If there is one thing that financial services organisations agree on, it’s that ESG has become a critical concern within their businesses – and with customers, investors and regulators. This is one of the key conclusions of MinterEllison’s recent Financial Services in Focus survey, which found that every one of the financial services clients surveyed believe stakeholder expectations around ESG have increased.

Despite the unanimity of this response, ESG remains an ambiguous concept for many organisations. Some groups struggle to define what exactly ESG includes, while others arbitrarily pick and choose the parts they want to focus on. This means that different organisations’ ESG strategies can vary dramatically.

Organisations need to be clear on the ESG issues, risks and opportunities that matter most to their business and their stakeholders in order to address them effectively. However, the large variety of approaches in the market can be both confusing and overwhelming.
What’s clear is that maintaining the status quo is not an option. While financial services organisations have a lot to gain by focusing on ESG activities, they also face substantial financial, legal and reputational risks if they don’t.

Climate a key priority for financial services

Given the financial services sector’s leading role in helping finance Australia's transition to a net zero economy, it’s no surprise that climate change is a key focus for the organisations we surveyed.

In recent years, many financial organisations have publicly committed to increasing the climate resilience of their businesses and working with their customers and supply chains to support the transition. Now, regulators, shareholders, customers and activists are homing in on the sector’s activities to call out the discrepancies between what organisations say and what they do in practice. This is evident from the growing number of accusations of greenwashing regarding the financing of new coal, oil and gas projects – many of which are resulting in litigation.

To help them meet their climate change obligations, 72% of the organisations we surveyed have climate change and environmental policies, while 56% have climate change investment strategies. A similar proportion (58%) of respondents said that achieving net zero targets is a concern for them, while 53% have stated net zero emissions targets. Meanwhile, half of the clients we surveyed said they have implemented sustainability and climate change reporting.

While many organisations do have other ESG programs and initiatives in place – for example around human rights or modern slavery, these are often delivered in isolation. This can leave organisations at risk of failing to meet compliance requirements or vulnerable to reputational damage.

Looking beyond the ‘E’ in ESG

Instead of focusing only on specific elements of ESG, financial services organisations need to take a holistic approach. This includes integrating ESG considerations into core business strategies and addressing ESG risks such as climate change as they would address any other strategic risk.

While organisations often focus on headline-generating issues such as climate change, diversity and inclusion, or modern slavery, ESG covers a far broader range of issues that affect how businesses operate.

Considerations may include taking a stance against bribery and corruption, putting in place anti-money laundering provisions and protecting the human rights of workers in developing nations. They may also include making ethical choices about investments. For example, when investing in social infrastructure, organisations need to consider how their decisions and actions will impact on the local community.

ESG issues don’t come conveniently compartmentalised. They are dynamic, multi-faceted and interconnected in ways that aren’t always obvious.

For example, climate change is forcibly displacing many people from their homes. This is leading to a growing refugee problem, which is creating a host of social, political and economic problems that can’t be neatly categorised as ‘climate-related.’

Adding to the complexity, there isn't always a 'right answer' when weighing up ESG considerations. Organisations, for example, must balance the need to supply oil and gas at reasonable prices to vulnerable populations so their immediate needs are met with the need to consider long-term impacts on the environment.

ESG issues, risks and opportunities will look different for different organisations. Organisations need to consider what is important for them, their business strategy and the role they seek to play in society in order to determine what they need to address and subsequently report on.

Financial institutions, for example, are expected to drive change in areas where they don’t have direct control, such as reducing their Scope 3 carbon emissions – indirect emissions that occur in an organisation’s value chain. This is enormously difficult and requires banks and other organisations to influence suppliers and others by making their expectations clear to the market.

Likewise, they may need to consider contractual clauses for their supply chains that reflect what they expect from suppliers in terms of meeting modern slavery, Indigenous matters or anti-bribery obligations, and what they will deliver in turn.

ESG is not a ‘nice to have’ for organisations. Organisations must address environmental, social and governance considerations as part of their business strategy because it makes business sense and the market demands it.”

