Facing up to ESG: key challenges for Sustainable Finance

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Introduction

This is part of our sustainable finance series which acts as a guide for businesses or for individuals looking to gain a better understanding of the role of sustainability in the future of the financial sector.

We are in a transitional phase for ESG. With the upcoming slew of regulatory developments expected across international markets, there will be a shift from ESG as a nice-to-have to a vital component of business strategy. There are an ever increasing number of cases which show how sustainability, if properly understood and leveraged, and profitability are positively correlated. As ESG becomes more of a priority in the corporate sphere, firms will need to understand the key challenges they face in implementing and integrating sustainability into the framework of their business in its entirety.

This article looks at the challenges facing the market as a whole as well as those facing individual firms.

Challenges facing sustainable finance

The main overarching challenge currently facing the entire market is the lack of agreement on or availability of ESG data. This is in large part due to the fact that there is no universal reporting standard or framework. Unlike traditional financial reporting there is no regulation on the scope of the information that is required for ESG reports, nor is there a compulsory audit validation process for the information provided. Not only does this make it difficult to accurately analyse and compare this data between companies, it also fuels undue market scrutiny into the effectiveness of ESG measures. To counteract the paucity and inconsistency of corporate ESG disclosures, the International Sustainability Standards Board (ISSB) is developing a ‘comprehensive global baseline’, with the first climate disclosure guidelines due to be issued by the end of 2022.

The next major challenge facing markets is the mobilisation and incentivisation of private companies to share their ESG data, especially SMEs. Actors within the private sector have typically been less transparent with their ESG data than other sectors. According to ESG Investor, the venture capital and private equity industries in particular have come under fire from policymakers for their seemingly brazen attitude towards sustainability issues linked to lagging incentivisation. One of the key areas of focus should be SMEs, which represent over 90% of businesses globally, more than 50% of employment and contribute over 40% of GDP in emerging markets according to the World Bank. SMEs will be key for the global transition to a sustainable economy, not least because it is much easier to integrate ESG considerations at the early stages in a company’s development than it is for large international corporations.

There are also a number of key challenges on an individual company level according to PwC:

Seeing beyond the ESG labels and focussing on the identification of specific issues that need addressing within an organisation. Breaking down and understanding the key issues behind the acronym is a vital starting point for any company looking to implement a successful ESG strategy. Firms should look to focus on specific sub-categories to ensure their approach is targeted and actionable.

Translating ESG strategy into the investment or credit decision making process. This is especially important for financial institutions such as banks, asset managers, or funds. Rather than depending on parallel checks to understand the ESG credentials, which wastes both time and resources, these should be embedded in the credit or investment cycle.

Making sure that there is enough in-house ESG expertise and training. Investors will often come across many different industries during the investment process and having experts or training opportunities in-house to provide in-depth knowledge of engaging corporates on ESG-related matters will be extremely valuable.

Delivering and communicating on ESG commitments. As more regulations are introduced concerning the mandatory disclosure of sustainability data, financial institutions will find that they must communicate how they have managed ESG risks and promoted sustainable practices within the firm. Therefore, effective communication and delivery of ESG commitments will prove to be essential to guard against any regulatory or stakeholder scrutiny.

Integrating ESG into existing company risk management processes. This will help to futureproof the company against exposure to any sustainability related risks.

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