Giulio Mariani
AI Innovation Manager EMEA
Experian

ESG global disruptive impact

Climate emergency is the biggest problem of the 21st Century. People – and not just activists – demand 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 drive large-scale shifts in weather patterns with disastrous consequences for the affected areas, nature, wildlife, and humans.

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

Recent COP26 and G20 confirmed how much the sustainability challenge as well as their associated opportunities and risks are becoming more and more relevant for governments, regulators, non-government organizations, businesses and especially for the 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) became a central topic in all main verticals of the markets, as a response to the social request of a clear change in the way to live and make business.

Business Challenge

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 from them not only to deliver financial performance but also at the same time serve a social purpose. This gives rise to the emergence of a new type of financing activities 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, capacity to measure these results as well as manage the associated risks.

Heightened demand of governments, society, and investors for sustainable financial products as well as increasing pressure from regulatory bodies highlight 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 management and supervision of ESG risks for credit institutions and investment firms.

However, even if a regulation is clearly in place, still there are 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 reality. Corporation are reporting annually information, however there is not still a clear framework for all required information that should be shared. Moreover, most SMEs are not able to share such information. The real challenge for bank is currently to find information on this segment to measure the impact on their business
  2. Methodology: methodology to calculate ESG taxonomy and measure of physical and transition risk have been recently issued by regulators, however the integration in the credit risk standard framework is still quite far from reality in most of banks
  3. Operation and governance: from credit risk to HR, finance, marketing, corporate responsibilities, talent acquisition, all main departments in financial industry are involved in the ESG migration; this is why CEO are setting cross-functions strategy 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 personalized services
  • Boost access to credit to companies investing in green transition, supporting green business and good practises
  • Comply with regulation in a strategic way, making innovation in the way organization monitor credit risk portfolio and plan acquisition strategies

How Experian can help

Experian can help organizations to comply with ESG regulation, with a wide offer of data and technology with business consultants and regulatory experts across EMEA markets.

As said, ESG is a huge challenge, but we can help to facilitate in the risk management area where bureau and alternative data can help to have an end2end 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 framework. We can help 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 advanced machine learning to assign ESG ratings. Finally – combining with Experian bureau data – we 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 how to incorporate ESG risks-related considerations in 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 financial services industry.