Cécile Walton, Director, MinterEllison Consulting

Where organisations are faltering

While there’s no question that financial services organisations understand the importance of ESG, many are unsure of how best to address ESG issues, risks and opportunities.

Fifty-three percent of respondents to our survey feel they have enough resources to manage the focus on ESG. However, respondents also say they need help with ESG health checks, risk reviews, direct and management guidance, reporting and disclosure advice.

When it comes to ESG, improving organisational performance boils down to three key things:

• having the right strategy in place, allowing for ESG considerations to be integrated into the business strategy
• adequately resourcing the execution of that strategy to ensure the right people, policies, processes and technologies are in place to enable the execution of the strategy
• reporting on progress and performance comprehensively and transparently, thus allowing internal and external stakeholders to hold the organisation to account.

When managed well, these three components form a virtuous circle that needs to be continually reviewed and refreshed. For boards, this means not only setting the strategy but also keeping management accountable for its implementation. Directors also need to work with management to transparently report on progress and performance. The market will respond quickly on whether that progress and performance is on par with what's expected.

Financial services organisations may also face legacy issues, where existing processes, products or suppliers aren’t aligned with their current ESG strategy. This may force them into making tough decisions as they assess their practices, products and services, and consider what they need to do differently – even if means taking a hit to their bottom line.

Organisations must look at ESG as an integral part of their business strategy and approach to strategic risk. They must also ensure their entire workforce is aligned behind the strategy and committed to its success. This involves widespread consultation and clearly articulating ESG-related roles and responsibilities from the start. This might mean, for example, having leaders responsible for setting investment or lending policies work with team members who implement them to ensure policies can, in fact, be introduced effectively.

Financial services organisations also need to deliver on the commitments they make or risk falling foul of regulators like the Australian Prudential Regulation Authority – as well as shareholders and consumers.

If all you are worried about is reputation or avoiding litigation, rather than considering how you’re going to protect the people, environment and assets involved, it will come back to bite you.”

Andrew Macintosh, Executive Director, MinterEllison Consulting

Contemplating what comes next

Australian organisations are at various stages of their ESG journeys. As with many changes, smaller organisations are finding it easier to rapidly implement new policies and strategies that reflect ESG considerations. However, they often have fewer resources. For larger institutions, the journey is slower and more complex but they're likely to have more resources to support the process.

With the ESG bar for organisations continuing to rise rapidly, the most important thing organisations can do is to jump in and make a start or double down on existing efforts by:

Demystifying ESG by identifying what it means to them

A materiality assessment will help identify the top two or three priorities that align with their business strategy and organisational purpose and values.

Questions to consider include:

• What are the key ESG issues that will affect day-to-day activities?
• What are our stakeholder expectations?
• How are societal expectations impacting us now and into the future?
• What regulatory and reporting obligations should we consider?

Assessing existing governance and risk management frameworks

While expectations and the associated complexity surrounding ESG are constantly evolving and increasing, organisations with the right risk and governance structures, processes, and checks and balances in place will find it easier to manage ESG-related risks.

Boards need to ensure they ask the right questions and then assess and challenge the information that's put forward by management. This process ensures decisions are defensible and can mitigate challenges from stakeholders such as activists, shareholders or regulators.

Ultimately, organisations need to consider ESG risks as part of their existing risk and governance management framework. With the right frameworks in place, organisations will be in a better position to effectively meet market expectations now and in the future. But if risk and governance frameworks and processes are weak and ineffective, it will be very difficult to demonstrate effective management of ESG-related risks.

Building internal capability across their whole organisation

Education, training and support are critical if employees are going to start considering ESG as part of every decision.

Education programs should, at a minimum, explain:

• how the organisation understands and approaches ESG
• the values and approach of the organisation
• the expectations that the organisation has of its people in context.

ESG considerations should also be integrated into other training programs – for example, existing compliance, risk and ethics training.

As with other issues of compliance and ethics that organisations face, team members should be encouraged to ask for guidance and advice if they are not sure what to do about an ESG issue or ‘speak up’ if they are concerned. This includes equipping them with an understanding of how the organisation will protect and support them if they raise legitimate concerns. Like all large-scale change management programs, this will take time.