Environmental, social and corporate governance and risks for institutions

In depth: Rachel Gordon wonders if ESG is just a matter of optics or are there real risks to manage?

Financial institutions are upping their game when it comes to environmental, social and corporate governance (ESG). Indeed, if they fail to do so, they could face censure from their shareholders, regulators and customers. Those who continue to greenwash will do so at their peril.

the CIF seeks to be at the forefront in this field and, in early November, published a substantial discussion paper to coincide with the COP26 Finance Day – the aim was to look at ways investors could put ESG central to their investment decisions.

The regulator is working on many ESG-components related to its entire business, including the appointment of its first Chief ESG, define ways to better deliver ESG outcomes for consumers and how he wants to improve diversity and inclusion, both within his own organization and across financial services.

the CIF is also working on ways to categorize and label investment products so consumers know if they meet their demands and values ​​– this work is expected to be completed next spring. So, ESG is no longer just a hot topic of discussion – it fits into the way businesses are supposed to operate and financial services have special responsibilities.

Assurance

Regarding the implications for insurers, ESG the risks are real and as Sarah Crowther, partner of CAD Beachcroft, says: “The UK heading towards obligation ESG reports and this is torn apart by investor demand and social inflation. From April 2022, the largest UK-registered companies and financial institutions will be required to disclose their climate change risks.

“The CIFThe July 2021 consultation, focusing on transparency around diversity on boards, tends to suggest that the focus, which until now has been squarely on “E”, is shifting towards “S” and ” G”. Publishing this data carries the risk of claims for ‘green washing’ or even ‘ESG-washing’. Although ESG disclosures are not yet mandatory in the UK, it seems that they are on the horizon which should put ESG firmly on the board’s agenda.

The failures and successes of COP26 remain on the news agenda, but the smaller picture is that more customers will want to know what they might be facing in terms of risk and whether their insurance will cover them.

the UK heading towards obligation ESG reports and this is torn apart by investor demand and social inflation

Sarah Crowther, CAD Croft

Liz Robinson, director – risk management for brokerage Tysers, comments: “ESG is a top priority for most financial institutions; there are pressures from employees, customers, investors, shareholders, activists and some governments to focus on sustainable investments, practices and results.

She points out that some institutions are ahead of others: “Some clients then have a head start in their policies around a proactive approach to sectors/companies trying to reverse climate change. That is to say, it may not be enough to simply stop investment in polluting industries, there is pressure to FIs to invest in the changes needed to reverse the harm that has been done.

She adds, “Underwriters are interested in customer insights and ESG policies – including the types of customers a bank or insurance company supports, the type of investments in a fund, or whether cryptocurrencies are part of their exposure – due to high energy costs for the storage/mining and also money laundering/black market type exposures.”

Compliance

Robinson continues, “In addition to the environmental regulations that have been/will be implemented, it is likely that there will be increased regulatory scrutiny, disclosure requirements and compliance associated with ESG for financial institutions.

“For example, the UK the government has published its intention to appoint a task force on climate-related financial disclosures TCFD report next year. We will likely see similar demands from we, Europe and the stock markets. Other non-financial risks are also on the agenda, including diversity and inclusion, flexible working, executive compensation, other social issues, such as Black Lives Matter.

Broadly, she says, the three main areas of focus for financial institutions are:

  • Comply with current reporting requirements and create a framework for those that will be required in the future
  • Creation and implementation of a ESG company policy and culture
  • Reduce investment portfolio, business and customer risks to avoid those considered to exacerbate climate change.

For many, none of the above is easy. But those who fail but expose themselves to litigation and even if the costs are covered by their financial lines insurance, the damage to reputation can be difficult to repair.

Dispute

As Naomi Hall, Partner at Fladgate, puts it: “As the litigation funding market continues to grow, so will the actions of shareholder groups. Although there have not yet been any publicly known claims in England relating to breaches or reporting or disclosure obligations relating to ESG, this could be the subject of claims in the future, especially in light of the ESG working document published by the CIF in November 2021, which took note of the proposals to introduce new rules to introduce new sustainable disclosure requirements and product labeling requirements.

“It can lead ESG related trends under S90A FSMA under which issuers may be liable for published information (other than listing memoranda) that contains a misleading statement or dishonest omission regarding securities. Disputes of this nature are already observed in the we where Exxon Mobil was sued for allegedly misleading shareholders by downplaying the risks to its business posed by climate change.

Meanwhile, law firm partner James Wickes PRC, adds:ESG is certainly becoming a topical issue for the asset management industry in particular. Many investors are clear on what is on offer if they choose a particular fund, but when it comes to sustainability it can be much more difficult to know if an investment meets the green criteria. There is a lack of standardization and definitions and you could get some really big claims in this area.

When it comes to sustainability, it can be much harder to know if an investment meets green criteria

James Wickes, PRC

Progress

But, while more transparency around investment products is sought, ESG measures are progressing, as in a number of insurers making commitments across their businesses, such as net zero commitments and to be fair and inclusive employers – measures which should also strengthen share prices and the customer confidence.

ESG protection may remain implicit rather than explicit in the wording of the financial lines, but it is very much the order of the day. Nadia Bagijn, Head of Financial Institutions at Travelers, comments: “There is a lot of work going on in this area from underwriters and brokers. It’s all about knowing your customer – you can have large financial institutions with a strong track record in ESG but they could still lend or invest in companies that are big polluters, for example.

“That’s why there’s so much talk about greenwashing and so brokers need to sit down with their clients and learn about them, their risks and the role of insurance. This is, of course, what many do. But this is not a new area for insurers either, for example carbon trading risks have been covered for years, with work in this area being led by JLT, from around 2010.

ESG risks are growing and not just in the climate realm – diversity and inclusion can also have risk implications. We may see insurances have stricter conditions, such as exclusions or reduced coverage for bodily injury, emotional distress or discrimination for example. But the right protection will also come with brokers listening to what customers want, talking to policyholders, and being clear about what can and cannot be covered.

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