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Compliance & Risk

Corporations add ESG to financial crime risk screens as bribery & corruption risk surface in carbon offset schemes

Rachel Wolcott  Senior Editor / Regulatory Intelligence / Thomson Reuters

· 5 minute read

Rachel Wolcott  Senior Editor / Regulatory Intelligence / Thomson Reuters

· 5 minute read

More companies are including ESG factors along with the other risk factors they track as part of a robust financial crime and anti-bribery & corruption rating system

Corporations have added environmental, social & governance (ESG) factors to their financial crime and anti-bribery and corruption (ABC) risk rating systems used to vet clients, suppliers, and third-party entities. Those companies with more advanced ESG programs have realized the vulnerability to bribery and corruption risks posed by some sustainability or climate change mitigation efforts, such as carbon offset schemes.

“ESG is also about green crime [and] human trafficking, which is linked with money laundering and with bribery and corruption. They all come into the same circle,” says Gabriel Cozma, head of financial and fintech at the Lysis Group, a financial crime specialist in London.

A few banks too now risk-rate their client base and third-party relationships according to some ESG criteria alongside ABC and money-laundering risk screening. Some will not on-board those clients or third parties who do not meet those criteria, Cozma adds.

“They want to take a different dimension to the risk-rating of a supplier, a client, or a third-party introducer. Do we want to do business with this entity based on this criteria including ESG? There is an underlying link between ESG and various deals in various countries, which have the ESG dimension, but at the end of the day it is business as usual. It’s about money and it’s about corruption. Or it’s about money laundering, or both,” he says.

Banks’ reputational risk committees should be considering ABC and greenwashing risks when vetting new clients and transactions, says Andrew Procter, a partner at Herbert Smith Freehills in London. “What [reputational risk committees] try to deal with is the risk that a line may be crossed,” Procter explains.

“They try to identify flags that might indicate a concern. “They look at things like the jurisdiction in which they’re dealing; does it have a bad reputation for corruption? By the sector in which they’re dealing, the nature of the transaction. Is it unnecessarily convoluted or complex? If there’s a greenwashing angle to it, that might also be a concern,” he notes.

Making the ABC / ESG link

Many financial services firms, corporations, and law firms, however, lack complete appreciation of the link between corruption and ESG, says Liam Naidoo, a partner at Hogan Lovells’ investigations, white collar & fraud practice in London.

“Corruption is an ESG issue in its own right because conducting your business ethically, not being corrupt and good governance — that is absolutely a social issue. It’s also an issue of good governance because by its very nature preventing corruption in your company requires you to have good governance policies and procedures,” Naidoo adds.

Kroll’s 2022 Anti-Bribery and Corruption Benchmarking Report, which surveyed 700 corporate executives, found that while corporations recognized the importance of incorporating ESG into ABC programs, those companies based in the North America and the Middle East were lagging in these efforts.

Only 43% and 38% of those respondents, respectively, said ESG metrics were part of their anti-bribery and corruption compliance. By comparison, 57% of corporations in the Asia Pacific region and 52% in Europe and Latin America had incorporated ESG metrics into ABC compliance.

Companies looked at risk factors such as air and water pollution, labor rights, human trafficking, human rights, and modern slavery as part of combined ESG and ABC screening, Kroll reported.

Carbon offset schemes pose ABC risks

Carbon offsetting programs and nature-based climate mitigation solutions are vulnerable to corruption. They can even fuel corruption by channeling cash to jurisdictions with weak governance and few controls, the Basel Institute on Governance noted.

“Doing sustainable business, i.e., your electricity resources or setting up carbon credit farms in Indonesia or wherever it might be, often requires corrupt conduct. Well-run corporates have got good [ABC] procedures and have spent a lot of money on it. And what they need to start doing quickly is understanding how that risk is changing because of the demands of ESG,” Hogan Lovells’ Naidoo explains.

Simply put, getting a carbon sequestration scheme up and running may require a bribe to be paid to government officials. Even intergovernmental organization-sponsored carbon offset schemes or development funds earmarked for low-carbon development or renewable energy could be abused by corrupt officials, consultants warn.

“Corrupt elites have a lot of practice in capturing foreign aid. So, when there is a lack of transparency and accountability in the allocation and tracking of climate funding — not to mention allegations of financial mismanagement — corrupt officials find it even easier to game the system,” according to Monica Guy, a communications and project officer at the Basel Institute on Governance.

Sustainable financial products carry risk

Sustainable loans to international agri-businesses have been flagged for ESG and corruption risk. These loans can fund deforestation and lead to human rights abuses. In some cases, local companies set up by agri-businesses have opaque structures to enable government officials to take a stake in that business in return for land or mineral rights.

“Massive private investment fuels the production of key agri-commodities such as rubber, palm oil, cattle products, soy, pulp and paper, and timber, yet little to no due diligence is conducted on those supply chains, clients, or transactions even though we know that those industries are extremely vulnerable to deforestation and human rights abuses,” says Alexandria Reid, senior policy adviser for deforestation and finance at Global Witness in London.

“This opens the door to laundering the co-mingled illicit profits made by businesses in those sectors,” Reid warns.

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