ESG norms for Banks
In the ’90s, when I was beginning my Banking career, my supervisors emphasized on the benefits of thoroughly reading the Bank’s Credit Policy & Manual. I recollect to this day, the Credit Manual pressing on the areas in which the Banks should avoid financing – ‘industries producing harmful greenhouse gases and producing substances that are harmful to the environment’. Traditional banking system always aimed at reducing the carbon footprints although their primary objectives have continued to be profitability, optimizing shareholders value and managing industrial relations. Later, while studying Islamic banking, I also found clear demarcation between Halal (acceptable) and Haram (unacceptable) areas for financing which included items hazardous to the environment and sectors involving exceptionally high level of uncertainties. Islamic finance re-emphasizes the stewardship responsibilities in maintaining the balance in the ecosystem and driving productive behaviour.
Europe has been a front runner in the propagation of many important regulations and innovations that have deep impacts on the financial industry; the Open Banking System, Neo Banks, GDPR Norms on data privacy. The impact of these new thoughts translated into regulation has not only influenced the European countries but also the world economy as a whole. The recent Whatsapp & Facebook debacle brought in prominence the issue of sharing and using unauthorized private data across the emerging economies of the world.
The European Union has been leading the agenda of “Sustainable Financing” along with many other countries. Sustainability is about meeting the needs of the present without compromising the ability of future generations to meet their needs. The starting point has been the adoption of the UN-SDGs (United Nations- Sustainable Development Goals). The United States administration also has large emphasis on the climate change related initiatives.
The European Union's (EU's) recent Sustainable Finance Disclosure Regulation (SFDR) 2021, has made it mandatory for corporations across Europe to provide Non-Financial Reports along with their standard financial statements, in the areas of impacts on ESG (Environmental, Social and Governance) parameters. It has now been compulsory for all corporations & funds to comply with the SFDR norms by June ’22.
Now, how does it affect the emerging economies of the world?
European Investment Banks, Institutional Funds, Private Equities (for example the likes of Norfund, CDC, Rabo Bank, Proparco & many others) have significant investments across emerging economies in the world including many countries in Africa. Many European Banks also have their subsidiaries, Rep Offices and branches in these countries. The Regulation requires that these corporations in Europe not only comply with the Non-Financial Reporting guidelines in their home countries but across their investments in Banks /Corporations across the world. European Banks have also been mandated to ensure the companies in which they have financed and have more than 500 employees complied with the ESG guidelines and are making conscious strategies & investments for reducing the carbon footprints and strive to achieve the Net Zero Levels of carbon emission. For annual reports as of 2018 onwards, the NFRD requires large companies to publish regular non-financial reports on employment diversity and the social and environmental impacts of their activities. The broad areas of interest in the NFRD are environmental protection, social responsibility and treatment of employees, respect for human rights, anti-corruption and bribery and diversity on company boards. The NFRD provides companies flexibility to set the non-financial KPIs and disclose information basis of relevance and usefulness.
Some emerging countries like Ghana have taken it up seriously in rolling out their Ghana Sustainable Banking Principles (GSBP) in 2018 created through Sustainable Banking Committee under the guidance of the Central Bank- Bank of Ghana. The committee also comprised the Environmental Protection Agency (EPA), Ghana Association of Bankers (GAB) and six banks operating in the country.
The GSBP framework has been made up of seven principles that provide sustainability integration considerations for a bank’s business activities and operations. In addition, there are five sector guidelines that provide additional guidance to banks on lending to these high-risk sectors - Energy and Power, Construction and Real Estate, Agriculture and Forestry, Manufacturing, and Mining, Oil and Gas.
The Reporting requirements are captured in the Principle 7, meeting the Sustainability Reporting Standards of the GRI (Global Reporting Initiative). The Universal Standards of GRI can be broadly classified under Economic, Environmental & Social categories. Bank of Ghana has decided to roll out monitoring and supervision of the principles in a phased manner.
Banks Boards has been advised to create a Sustainability Champion with the organization and create a revised rating tool to measure all their corporate investments on their ESG compliance journey. They are expected to have regular communication with the Sustainability Officers in their customer organizations to track progress.
It is said that 70% of the footprint of sustainability lies in the entire Supply Chain. Hence, all internal suppliers, vendors and even SME customers are also set measurable goals for achieving the ESG guidelines, off course without significantly escalating operating costs.
Now we may argue that the environmental and social consciousness in corporations is nothing new. We have been dealing with diversity issues through our Human Resource Departments, avoiding unethical financing through our Credit Department and Board Supervision. Companies have formed their CSR (Corporate Social Responsibility) wing and have shared a percentage of their profits with a non-profit foundation and invested in social activities. Why do we need a new regulation and compliance?
Many of the corporations have indeed been dealing with the ESG matters separately on a case-to-case basis, but their concentration has still been achieving the financial goals which is actually the initial goals of sustainability.
So, the bigger question is ‘Have we embedded the ESG impacts into our corporate strategy and business plan?’
Do organizations have a target of achieving Net Zero levels with a timeline?
Are we investing in new technology to achieve higher standards in terms of Carbon footprints?
The EU’s NFRD (Non-Financial Reporting Directive) and the SFDR norms have laid the path -the direction towards compliance. Key framework to the NFRD guidelines:
Although left to self-policing, corporations need to strive towards better compliance to manage their reputational risks. The penalty measures for non-compliance have been left for the individual countries to decide.
We would like to believe that the ‘stick’ may not be the correct tool for driving behaviour. But we cannot ignore the initial success of the ‘quotas’ while driving gender diversity across Banks and Corporations. We have seen how Banks and Financial Institutions (FIs) made sweeping changes in the way they perceived Operational Risk with the implementation of the Basel 2 guidelines with Banks required to hold additional capital against the operational risk exposures. We have to believe that strong and robust regulation shall drive behaviour and a unified approach for Non-Financial Reporting Guideline shall improve collective consciousness and drive sustainable investments across all categories of investors and not just a handful of environmentally conscious millennial investors.