Laying ESG Foundations

Elisabeth A. Wilson


December 21, 2021

There is a lot of talk about why intuitions should prioritize establishing Environmental, Social and Governance (ESG) policies, frameworks and risk governance but not many recommendations for how. The concept has been around for years, but myriad factors increased its prominence in the last year: the ongoing COVID-19 pandemic, the unprecedented social unrest in 2020, impending regulatory guidance (specifically around climate change), and an upcoming, younger generation of more environmentally and socially conscious investors. Despite the urgency that these factors bring to the ESG front, there are no formal regulatory expectations or standardized guidelines to help institutions.

For many, the first step toward ESG is especially challenging. Institutions are not one-size-fits-all, so there is no cookie cutter ESG formula. To determine which ESG subcomponents are key for each institution, it must be studied comprehensively. With too little knowledge, an institution risks undervaluing the concept of ESG and the resultant exposures and opportunities the company may face. Too much unfiltered information may result in an institution over-engineering implementation of ESG programs and risk frameworks.

Step One: Establish an ESG Argument

Establishing a strong argument for pursuing ESG programs and risk oversight is necessary to drive constructive conversations. With many regulatory institutions establishing formal climate change-focused committees or officer roles since the start of 2021 (coupled with President Biden’s Executive Order on Climate-Related Financial Risk in May), many may view ESG’s recent trajectory as politically motivated. This can make conversations around ESG somewhat tricky, as board members and business leaders could see ESG as a flash-in-the-pan that will not be as pressing for the next presidential administration, and may be less inclined to give longer-term ESG efforts any weight.

Formal regulatory guidance regarding climate-related financial disclosures is imminent: both the SEC and the Executive Order on Climate-Related Financial Risk indicated that proposed rules would be announced soon. It may seem tempting to hold off on establishing any formal ESG policies or frameworks until these guidelines are solidified, but companies should reconsider. Apart from increasing shareholder and public attention on climate change, the social disparities highlighted by the COVID-19 pandemic have spurred younger adults to prioritize the social and governance aspects of ESG.

These same generations will be inheriting the wealth accumulated by their Baby Boomer parents and grandparents in the impending “Great Wealth Transfer,” meaning that more environmentally and socially conscious generations will drive future investment strategies for years to come. Investors are more frequently leveraging ESG rating agency criteria (compiled by Bloomberg, Institutional Shareholder Services, MSCI Inc. and others) to gauge an institution’s sustainable, environmental, ethical and socially conscious business practices. To remain competitive and attractive to investors, shareholders and consumers in the near-term and to ensure potential regulatory compliance in the long-term, institutions must seriously pursue ESG strategies. This is the message that should be communicated to and internalized by the board and business leaders.

Step Two: Assess ESG Appetite

Next, determining how ESG programs and risk governance should align with an institution’s strategic imperatives is key. Most smaller or moderately-sized institutions will not immediately attain a BlackRock or JP Morgan level of ESG governance, nor may they want to. Determining the scope of ESG within an institution depends on the company’s brand, growth prospects, customer base and operational infrastructure. Some may not want to be ESG leaders or trendsetters and may be quite content simply driving forward-looking policies consistent with ESG.

Right-sizing ESG efforts to institutional goals is essential for any formal ESG program or risk framework, and institutions pursuing the bare minimum may face challenges. Investors, shareholders and consumers are on their guard when it comes to institutions potentially greenwashing standard practices to make them appear more ESG aligned. Having poorly instituted and packaged ESG policies could backfire, causing greater reputational fallout than having no ESG policies at all.

Step Three: Review the Standards

Several ESG standards have been readily accepted as best practices across the financial industry. The SEC and Financial Stability Board (FSB) have signaled they will leverage the Task Force on Climate-related Financial Disclosures (TCFD) guidelines as the basis for their future regulatory governance. TCFD materials are substantial if not fully comprehensive, leaving several key aspects of climate change governance (such as modeling timeframes) up to individual institutions. But the standards provide a tangible infrastructure that is proving to be relatable and scalable across the industry. They also detail basic climate change-focused guidance regarding credit, third/fourth parties, supply chains and an institution’s own carbon footprint that can be leveraged as the basis for developing risk frameworks and metrics.

Where TCFD leaves off, the Sustainability Accountability Standards (SASB) and Global Reporting Initiative (GRI) guidelines pick up. The former focuses on the social and governance pillars of ESG, specifically data privacy, gender inclusiveness, customer experience, product disclosures and appropriate employee incentivization. It recommends GRI, which straddles all three ESG pillars and serves as a subsequent risk framework and metric development beacon. When these and other similar standards are reviewed comprehensively, cross-referenced against ESG rating agency criteria and bumped up against an institution’s own strategic objectives, they form a blueprint for an institution’s initial efforts to establish baseline ESG principles, policies and risk practices.

Step Four: Assess Risk but Remain Flexible

With a sense of ESG appetite, scope and direction, an institution can initiate risk assessments across the pertinent subcomponents of the three ESG pillars to identify exposures and current control infrastructures. This is also where the broader company-wide ESG strategy may start to evolve as uncovered risks and gaps require solutions to shore them up. ESG appetite may also reshape as it becomes clear that risk identification does not necessarily have to have negative connotations. Risk exposures can be harbingers of opportunity and change, where an institution identifies new markets or technologies to invest in, new services to offer to consumers and new ways to reshape its brand and strategic growth opportunities. ESG-driven risk assessments are a chance to evolve an institution’s strategic position in alignment with the insatiable needs and wants of shareholders, investors and consumers, who are themselves reshaping social, economic and environmental expectations. This preliminary work is fundamental to laying an institution’s ESG foundations.

Elisabeth A. Wilson is risk manager at Atlantic Union Bank, Virginia, USA.