Setting the right strategy starts with defining just where and how financial institutions should engage on sustainability. It’s not just a matter of figuring out the right policies, but of identifying the right actions to make sustainable finance a lever for growth. Among the key questions financial institutions should ask:
- Should leadership on environmental (or social) issues be an essential part of purpose, as it is for several automotive and consumer goods companies? Is our engagement on environmental (and social) issues authentic to our culture, brand and products?
- How do we play an active supporting role in transitioning to net-zero?
- How does sustainability intersect with or influence the business strategy and operational models?
- How do we determine how climate change will impact our strategy and operations, and change market demand for our products and services?
- With whom, and how, should we collaborate to facilitate systemic change?
- What is most important to our stakeholders regarding what we do to address climate change?
These questions may lead boards and senior management of financial institutions to think about purpose and the organizational mission. The right answers will help define sustainability goals that suit the organization – that is, those that are authentic, achievable and meaningful, and aligned with stakeholder needs. Further, the most successful strategies will be those that are embedded into the very core of the business, with the right level of leadership and advocacy from the C-suite.
A strong sustainability strategy will ensure that both physical and transition risks are built into corporate risk and compliance frameworks, product development, underwriting and pricing decisions, and other key management decision-making processes. Physical risks may be more relevant to operational resilience, as well as credit, liquidity and balance sheet risk. Some suppliers and outsourcing vendors providing critical services (e.g., call center or technology support) were not ready for the sudden shift to virtual operations. Financial services companies must assess their capacity to sustain operations, as well as that of the businesses they finance and cover, as they assess potential disruptions from climate change. This may present tough decisions on the mix of off-shore, near-shore or onshore operations and third parties.
Transition risks are where sustainability intersects with product and customer strategies. This crosses retail, institutional and corporate clients. For example, companies that aren’t prepared or can’t find a viable transition pathway to net-zero may struggle to survive, especially if their financial services providers do not support the transition. For consumers, the challenges will be getting housing, finance, and insurance in areas adversely affected by climate change.
For banks and asset managers, it’s a question of defining the segments that are worth extending credit to and investing in. For insurers, it’s a matter of adjusting underwriting and pricing models based on more flooding, wildfires and the like – efforts that have already begun. As a whole, the financial services sector should be under no illusion that it can support the transition without financing carbon-intensive industries in the short and medium terms. In reality, brown industries and companies need financing to get to green.
A major challenge for financial services firms will be deciding if, or how, to support the transition. Some financial services firms have decided to stop working with, or investing in, certain sectors or companies. This has been done out of principle or to reduce associated reputational risks. Other firms have decided their role is to support the transition by incentivizing and financing necessary changes. They believe that is more in line with their principles and that the risks can be managed. It’s a tough decision for firms.
Sustainability strategies will balance divestments from some sectors with increasing commitment to others. Again, it’s a matter of asking the right questions:
- What is our pathway to supporting our customers and clients as they transition to net-zero?
- How are we making decisions on where to invest and provide financing? How do those decisions align with our purpose and strategy?
- Which new technologies offer the most promise for the transition to net-zero, and thus are worth financing or investing in? Which sectors or companies are developing or using these technologies?
- What new risk-mitigation products and services can be developed to support customers and clients? What risk or portfolio modeling services do our customers and clients need?
In the context of climate change, there are trillions of dollars to be made via the right investments, with opportunities across many sectors, from renewable energy sources and green housing, to alternative food sources, to smart packaging technologies. For example, the International Energy Agency projects the need for $3.5t in annual global investments to build the infrastructure for a green economy.1
Given the broad consensus that the pace of investment has been too slow, first-mover and fast-follower advantage is still available for investors that make the right moves in the near term. A recent Harvard Business Review report2 confirmed the importance of robust strategies: “Investors are increasingly asking … not whether a company has good intentions, but whether it has the strategic vision and capabilities to achieve and maintain strong ESG performance.” If this is true from an investment angle, it is true in terms of how financial services firms make decisions on whether to fund or ensure that firms are taking climate change seriously.
What financial institutions should do now:
- Identify the link between sustainable finance, net zero and the organizational mission or purpose.
- Map the risks and opportunities related to climate change by business unit, product line and geography.
- Define a clear strategy and vision for sustainable finance – what the organization hopes to achieve and how it will meet its objectives.
- Identify the right organizational structure, including accountable senior executives and board oversight.
- Communicate the sustainability vision and strategy to employees, investors and other stakeholders.
The bottom line: envisioning the long road ahead
Setting a strategic context for climate change should be a near-term priority because sustainable finance is very much a long-term game. Banks, insurers and asset managers should participate in ongoing industry efforts to establish data and disclosure standards. But, establishing the bigger-picture strategic context for the business must be a priority, as it holds the key to navigating the most significant risks and seizing the upside.
Additional Contributor: Judy LJ Li, EY APAC Financial Services Sustainable Finance Leader.