Giulio Mariani
AI Innovation Manager EMEA

ESG global disruptive impact

The climate emergency is the biggest problem of the 21st Century. People – and not just activists – are demanding actions and solutions to solve this.

Humanity is facing several challenges which will define its chances for survival in the coming future. Climate change and associated global warming, mainly caused by human-induced emissions of greenhouse gases, are driving large-scale shifts in weather patterns with disastrous consequences for the affected areas, nature, wildlife, and humans.

At the same time, the pandemic changed the dynamics of the global economy. Digitalisation has become more and more important in people’s daily life. The “Human impact” has become more important than the economic impact and issues related to human equality and societal welfare are becoming a prime concern.

The recent COP26 and G20 confirmed how much the sustainability challenge, as well as their associated opportunities and risks, are becoming more relevant for governments, regulators, non-government organizations, businesses and especially for financial institutions — since they have a significant role in the fight against climate change and social injustice, particularly in their choice of funding and investments.

In this scenario, Environmental Social Governance (aka ESG) has become a central topic in all main verticals of the markets, as a response to the social request of a clear change in the way we live and conduct business.

Business Challenges

All industry verticals must change traditional business models to respond to environmental concerns.
Companies who adhere to ESG attract purpose-driven talent, responsible investors, and outperform traditional companies.

The new reality which financial institutions are facing today requires them to not only deliver financial performance but at the same time serve a social purpose. This gives rise to a new type of financing activity called sustainable finance. In the European Union sustainable finance has a key role to play regarding the policy objectives under the European Green Deal as well as the EU’s international commitments on climate and sustainability objectives.

However, financial institutions need to ensure that every finance product marked as ‘sustainable finance’ is worthy of that label, which requires a transparent methodology, the capacity to measure these results as well as to manage the associated risks.

The heightened demand on governments, society, and investors for sustainable financial products, as well as increasing pressure from regulatory bodies, highlights the need for financial institutions to consider ESG risks in their risk management framework. Therefore, for financial institutions sustainability is not just an ethical question, but also an economic question which drives a new type of risks: ESG risks, mainly labeled as “Physical” and “Transition” risks.

Globally, main central banks (like ECB, BoE) have already issued clear requirements for financial firms to comply with clear rules and requirements. In June 2021, BoE published its climate-related financial disclosure (SS3/19), which sets out the approach to managing the risks from climate change across operations and in September 2021, EBA publishes its report on the management and supervision of ESG risks for credit institutions and investment firms.

However, even if a regulation is clearly in place, there are still many open questions and challenges to be faced from the whole banking sector.

The challenges:

  1. Data: reliable information on ESG factors is still very far from being a reality. Corporations are reporting annual information, however there is still not a clear framework for all the required information that should be shared. Moreover, most SMEs are not able to share such information. The real challenge for banks currently is to find enough information on this segment to measure the impact on their businesses.
  2. Methodology: methodology to calculate ESG taxonomy and measure the physical and transition risk have recently been issued by regulators, however the integration in the credit risk standard framework is still quite far from reality for most banks.
  3. Operation and governance: from credit risk to HR, finance, marketing, corporate responsibilities, and talent acquisition, all these main departments in the financial industry are involved in the ESG migration; this is why CEOs are setting cross-function strategies to deploy this into organizations.

Commercial Opportunities:

  • New data sources can help to have wider and deeper knowledge of your customers, helping them with more personalised services.
  • Boost access to credit to companies investing in green transition, supporting green business and good practices.
  • Comply with regulation in a strategic way, making innovations in the way organisations monitor credit risk portfolios and plan acquisition strategies

How Experian can help

Experian can help organisations to comply with ESG regulation, with a wide range of data, technology, business consultants and regulatory experts across all the EMEA markets.

ESG is a huge challenge, but we can help to facilitate the risk management area where bureau and alternative data can help provide an end-to-end vision of climate-risk into credit processes.

Experian ESG solution let’s our clients get access to ESG data, taxonomy and analytics models to measure ESG factors into credit risk frameworks. We can provide help to all businesses, from large corporate ESG ratings to SME companies, using traditional and alternative data assets.

We combine web crawling methods to collect and aggregate raw ESG data and use advanced Machine Learning to assign ESG ratings. Finally, we combine this with Experian bureau data to offer a framework for credit risk analysis of ESG physical and transition risks.

Future Outlook

The risks related to climate change and social issues are expected to intensify in the coming years and be at the top of the list of bank executives’ concerns. In the European Union regulators such as ECB and EBA provided guidance to the financial institutions on how to incorporate ESG risk-related considerations into their strategies and objectives, governance structures and risk management frameworks. For example, the new EBA loan origination and monitoring guidelines require the usage of ESG ratings for portfolio underwriting and management.

Therefore, ESG strategies will grow rapidly in the future and ESG information will be used for investment and risk management decisions across all main industries, especially the financial services industry.