the pressure put on banks by civil society and their own customers is very important, because they felt the pressure – and they acted. Was it fast or good enough? Perhaps not, and progress is still needed. But it is important to give credit where it’s due. Those who have criticized the banks for not doing enough to advance ESG issues probably are not aware of this history. They also may have criticized banks as acting out of self-interest. But the policies did have a real-world impact on business across the world and helped raised the bar for how companies do business. The end result is what we all want: the decreased financing of activities that are the most destructive to the environment and to people.
Carpe Diem: Seizing Opportunities
All that said, banks can still do more. Up until now they have largely regarded ESG from a defensive perspective as a way to detect and avoid threats. Going forward, they can pivot to look at ESG as a source of opportunity. As an example, Credit Suisse created a dedicated sustainability advisory group to provide counsel to their investment banking clients on sustainability growth and finance opportunities. And ING became the first bank to offer sustainability-linked loans linked to how well a company performs on sustainability. Goldman Sachs announced it would spend USD 750 billion on sustainable finance over the next decade. Notably, the announcement was made by CEO David Solomon, as opposed to a ‘Head of ESG’-type role, marking a sign of how seriously the issue is viewed. Prodded by initiatives like the European Green Deal, corporations globally will have to undertake the necessary, yet costly, reworkings of their operations. Not only will supplying the necessary capital be an enormous opportunity for banks, but so will providing advisory services – because clients need help navigating this transformation.
Even from an organizational perspective, one can observe that the tide is changing. ESG functions have moved from sitting under the communications or public affairs department at banks, to being under the purview of the Chief Risk Officer or the General Counsel responsible for legal matters and compliance. This change is evidence of how banks are becoming less siloed, with ESG being seen as more than just a corporate social responsibility and ‘check-box’ exercise, but as a core business pillar.
Walking their talk, long-term
It is safe to assume that going forward the pressure on banks will only intensify. A range of stakeholders, including regulators, investors, NGOs, and employees, will keep demanding banks do more to contribute to a greener and more equitable future. Based on our work with banks over the past 15 years, there is every reason to believe they can rise to the challenge. They have come a long way already – their critics notwithstanding – and they have the tools in place to go further still. Ultimately, we expect that banks with the right commitment to ESG, and more importantly, the right actions, will be perceived not as part of the problem, but as part of the solution.