The financial services industry is the primary driver of an economy and plays a significant role in achieving sustainable development.
Financial institutions providing services ranging from investment, lending, insurance and asset management are critical stakeholders in society regarding Environmental, Social and Governance (ESG) and sustainability.
The adverse shocks and disruptions from sustainability and ESG-related risks can have substantial negative implications for the financial services sector and the economy. This pervasive impact of the financial services sector across all aspects of an economy requires financial institutions to ensure that ESG is well integrated into their corporate strategy.
In recent years, we have witnessed financial regulators such as central banks take proactive measures to ensure that financial institutions integrate ESG into their strategies. However, these institutions must approach their integrations thoughtfully and deliberately to ensure that it adds value to the organisation and contributes to financial success and viability in the short, medium, and long term.
Here are some key considerations when integrating ESG into financial institutions.
One important consideration is for financial institutions to develop a bespoke ESG policy that guides evaluation of their core services. For example, developing a tailored ESG policy that guides investment decisions using a well-defined criterion.
It involves developing clear ESG metrics and data points aligned with the organisation’s strategy that guides the investment process in addition to the traditional metrics already in place.
Another consideration is incorporating ESG across their reserving processes. For example, climate risk requires lenders to consider the impact of physical and transition climate risks on the level of reserves held for credit exposures. Insurers are also expected to make similar considerations when reserving in light of how climate risks could affect the frequency of claims and the amounts paid.
Lastly, ensure that ESG risks are incorporated into overall risk management framework. For example, the impact of climate-related risks on financial institutions needs to be translated into financial risks, such as credit and liquidity risks.
Through this process, organisations can conduct stress testing on their portfolios and build resilience that helps them manage various scenarios that could impact their business.
