Sustainability in financial services is important – but is it sustainable?

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Simon Gray

A provocative title for an emotive subject perhaps – yet still a very important one and worthy of debate, particularly given recent well-publicised fires raging in Europe, British Colombia and Hawaii and of course resistance to the recently implemented Ultra-Low Emission Zone (ULEZ) in London.

In recent months, a whole host of new regulations with many varied acronyms have come into play – some domestic and some international via the EU for example. These impose new duties and costs on asset and fund managers requiring them to make expensive disclosures. Cynics query their value arguing that few consumers will read them. And there do appear to be too many different authorities setting different obligations – obligations that at first sight appear challenging to fulfil? However, consumers will most likely derive comfort from their existence – but at what cost? And is that cost the cost to the planet of not doing so or the cost of higher product fees for compliance? Saki’s immortal line: “Design in haste, repent at leisure” springs to mind.

Creating a more sustainable future for the world anticipates an all-hands-on-deck approach from financial services industries: Cue Sustainable Finance. On the face of it, this makes perfect sense given that the financial sector holds enormous power in funding and awareness of sustainability, via its high profile in R&D or investing in ethical businesses.

Sustainable finance is defined as investment strategy that factors in the environmental, social, and governance (ESG) factors of economic activity. More specifically, environmental factors include mitigation of the climate crisis and using resources in a sustainable manner. Social factors cover human/animal rights as well as consumer protection and positive discrimination. Governance refers to the management and employee relations of both the public and the private sectors.

But it is not all plain sailing – one wonders whether the benefits of what is realistically achievable have been significantly exaggerated relative to cost and are there risks of politically driven regulation? Might it also be the case that some regulators are trying to prove their green credentials or even competing to be ‘greener than thou’? Saki’s prescient comment may perhaps be reinforced with “careful what you wish for”. Might ULEZ in London evince this? Time will tell.

Sustainable business ethos is the new disruptive force in financial services. It is no longer just marketing spin or prophesying. In the modern world, leaders believe themselves to have been vindicated in thinking differently about environmental and social performance and this is buoyed by increasing regulatory expectations.

The Task Force on Climate-related Financial Disclosures (TCFD) has developed a set of recommendations that are changing the way organisations manage climate risks and opportunities. TCFD is mandatory for all UK companies that are currently required to produce a Non-Financial Information Statement. This includes UK companies that have more than 500 employees and are either traded companies, banking companies or insurance companies. It is organized around the four core TCFD pillars: governance, strategy, risk management, and metrics & targets.

The difference between Task Force on Nature-related Financial Disclosures (TNFD) and TCFD is that TNFD also defines atmospheric systems and processes, including climate change but also wider nature-related issues like air quality, to be part of nature, but refers to TCFD for specifics on disclosure of climate mitigation related risks and opportunities to avoid duplication of recommendations. While there are plenty of acronyms with this subject, there are also plenty of task forces vying to apply their own layers of regulation to an industry in danger of being so burdened with cost after cost, at the ultimate expense of consumers, that they may jeopardize their own aims, as Mayor Khan can attest.

As for the EU’s Sustainable Finance Disclosure Regulation (SFDR), this has a broader sustainability coverage than the TCFD guidelines – the latter focuses on climate change. The SFDR aims to help investors by providing more transparency on the degree to which financial products consider environmental and/or social characteristics, invest in sustainable investments or have sustainable objectives. But guess who pays.

In terms of the recent TCFD requirements, firms in the first phase of disclosure requirements will have found that, as many will have predicted, the process is not straightforward. Examples of challenges faced include data limitations and inevitable divergence between disclosure requirements, be it from TCFD or SFDR. It is a full playing field with endless different obligations – a particular issue where investments cross boundaries for the purposes of marketing. And where data gaps are concerned, the FCA's guidance states that firms are not required to disclose certain information if the lack of data or the methodological challenges cannot be addressed through use of proxies and assumptions, or if to do so would lead to misleading disclosures. But such flexibility introduces subjectivity, which is not always helpful.

A development, welcomed by some, has been the growth in new professional roles - opportunities to some and costs to others. For example, accounting professionals have developed new skills for collecting, collating, analysing, reporting and, of course, selling new business metrics – invariably now mandated by regulators – such as greenhouse gas emissions, ethics and anti-corruption indicators. Treasury departments are expected to understand how climate risk assessment impacts insurance matters and credit facilities, as well as the nuances of green bonds. Finance functions must be able to model renewable energy contract risks and factor-in the costs of ESG reporting and staff training. This is all part of what some see as ‘the ESG dividend’.

A further development in recent years has been a focus on corporate democracy with stakeholder capitalism being the new mantra for the financial future. Shareholders remain vital but are no longer the dominant audience. Now other key stakeholders such as customers, regulators, communities, employees and the broader population all must have their opinions considered. So corporate decision making becomes more sophisticated, but also more cumbersome, complex, blurred and expensive. Pure profit maximisation is no longer a thing.

Those who lament the cost of compliance of these new ESG requirements from regulators, need to consider how investors are demanding greater transparency and accountability from companies, not less. And regulators are inevitably responding to pressure from politicians who respond to pressure from pressure groups. Putting it simply, the customer value proposition is changing, thanks at least as much to regulation as to consumer demand.

Like it or not, it seems likely that sustainable finance is here to stay. It is increasingly part of the mainstream. Whilst the costs of compliance have increased again, this is probably, still, just, less expensive than the costs of non-compliance, with the prospect of regulatory fines, the costs of remedial action and the risks of reputational damage. The FCA’s focus on sanctioning greenwashing is testament to this.

Time will tell whether all this will make a material difference to the world.