In an era where world-changing events are happening with greater frequency, sustainability has become increasingly important to the survival of life and commerce as we know it. The United Nations defines sustainability as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”[1] While not necessarily the same as a large profitable private sector institution such as a bank or fintech company, the U.N. views the private sector as a valuable partner in implementing sustainability goals. Likewise, financial services can look to the U.N. as a driver of change and a partner in developing sustainably. In 2006, the U.N. supported the Principles for Responsible Investment which advocated ESG investment vehicles. Additionally, in 2015, the U.N. launched 17 sustainable development goals as part of a 15-year plan that will certainly influence public policy in the coming years. Financial services firms would do well to model their planning and structures in alignment with these goals.
The International Monetary Fund’s Global Financial Stability Report[3] identifies a link between Environmental, Social, and Governance (ESG) principles in the private sector and global financial stability and shows that failures in corporate governance can undermine financial stability and create environmental and humanitarian crises. It highlights that a lack of corporate governance principles contributed to recent major financial crises, including the Asian and 2007-2009 global financial crises. The report also identifies a net increase in investment in ESG since 2012, showing a definitive increased investor interest in ESG (see below graph). A 2014 study by Eccles et al[4] showed a long-term trend by looking at 90 companies that invested in ESG in the 1990’s versus 90 different firms that had low sustainability investments over 18 years. The study found that the high-invested ESG firms outperformed the low-invested ESG ones overall in both their stock market and accounting performance. Additionally, a 2014 Oxford University study showed a “remarkable correlation between diligent sustainability business practices and economic performance.”[5] All of this evidence demonstrates not only a trend but also a global paradigm shift toward ESG.
While the evidence shows that the increased adoption of sustainability and ESG principles correlates to growth and performance, it is not quite obvious what is driving that growth. Research shows 5 levers that link ESG to value creation[7]:
1. Top-line growth: Companies engaging in ESG practices that are perceived to be beneficial by investors and social stakeholders have a financial advantage through greater access to funding and regulatory approvals, consumer preference, and public willingness to spend more for sustainable options.
2. Cost reductions: ESG is linked with resource efficiency, which has a significant correlation with financial performance, especially in the reduction of cost and “true cost”.
3. Reduced regulatory and legal interventions: In banking, where provisions on capital requirements, “too big to fail,” and consumer protection are so critical, the value at stake from state intervention is typically between 50 and 60 percent. 1. satisfaction and sense of connection. Forward-looking companies note that ESG adoption across the supply chain is an important factor to consider.
4. Employee productivity uplift: Companies that conduct ESG activities can attract quality employees, as strong ESG principles can engender a sense of purpose which helps to retain those employees and increase their productivity by increasing their job1. satisfaction and sense of connection. Forward-looking companies note that ESG adoption across the supply chain is an important factor to consider.
5. Investment and asset optimization: Allocating capital to more sustainable options protects investments and can enhance returns. Regulatory changes like emissions caps and bans on plastics continue and a failure to account for them in forecasting and investment strategy could lead to write-downs, stranded investments, increased adherence costs, and outright losses.
While some of these levers impact some industries and/or regions more than others, successful and profitable companies consider each in their approach to avoid missed opportunities and benefits.
In the past, financial services has viewed fiduciary duty as focusing solely on returns. But as recent legal opinions and regulations have shown, it is a failure of fiduciary responsibility to ignore sustainability. With the FCA enacting ESG disclosure legislation, the EU adopting specific prudential and conduct-based directives, and the Financial Stability Oversight Council (FSOC, made up of several agencies including the US Treasury, SEC, Federal Reserve Board, and Office of Comptroller of Currency) pushing for regulators to enhance legislation around capacity building, disclosure, data, assessment, and mitigation of climate-related risks, there is a clear trend toward increased regulatory focus on sustainability as well as a belief that sustainability is an important component of financial risk. Additionally, real world events have proven to impact value for investments and shareholders. Events like massive oil spills, water contamination, and improper waste disposal, which can all be mitigated through environmental controls, not only carry substantial headline risk, but also can be a major detriment to stock price and return on investment and thus important datapoints for consideration in fiduciary duty. The future of financial services lies in disrupting the old systems and dismantling the status quo by adopting ESG principles and practices. All of the evidence points toward at worst decreased risk (reputational, operational, compliance, strategic, etc.) and at best increased profitability. Companies can only benefit from adopting or accelerating ESG efforts, and should consider all of the causes of ESG growth when doing so to maximize those benefits. As Blackrock’s Larry Fink concluded in his 2019 letter to CEOs: “Profits are in no way inconsistent with purpose—in fact, profits and purpose are inextricably linked.”[8]
Many financial services firms have an existing ESG discipline centered around sustainability. This can include a range of topics from climate change and pollution to labor practices, consumer privacy and corporate behavior. This ESG discipline was historically incorporated into some alternative portfolio investment strategies that began as activist investor platforms. However, cultural shifts and major events have shown that investors and policymakers want more focus on ESG. An example of this apparent investor dissatisfaction with the status quo became evident in the May 2021 vote against sitting Exxon Mobil directors in favor of activist candidates.[9] The culture is further shifting with more firms recognizing the need to go beyond simply considering these principles in evaluating potential investment vehicles. It is now critical to financial stability to recognize that the risks associated with the lack of these principles can create major losses. We can see the global financial impact of the lack of ESG principles in flooding, wildfires, and weather-related disasters, with the World Meteorological Organization tracking between 1970 and 2021 a global impact of approximately $4.3 trillion and rising.[10] We know that a lack of corporate governance leads to global financial crises with some notable examples in the last two decades alone. Improving processes and technology in support of these principles internally as well as applying them to investing can increase profitability and create financial sustainability for firms, their staff, clients, community, as well as the world.[11]
About Bip.Monticello
Bip.Monticello, a member of the BIP Group, is a management consulting firm supporting the financial services industry through its deep knowledge and expertise in digital transformation, change management, and financial services advisory. In partnership with Bip.xTech, we collaborate with our clients to infuse the spirit of data-driven organizations and build digital solutions, helping them make their operations more efficient and achieve a competitive advantage in the marketspace.