A previous version of this article was published in August 2021 in the Callahan & Associates 2021 Supplier Market Share Guide: Credit Union Auditors.
The COVID-19 pandemic, extreme weather events, and the fight for racial and social justice turned 2020 into a year of corporate awakening, bringing social and environmental responsibilities and sustainability practices to the forefront.
These practices fall under the umbrella of environmental, social, and governance (ESG), which has found itself in the spotlight as consumers evaluate companies on how far they’ve advanced their sustainability efforts.
It’s easy to think that ESG is something for large, publicly traded companies to worry about—not financial institutions. In reality, ESG impacts every organization, regardless of size.
The current focus on corporate social and environmental responsibilities are likely why financial institutions are reframing their approach to recruiting, improvement initiatives, community engagement, and more.
Many have begun evaluating the following questions and aligning their answers with ESG strategic practices.
- Do we seek and recruit talented people from across a diverse pool of candidates?
- Are we proactively addressing the environmental impact of the organization and taking measurable steps to improve?
- Do we engage all key stakeholders in the community?
- Does our board represent a diverse mix of members that reflect the community we serve?
- Are our management incentive arrangements aligned with our mission and our promises to stakeholders?
- Do we report out to the community on any of the above matters?
What Is ESG?
ESG provides an opportunity for financial institutions to better serve their market. To do so, a financial institution must first understand the quantitative and qualitative aspects typically analyzed within each factor: environmental, social, and governance.
Environmental factors relate to a financial institution’s interaction with the physical environment, including the following:
- Climate change considerations
- Greenhouse gas emissions
- Environmental policies and regulations
- Renewable energy
- Raw material sourcing
- Water and waste management
Social factors relate to a financial institution’s practices that have a social impact on a community or society, including the following:
- Community relations
- Diversity, equity, and inclusion
- Employee health and safety
- Human capital development
- Labor management
- Privacy and data security
- Product quality and safety
Governance factors include the following:
- Business ethics
- Corporate resiliency
- Board and leadership diversity
- Executive compensation and incentives
- Ownership structure
Governance also considers how well executive management and the board of directors address the needs of the organization’s various stakeholders: employees, shareholders, customers, and members.
The board and leadership diversity factor include considering if the board of directors and management are representative of the community they serve. The Wall Street Journal reported in June 2021 that S&P 500 companies added 456 new directors to their boards in 2020. Approximately three-quarters of the new directors are women or belong to a racial or ethnic minority, which is an increase from 60% in 2019.
Key Benefits of ESG
Organizations focused on meeting their ESG goals have seen the benefits to their bottom line and brand value. By reporting transparently on the ESG factors outlined in mission and purpose statements, those same organizations have increased stakeholder interest.
Investors desires to enact environmental and social change has led them to investing in sustainable funds, as an avenue by which they can support that change. One of many benefits experienced as a result of organizations that implement ESG is evident through increased interest in sustainable-fund investments.
According to Morningstar, sustainable funds are more attractive than ever for US fund investors. From 2016 to 2018, annual flows hovered around $5 billion per year. In 2019, flows increased fourfold to $21.4 billion and, in 2020, soared to $51.1 billion.
Current ESG Trends
US Securities and Exchange Commission (SEC) Regulatory Framework
Due to growing interest and investment in ESG funds, the SEC is integrating ESG considerations into their broader regulatory framework. This is meant to ensure public companies comply with existing climate and ESG-related disclosure requirements.
The SEC has also launched a new page that brings together agency actions and the latest information on climate and ESG risks and opportunities.
Financial Accounting Standards Board (FASB) Staff Education Paper
FASB issued a Staff Educational Paper in March 2021—Intersection of Environmental, Social, and Governance Matters with Financial Accounting Standards—to provide investors and other interested parties with information about the intersection of ESG matters and financial accounting standards.
The educational paper doesn’t change or modify current generally accepted accounting principles (GAAP), but it does provide an overview of ESG reporting and discusses the FASB’s role in setting financial accounting standards.
ESG Global Metrics
There’s currently no standard set of metrics to measure ESG capabilities, but there are comparisons that can be made across an industry.
Further efforts are being made to adopt standard metrics, but one of the world’s most widely used standards for sustainability reporting are the Global Reporting Initiative’s GRI Standards.
ESG Integration in Private Companies
ESG integration isn’t limited to public companies. Private organizations are also taking steps toward ESG integration to better serve their stakeholders and stay competitive in the marketplace.
Many financial institutions, for example, are including their progress in annual reports and on their websites. This reporting includes:
- Diversity and inclusion initiatives
- Actions taken to reduce environmental impact, including switching from incandescent lights to LED or having solar powered buildings
- Added board seats to include a more diverse group
What Financial Institutions Can Do to Integrate ESG
There are numerous steps financial institutions can take to begin integrating ESG with their business practices, such as:
- Define stakeholders by understanding who’s impacted by the financial institution, including employees and their customers
- Define purpose by identifying whether actions taken align with the mission of the financial institution. Actions that don’t align with the mission may result in negative interest.
- Develop and report on metrics to show how the financial institution measures progress
- Establish programs to meet and exceed metrics, including incentives
- Evaluate and refresh these efforts regularly
Stakeholder expectations around ESG and related reporting will continue to rise. As financial institutions reflect on their mission and values, it’s imperative they’re able to measure progress and identify gaps.
ESG reporting gives financial institutions the opportunity to proactively tell their story, share progress, and make plans to improve. To do so in a meaningful way, it’s crucial for financial institutions to understand their stakeholders and develop an ESG strategy for both the present and the future.
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For more information about ESG practices, contact your Moss Adams professional.