Several factors have contributed to the heightened awareness of the importance of sustainability and its social, economic and environmental effects — particularly in the banking sector. The Paris Agreement on climate change, the driving force behind the UN’s sustainable development goals (SDGs), has resulted in a $12 trillion market each year, and the potential for $90 trillion investment opportunities before 2030.
Changing investor concerns and increasing engagement in environment and social issues has given rise to emerging mandates and legislation. These include: the European Union’s mandatory disclosure on sustainability performance by the financial services sector for large public-interest companies and the Financial Stability Board’s Task Force on Climate Related Financial Disclosures (TCFD).
Larry Fink, CEO of Blackrock, in his 2017 letter to investees stated “As wealth shifts and investing preferences change, environmental, social, and governance issues will be increasingly material to corporate valuations.”
Both the Abu Dhabi Exchange and Dubai Financial Markets are now members of the Sustainable Stock Exchange Initiative (joining 83 stock exchanges). In January, 25 local entities — many of them banks — signed the Abu Dhabi Sustainable Finance Declaration, announcing their intent to advocate sustainable finance and investments focused on driving long-term socioeconomic and environmental development.
So what is the banking sector’s role in supporting the growing space of sustainable finance, and how is sustainability reporting supporting this trend?
Although there has been an increase in the dialogue and rhetoric regarding sustainable finance, the mobilisation of both private sector and government capital continues to be measured. Some of the key barriers to sustainable finance include:
Regulatory and policy gaps (including uncertain and inconsistent regulatory/policy regimes and differing regulatory regimes across regions) Transfer of knowledge and skills from the developed world to the developing, particularly in the area of project generation; Technology innovation to reduce cost (new technology/improvements); Challenges of attracting and mobilising finance/investment into emerging economies given the level of inherent risk and risk/reward balances; Challenges and costs associated with relevant micro projects and/or the lack of large-scale projects; and Need for sound transparent disclosures to support investment decisions and due diligence processes, analysis and emerging new valuation methodologies.
The role of sustainability reporting
With credit risk and valuation approaches increasingly shaped by environmental, social and governance-related input, there is a pressing need for better reporting and market disclosures. Financial data alone is no longer sufficient.
In the Middle East, banks are only beginning to leverage the available environmental and social data to inform actionable business insight. At the same time, they are gradually putting more emphasis on sustainability reporting — though there is room for improvement.
In KPMG’s 2018 Corporate Responsibility Reporting Survey, of the top 100 largest organisations by revenue in the UAE, 37 per cent of banks were reporting their sustainability performance.
In the banking sector, sustainability reporting may be useful in the following key areas.
Sustainability considerations and analysis may allow banks to access new markets and explore new client engagement approaches. Examples include the Australian New Zealand Banking Group, which announced a sustainable finance target of USD 7.1 million, and appointed a head of sustainable finance. Locally, First Abu Dhabi Bank issued the only green bond in the market in 2017. We have also seen banks begin to introduce ‘green loans’ and SDGs social bonds.
Banks are aiming to implement sound risk-management processes, which involves aggregating, managing and integrating sustainability data and metrics with financial data to help understand and reduce their risk exposure. The assessment of climate risk exposure across lending portfolios is an example.
Sophisticated valuation approaches have emerged, where banks look to incorporate non-financial considerations into valuation considerations, recognising that the ability to see the whole picture is fundamental to valuing a company. Considering sustainability related performance has been found to identify potential upsides, where companies manage such issues better than their peers.
Sustainability reporting could also improve stakeholder engagement, brand reputation and social license to operate for banks. Other stakeholders such as consumers, governments and non-governmental organisations are demanding greater transparency and accountability.
Sustainability reporting goes beyond the carbon footprint and health and safety initiatives. Frameworks prescribe that companies should report on topics that are material to their company and their stakeholders.
Financial institutions differ from most organisations in that their main impact is indirect, through their investments or lending portfolios, so sustainability performance should include both indirect and direct effects. Considerations include:
■ Disclose sustainability or the environmental, social and governance (ESG) policy of the bank. For example, is there an exclusion policy in the investment strategy?
■ Disclose the exposure to environment and social risks through lending and investments.
■ Report on the positive impact made through the investments of the institutions and set targets for this impact.
The lack of disclosure of sustainability data can represent a challenge. However this is gradually being addressed by governments in the region and stock exchanges.
Christiana Figueres, former head, United Nations Framework Convention on Climate Change, said that “Rivers of capital need to flow to assets and projects that are the right ones for the 2050 world we have to build.”
Organizations would be well advised to include sustainability reporting within this list of projects, as it can act as an enabler for sustainable finance and facilitate the promotion of sustainable development.
The drum beat of “meet or beat the quarter” is increasingly being challenged by a chorus of investors, employees, customers, and other stakeholders calling for greater focus on the long term.