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MERJE Insights: ESG is on the rise, but what is it?

  • Publish Date: Posted over 3 years ago
  • Author:by Kirstie Burn

​During these testing times, it seems that we’re all becoming more mindful about the people and environment which surround us. This has given rise to Environmental and Social Governance (ESG), which refers to the central factors which measure the sustainability and societal impact of an investment in a company or business.

It’s precisely these criteria which help to ascertain the future financial performance of companies, which is why we need to pay heed to implementing such policies over the course of 2021 as we try to heal and recover in the current climate.

This comes after the recent news that Credit Suisse expanded its ESG teamin a bid to drive integration across the bank and fuel the Swiss lender's ambition to be a leader in sustainability, and the UK government announceda £10 million investment into green finance hubs that will provide data and analytics to financial institutions to support their investment and business decisions by considering the impact on the environment and climate change.

But what exactly is ESG and why does it look set to be big news in 2021?

Traditionally, the term ESG brings to mind environmental issues like climate change and resource scarcity. Indeed, they do form a vital function of ESG, but the concept encompasses so much more than that alone.

For example, it covers social issues like a company’s labour practices, talent management, service delivery, product safety and data security. It also addresses governance matters like board diversity, inclusion, executive pay and business ethics.

Watchdog the FCA, in particular, set the wheels in motion, by placing increased focus on the ESG arena, which has resulted in more businesses having to conform to designated frameworks and policies. This came after a move in March 2020, in which the FCA announced new efforts to help provide transparency to the risks which companies face due to climate change. Now, we are starting to see the tangible effects of this initiative, as evidenced by the latest update from Credit Suisse.

The regulator’s proposal requires all companies listed on the UK’s premium stock markets, including on the FTSE, to toe the line with comprehensive new climate standards. This is because efforts to increase transparency around the private sector’s climate change impact have developed steadily in the past couple of years as the issue became more prevalent and talked about on the world stage.

The FCA proposal draws on the recommendations envisaged by the Task Force on Climate-related Financial Disclosures (TCFD), which is one in a number of initiatives aimed at reviewing how the private sector addresses financial risks related to the climate crisis.

The FCA proposal went on to embrace the TCFD’s recommendations for premium listed commercial companies. In 2017, the TCFD established one of the most comprehensive standards for climate disclosure in the world, presenting a number of interconnected proposals intended to help companies identify, assess and mitigate climate-related risks and opportunities. These propositions have since emerged as the leading framework for climate change reporting and focus on four complementary elements:

1.Governance: Transparency regarding a company’s governance around risks and opportunities concerning climate-related issues.

2.Strategy: Disclose the existing and tentative impacts of climate-related risks and opportunities on strategy, operations and financial sustainability.

3.Risk Management: Transparency concerning the identification, assessment, mitigation and management of climate-related issues.

4.Metrics and Targets: Disclose the metrics and targets used to assess and manage relevant climate-related issues.

So why must the private sector take ownership and embrace ESG efforts?

The present climate emergency calls for all parties to combine their efforts in order to decrease and prevent the negative environmental impact the world is facing today. This is particularly true for the private sector, with commentators saying that the FCA guidelines marked a significant step for climate disclosure and that companies who don’t respond would be likely to struggle.

Although many regulatory bodies across the globe first started to emphasise the importance of sustainable investment through non-binding standards and measures, regulators such as the FCA are increasing their pressure towards the private sector. Governmental agencies have since set out concrete policy changes which were supported by binding regulatory requirements.

In late 2019, the European Union adopted a regulation on sustainability-related disclosures in the financial services sector. This Disclosure Regulation, which comes into force early this year, aims to further coordinate present European policies on sustainability-related disclosures by introducing new requirements on financial advisors and financial market participants.

Similar to the FCA’s proposal, the EU wishes to enhance the transparency of professional investors and financial advisors by disclosing the potential negative ESG impacts of their investments. Accordingly, investment products which already claim to be sustainable will face further legal scrutiny and are required to provide even more detailed information to avoid fraudulent claims.

Why is exemplary risk management essential as a result?

The high number of new regulatory demands the private sector faces due to recently proposed legislation in the UK and elsewhere showcases the importance of developing a comprehensive due diligence and risk monitoring process so companies can respond in real time to a variety of issues.

If you would like any advice to help mitigate compliance-related risks, we can help you to identify possible negative ESG impacts concerning your company and enhance transparency of third-party operations, assessing potential climate-related risks and opportunities in your network. Please feel free to get in touch