Embracing sustainability: The role of banks and their ESG practices

Whether through credit activities, underwriting securities issues or as depositaries, banks have more work to do to demonstrate that their “green ambitions” are more than just words, and that they are taking an active part of the climate solution.

For Alessandra Simonelli, Group Head of Sustainability at Banque Internationale de Luxembourg: “Banks play a crucial role in promoting ESG practices. They have a significant impact through their financing and investment activities.”

“By integrating ESG factors into risk assessment, banks contribute to the development of more sustainable business practices internally as well as within companies they finance. They are also supporting the development of energy efficiency and environmentally sustainable practices for buildings through green mortgages and loans, encouraging real estate owners to invest in energy saving measures and renewable energy installations.

Regarding their investment activities: by proposing ESG investment services, banks meet the growing demand from investors and contribute to fostering capital flow towards sustainable investments. Banks also have transparency obligation while increasingly disclosing their ESG performance and impacts. This includes the impact they have on contributing to the transition to a low-carbon economy when financing sustainable projects.

They clearly play a role of transition facilitators both through their own actions and by enabling their clients and partners to embrace sustainable practices.”

Some private and institutional investors are raising more expectations for ESG investments and to understand the positive impact on sustainability factors. They also want their banks to make their own contribution. That means banks must incorporate ESG across all their activities and disclose their ESG practices, not only in their own lending portfolios.

For Alessandra Simonelli: “Investor expectations are slowly evolving as sustainable investing gains prominence. Competitive financial return still remains a priority, on top of managing risks associated to ESG factors. In that context, sustainability awareness and education are key to make sustainable investments attractive. Considering current market maturity, it is challenging to provide comprehensive disclosure of ESG related information from investment products, but this will progressively evolve so as the possibility to really align the products to clients’ personal values. Clients want to clearly understand the impact of their investments through detailed impact reporting.”

Transparency is critical – reputation, sales and profit can suffer if banks promise a more sustainable future but continue to fund the expansion of fossil fuel and other high-emission sectors and not assess governance or social violations. This can lead to accusations of greenwashing - a risk also linked to the increasing communication around sustainability contributions.

For Alessandra: “the risk of greenwashing is significant but not the only one. Indeed, other risks seem as important, such as the regulatory and compliance risk linked to a complex and still evolving regulation coupled with the lack of data availability and quality. We are also observing potential operational and transition risks, increasing the urgence of an adequate risk management framework.”

In the EU, UK and US, legislators, central banks and regulators have adopted rules - or are preparing to do so - that require financial institutions to disclose more transparent information over their consideration, or not, of environmental, social and governance characteristics and/or objectives.

In Europe, considerable progress was already made towards harnessing the regulatory framework to achieve sustainable goals, particularly for investment rules. Supervisors are highly conscious that non-ESG compliance is a potential risk to investors and consumers, as well as economic and financial stability. With this, they are requiring claims of sustainability impact to be backed up by hard data.

Alessandra highlights that: “banks can take several measures to mitigate the risk of greenwashing. They can work on the development of robust ESG assessment frameworks to evaluate the sustainability performance of companies and projects and enhance due diligence when interacting on financing or investment projects. Investors and stakeholders can assess the authenticity of sustainability efforts with transparent ESG reports based on recognized frameworks: focusing on banking operations, their financing activities, and clear and comprehensive ESG disclosures .This can be completed with third party verification or external assurance increasing credibility and transparency of those external disclosures.”

Even though sustainability is not new, the new regulatory frameworks have shaped a new paradigm, constraining the banking industry to adapt its operating model leading to new challenges.

“Data and upskilling of employees and clients remain the key challenges. The integration of social factors will also become a real challenge after the focus on the environmental aspects. Banks will also need to continue their efforts of better assessing and manage climate-related financial risks, especially with long-term perspectives. Last but not least sustainable finance innovation will be key to meet the evolving demands of investors and society.” concludes Alessandra Simonelli.