August 16, 2022
Within a relatively short period, environmental, social, and governance (ESG) topics have entered the mainstream and become a frequent topic of conversation in board rooms and executive suites in every business sector. How might the regulatory environment change, and what are the implications for the banking sector?
ESG and the Coming Wave of Regulations
While the ESG is now part of the public consciousness, regulatory oversight of ESG-related issues remains disjointed and confusing. This confusion largely stems from the breadth of areas under the ESG umbrella. Consequently, ESG compliance ranges from self-imposed rules and practices to complying with stringent government regulations. Nonetheless, there’s a growing body of rules and regulations for ESG under development.
The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC)have issued climate-related risk management principles. Similarly, the Commodity Futures Trading Commission (“CFTC”) recently requested input on climate-related financial risk. Additionally, the Federal Housing Financial Agency (FHFA) has focused on climate change and most recently announced its membership in a network of central banks focused on greening the financial system.
The Securities and Exchange Commission (SEC) is playing a particularly active role in shaping the ESG regulatory environment. It has committed to an ”all-agency approach,” which includes a recent proposal to enhance disclosures by certain investment advisers and companies regarding their ESG investment practices.
While much of the current regulatory activity pertains to environmental issues, increased, oversight of social and governance will inevitably follow. Notwithstanding the complicated regulatory environment, investors, customers, employees, and activists are becoming increasingly vocal on ESG-related matters. While satisfying regulatory requirements is critical, financial institutions will face growing pressure from various stakeholders to address all forms of ESG risk.
The Building Blocks of an ESG Compliance Program
From protecting the environment, promoting social equity, and establishing robust governance, ESG will require financial institutions to rethink every aspect of their operations. So how can your financial institution focus on ESG, prepare for changes in the regulatory environment, and meet stakeholders' expectations?
1. Make ESG a strategic imperative
Starting with your board of directors, establish the importance of ESG. This includes identifying senior executives who will assume responsibility for critical ESG-related initiatives. During each board meeting, set aside time to discuss the efforts underway to address ESG topics. It might also make sense to restructure executive compensation packages to incorporate the achievement of ESG-related goals.
2. Ensure consistent executive communication
Addressing ESG-related topics effectively requires changing your financial institution’s strategies and corporate culture. This requires that employees understand why ESG matters and why there is a need to change how your bank operates. Make sure executives communicate in clear and compelling terms the importance of ESG and how each employee can help support the effort.
3. Embed ESG within your policies and procedures
Focusing on ESG will require revisiting and updating your bank’s policies and procedures. For example, when sourcing third-party vendors, does your bank scrutinize the provider’s environmental practices? When it comes to hiring, has your bank focused sufficient resources on ensuring diversity and equity in new hires? As you update your business practices, involve your legal department or third-party firm to ensure your actions do not create legal liability.
4. Incorporate ESG within your risk management frameworks
ESG risk frameworks are in their infancy. To identify, evaluate, mitigate, and report ESG risk, consider embedding it within existing risk frameworks. While ESG includes many elements, consider it a discrete form of risk. By doing so, you’ll be able to adopt risk management best practices, such as designating ESG risk owners, identifying key risk indicators, and leveraging existing reporting protocols to raise organizational awareness.
5. Engage suitably qualified third parties for guidance
ESG is a new area of focus, and there’s a great deal of confusion regarding how best to tackle the risk and opportunities it presents. Specialized consulting firms and well-known national and international firms offer a range of services to help financial institutions tackle ESG-related issues. Many also publish articles, research papers, and surveys related to ESG, which can provide insight into the latest ESG trends and best practices.
ESG is a dynamic risk area that will present financial institutions with complex compliance challenges for the foreseeable future. While delaying your ESG compliance efforts is tempting until the regulatory picture becomes clearer and best practices appear, pressure from investors, employees, and activists will only intensify. Furthermore, given the breadth of topics covered under ESG, compliance will require a sustained effort, including a willingness to reimagine almost aspect of your financial institution's operations. Such efforts take time and require immediate action to accomplish in a reasonable period.
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