ESG as a value driving opportunity

The term “ESG”, is becoming increasingly important for the companies, financial institutions, and the whole economy. The entry into force of EU regulatory framework, increasing consumers’ environmental awareness and the growing market pressure from investors shifting into green investments are the game changers in the financial sector.

In these circumstances, Financial Market Participants will certainly do not have a choice but to submit to regulatory compliance emergency. But let’s make it more than that ! With a well-crafted ESG strategy, you can instill a sense of purpose among your employees, boost your brand’s image and reputation and build a relationship of trust with the local authorities.

Thereby, ESG strategy can be an excellent value-driving opportunity for your business. In this article, we will discuss not only what ESG stands for but also how to turn this regulatory constraint into a real business opportunities.

Every company, including yours, is interconnected with environmental, social, and governance (ESG) concerns. There is no doubt that ESG factors are growing in importance and their integration into management and investment decisions is a new imperative. So, let’s talk ESG, and it all starts by its individual elements :

The E in ESG is about environmental criteria. It includes :

• Resource management (energy, raw materials, soil, and water),
• Waste production and management/recycling (industrial, chemical, plastic),
• Greenhouse gas emissions (carbon, methane),
• Biodiversity (of plant species and animals).

The S stands for social criteria, such as :

• Accident prevention,
• Staff training,
• Respect for employees’ rights and social dialogue,
• Promotion of diversity (gender, culture) in the supply and subcontracting chain,
• Social dialogue.

The G means governance. It’s the compliance with good corporate governance rules on matters such as :

• Independence of the board of directors,
• Tax practices,
• Internal organization of audit and risk management.

Firms are facing growing pressure to notify on ESG matters driven by shareholders impact, regulations, consumers attitudes, reputational concerns and more.

Ongoing implementation of the Sustainable Finance Action Plan is supposed to transform EU into a more strategically oriented market in regard to ESG factors, and thus contributes to climate change mitigation.

So what it stands for ? The action plan set out a comprehensive strategy to further connect finance with sustainability. It included ten key actions that can be divided into three categories :

Reorienting capital flows towards a more sustainable economy

1. Establishing a clear and detailed EU taxonomy, a classification system for sustainable activities.

2. Creating an EU Green Bond Standard and labels for green financial products

3. Fostering investment in sustainable projects

4. Incorporating sustainability in financial advice

5. Developing sustainability benchmarks

Mainstreaming sustainability into risk management

1. Better integrating sustainability in ratings and market research

2. Clarifying asset managers’ and institutional investors’ duties regarding sustainability

3. Introducing a ‘green supporting factor’ in the EU prudential rules for banks and insurance companies

Fostering transparency and long-termism

4. Strengthening sustainability disclosure and accounting rule-making

5. Fostering sustainable corporate governance and attenuating short-termism in capital markets

According to new legislations, the EU Commission has strengthened its legal framework to compel companies to increase ESG transparency. Among the main regulations : CSRD, SFDR, EU TAXONOMY.

Under the EU Corporate Sustainability Reporting Directive (CSRD) large public interest entities in Europe must include information about the policies they implement in relation to ESG factors.

Two complementary major texts lay the foundations of a real anti-greenwashing system : the EU Taxonomy and Disclosure regulations (also called Sustainable Finance Discolure Regulation, SFDR).

The EU Taxonomy regulation is a framework for classifying economic activities according to their sustainability. This text aims to direct capital flows towards activities that contribute to the fight against climate disruption and the achievement of the Paris Agreement. Companies will be obliged to indicate the share of their turnover, capex, opex or financial products that are eligible (or not) and aligned (or not) with the taxonomy.

The SFDR regulation requires companies in the financial sector to communicate extra-financial information for each of their products and to classify them according to a dedicated typology.

The financial sector plays a central role in ESG transformations because of its role in financing economy and reorienting capital flows towards more sustainable projects.

In this context, the fact that the biggest leading banks and insurance companies puts such a big bet on ESG is dictated by a double constraint.

On the one hand, they must implement, like any other company, a number of measures to ensure compliance with ESG constraints (environmental, social and corporate governance).

On the other hand, the financial sector has always been a subject to regulatory pressure and increased transparency. This is linked to their role in financing the economy and their role of example in the way in which they will invest in the assets for their funds and products, or in the way in which they will distribute their credits (all aspects of structured financing down to mortgage of an individual customer).

