ESG: From Niche Activity to Core Priority for All Financial Players

Data Basics Sophie Dionnet

Over the past 15 years, evaluating Environmental, Social, and Governance — or ESG — criteria has gradually evolved from being a niche activity to becoming a major trend for the entire financial industry. The growing regulation in the space combined with the constant pressure from investors and end customers and proven materiality of climate change are acting as powerful catalysts of a deep transformation of the financial industry, impacting all players: banks, asset managers, insurers, and others.

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While the topic is now at the forefront of all financial players’ strategic agenda, successfully embedding ESG in all key financial processes is far from being a given. Developing the right analytics and models, blending traditional financial data with ESG metrics, and ensuring ESG fuels all financial decisions and products with the right impact are among the many challenges companies have to overcome. This two-part blog series highlights how data (and data science) are core to the ESG revolution. 

Unlike financial criteria, ESG remains an ill-defined space where alternative data sources have a major role. Beyond data sourcing, the key to successfully embedding this data in financial organizations — with all employees empowered in understanding ESG impacts and supporting their customers on this front — demands a deep revisiting of business models and the development of agile, collaborative data science and analytics.

financial services

Break Down What ESG Really Means

To understand what is at stake, let’s step back and look at what ESG is about. Environmental, social, and governance criteria are the three main types of extra-financial dimensions all economic players are exposed to. ESG criteria can and should be applied across all financial processes, from investment and insurance to credit scoring and risk identification.

For context:

  • Environmental criteria consider how a company performs with regard to nature (i.e., energy use, climate change, waste, pollution, and natural resource conservation). 
  • Social criteria examine the company’s relationships with its own employees and all other people impacted by its activities, most notably through its supply chain (i.e., do the company’s working conditions demonstrate high regard for its employees’ wellbeing? How does the company guarantee that its supply chain is aligned with the UN Global Compact principles end to end? Does it have community focused activities?) 
  • Lastly, governance criteria focus on the balance in powers and structure of the different governance bodies of each organization, business ethics policies, and factors like avoiding conflicts of interest and giving stockholders the opportunity to vote on important issues. 

Examples of questions financial companies might ask:

  • How do we build resilience to business disruptions caused by climate change and resource scarcity?
  • How can we operate our business more efficiently, realizing efficiencies across all the inputs to our operation?
  • How can a sustainability strategy help enhance our reputation with customers, employees, investors, and analysts and drive value? 

Move Beyond Exclusively Financial KPIs

Let’s look at an example. As an actively growing tech company, Dataiku has an impact on the environment (through business travel, the use of cloud services, facilities, and purchase decisions, to name a few), and could see its activity impacted by different types of environmental events, such as:

  • Directly, by preventing its employees from using its facilities
  • Indirectly, by impacting the activities of its customers and, in turn, their needs from a data science platform standpoint

As all software and service industries, its strongest direct impact is in the social space. The choices made from a hiring, diversity, and employee wellbeing standpoint will play a significant role in its sustainable growth and management of its impact on communities. Further, as any young organization, ensuring that it benefits from a strong governance is a must-have to fuel a balanced growth trajectory.

Ensuring that Dataiku is conscious of its direct and indirect impacts and manages them effectively — notably when it comes to the usage of AI democratization technologies by its customers — plays a critical role to appropriately assess the risks and opportunities of Dataiku’s business model.

This is what ESG is all about: ensuring that financial players do not make their decisions based exclusively on financial KPIs, but also by leveraging extra-financial indicators which are significant revealers of the reality of business models and their impacts. From a financial perspective, the fossil energy sector remains one of the most appealing ones — less with a balanced ESG perspective, backed by the regulatory requirements for financial players to properly manage their climate change risks. 

ESG historically emerged in the asset management space, supported by the desire from a minority of investors to disinvest from the most controversial activities and, instead, align their investments more closely with their values. The last 10 years of acute consciousness of the materiality of climate change impacts, the emergence of binding regulations, and the rise in demand from consumers have made ESG an essential strategic priority for all financial players, including but not limited to: 

1. Asset managers, to answer the demand from the vast majority of investors for ESG-embedded investments, with a full range of possible outputs from light integration to impact funds.  BlackRock, the world’s largest asset manager, puts climate change at the center of its investment strategy, exiting investments that “present a high sustainability-related risk.”

2. Banks, to better integrate ESG risks in their funding activities, answer growing regulatory obligations for climate-related and environmental risks management, and meet demand from the buy side and end-customers for ESG products (indexes, options, green bonds, social bonds, and products, to name a few). All Tier 1 banks have now added climate change management core to their strategic plans. Morgan Stanley, for instance, plans to mobilize $250 billion toward low-carbon solutions between 2018 and 2030, focusing on clean tech, renewable energy financing, and sustainable bonds.

3. Insurance companies, to embed ESG risks in their risk modeling and product development, starting with climate change, and answer their regulatory duties as institutional investors. Aviva has recently announced their ambition to become a net zero company by 2040, the first of its kind in the financial services space, driving the need to fully revisit their ways of operating and investing. 

Make ESG a Priority 

With regulation targeting improved transparency for all stakeholders and enhanced integration of ESG factors in risk management, all financial players will need to significantly reinforce their capacity to model ESG. They will need to embed it in their processes with an agile approach so as to adapt to maturing regulation as well as to differences across geographies and types of customers. 

The capacity to swiftly produce new aggregated analytics for different scopes and thus easily answer varied demands will be essential to efficiently adapt to this moving framework. Stay tuned for our next article in this series which will break down why meeting the demand for ESG is a significant data and modeling challenge (and how to navigate it!).

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