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Compliance & Risk

ESG report highlights new challenges for financial institutions

· 5 minute read

· 5 minute read

A new report from Thomson Reuters Regulatory Intelligence looks at the fast-emerging challenges for financial institutions in the still-changing environment of ESG initiatives and investments

Environmental, social, and corporate governance (ESG) issues have become a strategic priority for many corporate executives and boards. Almost every industry is being impacted by the collective efforts of governments to tackle climate change, and financial authorities around the world are indicating that issues such as human rights, social justice, and human diversity need to be managed alongside organizations’ more traditional values.

Perhaps this impetus is felt most strongly among financial institutions, as financial services firms are seen as having a critical role to play. Financial institutions are not only capital providers to industry and channels for investing individual wealth, they also are heavily involved in managing the transition from a fossil fuel-dominated economy to one supported by renewable energy.

Further, international and regional financial authorities have proposed common standards and metrics for sustainability-related disclosure rules at investment management and brokerage firms in order to help investors understand the opportunities and risks of ESG investing.

To explore these rapidly evolving developments, Thomson Reuters Regulatory Intelligence has published a new report, ESG: Fast-emerging challenges for financial institutions, that looks at the risks and opportunities for financial services firms in the still-changing environment of ESG initiatives and investments. (Report available for download below.)

As the report notes, these new corporate requirements come as ESG-related investments have exploded. Sustainable investments in 2020 reached an estimated $35.3 trillion, or more than one-third of all assets under management, in five of the world’s largest markets.

That means that investment managers, banks, securities firms, and their regulators face a difficult task. The risks associated with ESG issues are often so new that they are difficult to quantify. For example, the uniqueness and complexity of climate risk, along with the long-term nature of those risks, make measuring and quantifying the threat a daunting task, both for institutions and the regulators that must develop new rules and regulations.

Investment managers, banks, securities firms, and their regulators face a difficult task because the risks associated with ESG issues are often so new that they are difficult to quantify.

And while there is an understandable global urgency about climate risk, financial institutions are also striving to address a slew of additional social problems. These range from employee diversity and inclusion to income gaps and social inequality, particularly among the poorer communities in which the institutions may operate.

At the heart of this debate, as the report describes, is a more fundamental question over the overall “purpose” of companies and whether they should jettison their long-held singular focus of maximizing shareholder value and instead adopt a more inclusive “stakeholder” strategy. Such a strategy would consider employees, communities, and other constituents into companies’ decision-making processes.

For example, how financial firms manage their post-pandemic “back-to-work” policies is just one issue that exemplifies the new reality facing executives and boards — and regulators are taking notice as authorities in both the United States and the U.K. said they are considering imposing new diversity and inclusion rules.

As the report notes, the lack of international policy harmonization on ESG issues may mean that financial firms may face a regulatory patchwork of new policies and disclosure requirements on climate, diversity & inclusion, and governance mandates with each jurisdiction likely to approach these questions in different ways.

Indeed, financial firms’ effectiveness at navigating these divergent rules and regulations will be heavily influenced by their governance, compliance, human resources, and risk management processes. Yet, corporate governance is too often an afterthought when discussing these critical ESG issues. However, effective governance and oversight is imperative, especially given the complex nature of these critical issues facing boards and management today.

This report, which surveys emerging policies and regulations among the G20 countries, seeks to guide financial firms on what they can be doing now to prepare for these regulatory challenges. It prompts financial firm leaders to ask such questions as:

      • Do we currently have a comprehensive approach to ESG issues and a way to embed these new risks within our existing enterprise risk-frameworks?
      • What are the roles and responsibilities for our compliance, human resources, and risk management professionals, and do we have the right talent with the needed skill sets in place?
      • How can we identify those among our customers who have the greatest exposure to climate change and other issues, and work with them to mitigate such risks?

While it is impossible to have all the answers for dealing with the emerging and still-fluid regulatory environment surrounding ESG issues, this report aims to provide financial institutions with a greater degree of clarity about the issues at stake and what actions their leaders should be considering.

You can download a full copy of TRRI’s “ESG: Fast-emerging challenges for financial institutions” below.


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