So in that sense, they are going to have to distribute the money much more towards projects, goods and services that are aligned with ESG constraints. Furthermore, they will be progressively more and more obliged to keep all the details of their financing (ex. Is it aligned with ESG criteria ? Is the car purchased by a customer is non-polluting ? Is the customer not invest in an energy-intensive housing ?). There is no doubt that the challenges of reporting, transparency and additional responsibilities will increasingly incumbent upon the financial sector.

Today, it is the entire business community that is considering European regulations and EU taxonomy and that is looking for specific ESG criteria and companies’ performance relating this to the ratings, but it all started with the banks. Further, it is more than likely, that solutions proposed by the financial sector in terms of ESG, will continue to be followed by the whole economy.

At the end, the investors community is also being much more educated on what type of information is worth looking at to verify a good business and a good investment. And a good investment is not only about the financial returns anymore ; it is also about managing the risks related to ESG.

Achieving the objectives of the Paris Agreement requires a massive transition of the economy, with all sectors affected and a strong pressure from the European Union. It means that especially banks, insurance companies and other financial market participants, will need to adjust their business models and develop plans to align their balance sheets with this transition.

Indeed, ESG-related efforts have been at the top of the list of declared priorities for major international banks. Sure, wisely chosen ESG strategy, can help to define priorities and to significantly increase the chances that the business growth will be continuous and assisted with a very responsible growth. But it may even be a little bit more than that.

Here, we present you few ideas on how to boost the ESG potential to create more value in your organization :

Build a relationship of trust with the authorities

Up to half of the profits in the financial sector are at risk of government intervention. Banks are on the podium of this inglorious ranking, where capital requirements are “too big to fail” and consumer protection is so critical that the stake is usually ²⁄₃ of profits.

The stakes are high, but the strong ESG proposition will help diminish companies’ risk of adverse government action. In the best case, it can even induce government support. Thus, the powerful ESG proposition is equal to easing regulatory pressure. That’s how your company can reach superior strategic freedom and it applies no matter the sector or geographies.

Boost your brand’s image among your customers

ESG can influence your consumer choices. Many studies show that customers are willing to choose socially responsible companies or an ecological alternative of the same product or service.

On the other hand, a smart ESG proposition can be a bridge to access new markets and go deeper into existing ones. Local authorities who trust their investors are more likely to honor them with access, approvals or licenses that help to seize opportunities.

Moreover, the enterprises engaged in activities involving the society have easier access to resources and obtained significantly higher valuations than their competitors.

Instill a sense of purpose among your employees

Research shows that employee satisfaction is positively correlated with shareholder returns. A strong ESG proposal helps companies attract and retain quality employees and increase their motivation and productivity by instilling a sense of purpose.

Social experimentation has also proved a positive correlation between social impact of the Company and higher job satisfaction of its employees. An Australian bank has randomly given bonuses for some of their employees in the form of corporate payments to local charities. It turned out that those employees reported biggest job satisfaction than their colleagues who were not chosen for donation program.

It is also worth mentioning that just as a feeling of a higher purpose can inspire employees to operate better, a poor ESG proposition can diminish their job efficiency.

There are several ways of looking at ESG. First of all, it is a major regulatory constraint. However, a good defined ESG strategy, could be also a value-added factor of your activity. So the question is : how do you transform this constraint into an asset and turn into opportunity with a financial return at the end.

In Valthena, we know how to inject business purpose into regulatory transformation. We provide transformation support and have an in-depth knowledge of the challenges You can faced in the context of ESG strategy :

• How to precisely identify your regulatory obligations ?
• How to source your data and measure your impact (e.g. Data Sourcing, Data Analysis, Data Communication)?
• How to mobilize your resources around a federative project (e.g. Change management)?
• How to put ESG at the center of your IT systems (e.g. regulatory reporting, taking into account new criteria in your credit allocation)?

Valthena has gathered a team of experienced professionals with complementary skills (from ESG expertise to implementation capabilities) that can work hand-to-hand with your teams from Business Strategy to Go-Live. Let’s talk ESG with us !

[1] W. J. Henisz, “The costs and benefits of calculating the net present value of corporate diplomacy,” Field Actions Science Reports, 2016, Special Issue.