The ESG challenge in finance – what it is, and why it's more than CSR on steroids

Its unique ability to mobilize capital means the financial sector is crucial in the transition to a more environmentally and socially sustainable world. As such, pressure is mounting on financial services firms to present proactive, comprehensive environmental, social, and governance (ESG) strategies. Robust ESG reporting frameworks are also needed due to increased scrutiny from regulators, investors, and consumers. Inside-out shifts in corporate values, too, are seeing firms enhance ESG data and analytics to underpin future-proof approaches.

While ESG is complex in any sector, it presents specific challenges in finance. We’ll explore these below, and outline the additional nuances of ESG in comparison to corporate social responsibility (CSR).

Key ESG challenges in finance

1. Lack of clarity: Across required data sources, reporting needs, and performance standards.
   
   
2. ESG risk: Climate change and social factors, for example, can pose significant risks to finance firms’ assets and reputations.
   
   
3. ESG reporting frameworks: Insufficient or missing data can generate high subjectivity levels and hinder coordination. Making results visible is complicated in itself; a challenge intensified by the stringent proof and substantiation required.
   
   
4. ESG data management: How to ensure ESG data and analytics processes are correct and up to date? Compliance is key, naturally, across ESG data gathering, storage, sharing, and analysis. ESG data management must also be carried out as efficiently as possible, without unnecessary expense.

Why ESG in finance is more than CSR on steroids

With wide-ranging effects across finance organizations, ESG exceeds the remit of compliance and CSR. For an organization to implement a thorough, effective, and future-proof ESG strategy, its scope must extend beyond its own walls. It must include a firm’s downstream financed activities, as well as products and services acquired upstream via its supply chain.

We can summarize the dimensions of ESG strategy in finance over five key areas:

1. Impact: Tracking ESG impact of loans, investments, and other products; implementing new investment policies factoring in ESG concerns.
   
   
2. Revenue: Creating new products and services to drive brand loyalty, new revenue streams, and sustainable outcomes.
   
   
3. Risk: Assessing climate and social factors’ effects on traditional financial risk pillars (credit risk, market risk, liquidity risk); understanding the reputational risk that can arise with greenwashing allegations.
   
   
4. Reporting: Providing disclosure for stakeholders, including risk modeling. Culture: Embedding and foregrounding an ESG mindset in business processes and governance.

Within an ESG transformation, these five factors will affect every area in a financial service organization, albeit differently. For example, ESG revenue may stem from green and social impact bonds in capital markets, or from lower interest rate mortgages for energy-efficient homes in retail markets. ESG impact within corporate banking, meanwhile, could be tied to loans’ achievement of positive social or environmental outcomes.

ESG also extends beyond primary lines of business, impacting financial institutions’ support functions: Risk, finance, compliance/audit, HR, IT/operations, and procurement.

ESG: Multidimensional change, vital opportunity

ESG is an equally daunting and unavoidable challenge. To further explore how the financial services sector can effectively address ESG, putting in place three essential foundations, download our whitepaper on the topic.