Environmental, Social, Governance (ESG) – you have most likely heard of it, but what is it? And what does it mean for the future of commercial lending? ESG has become an umbrella term that can encompass a large number of related terms and issues, all of which represent risks to businesses, economies, society, the planet, and efforts to address those risks. Consumer demand for ethically and sustainably sourced products has led to corporate social responsibility (CSR) commitments that reach across industries and supply chains. This, in turn, has led more and more businesses to consider ESG a new benchmark in evaluating and deciding on a financial institution.
Awareness and agreement have increased dramatically over the past decade – in social, business, and financial worlds alike – about the importance and risks of ESG issues to the long-term well-being and sustainability of human society, economic growth, and the planet itself. In the past few years, we have seen:
- Huge growth in sustainable investments and influx into investment funds
- 90% of global public investors prioritizing ESG investment policies
- Increased support from governments and governmental organizations for ‘green’ projects, both via regulation and fiscal spending
- Proof of better financial performance by companies incorporating ESG
- An uptick in financing and investing in ESG-focused companies and projects, with implications for banks and commercial lending
- An increased commitment from central banks (e.g., NGFS) to include climate change in stress tests has accelerated commitment and shown vulnerability of global financial system to non-financial risks
Driven by changing social forces and accelerated by the COVID-19 pandemic, discussions around ESG have risen to even more prominence, and priority, in the past year. Today, most major banks are engaging in sustainable finance solutions in support of clients’ increased focus on ESG. But if we’re going to judge an institution based on its response to ESG pressures, what do those benchmarks look like? In striving to incorporate ESG, we need to answer:
- How can it be defined? quantified? measured? classified? standardized? disclosed?
- How do we determine relative comparability among other standards/metrics?
- What determines meaningful impact, and what separates it from “greenwashing?”
- What is the right impact threshold to qualify as a ‘green’ project?
- How do we translate ESG data and impact into economic impact?
Coordination of initiatives and events is a key issue, but perhaps above all else as far as investment is concerned, the remaining gaps and challenges concern data. There are now encouraging signs that consensus may yet develop in ESG data and reporting. A coalition involving WEF/IBC and accounting firms (Deloitte, KPMG, PwC, EY) issued in September a proposed framework (“Measuring Stakeholder Capitalism”) for global ESG standards with the goal to “define common metrics for sustainable value creation,” drawing upon and intending to coalesce existing frameworks and standards. The paramount issue for operations and servicing will be flexibility and agility around the data collected, with an eye toward:
- Correlation to finance
Luckily, the efficient and accurate collection and reporting of data has also been a primary focus for banks and their partners in the past decade. In commercial lending, data quality begins and ends with having the right technology in place. To ensure data that will effectively inform decisions and provide a basis for actionable reporting, banks need a technology partner/solution that can help make sense of the data, provide a process, and enable the furtherance of ESG goals. Critical components include:
- A straight-through process to ensure data integrity and completeness
- Real-time access to all data
- Sustainable lending metrics incorporated directly within the loan onboarding process
- Data flexibility whereby new fields can be easily and quickly added to the process
- Comprehensive exposure and risk data including collateral, risk ratings, guarantees and borrower relationships
- Data housed within the same system for reporting, providing a single source and version of “the truth”
- Incorporating data easily into existing loan reporting requirements – a sustainable lending trial balance, sustainable lending profit/loss metrics, sustainable lending officer reports, etc.