Environmental, social and corporate governance and risks for institutions
In detail: Rachel Gordon wonders if ESG is only a question of optics or if there are real risks to be managed?
Financial institutions improve their game on environmental, social and corporate governance (ESG). Indeed, if they do not, they could be criticized by their shareholders, regulators and their customers. Those who continue to green will do so at their peril.
The FCA seeks to be at the forefront in this area and, in early November, released a major discussion paper to coincide with the COP26 Finance Day – the aim was to examine ways in which investors could put ESG at the heart of their investment decisions.
The regulator works on many ESGaspects related to all of its activity, including the appointment of its first manager ESG, defining ways to improve ESG outcomes for consumers and how she wants to improve diversity and inclusion, both within her own organization and across financial services.
The FCA is also working on ways to classify and label investment products so that consumers know if they meet their demands and values - these should be completed by next spring. So, ESG is no longer just a hot topic of discussion – it is increasingly embedded in the way businesses are supposed to operate and the financial services have special responsibilities.
Regarding the implications for insurers, ESG the risks are real and like Sarah Crowther, partner of CAD Beachcroft, says: “The UK turns towards obligation ESG report and this is torn by investor demand and social inflation. From April 2022, the largest UK-registered businesses and financial institutions will be required to disclose their climate change risks.
“The FCAThe July 2021 consultation to July 2021, which focused on transparency around board diversity, tends to suggest that the focus, which until now has been squarely on “E,” is shifting to “S” and “G”. The publication of this data carries the risk of allegations of “green laundering” or even “”ESG-washing’. Even if 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 bigger picture is that more customers will want to know what they might be affected with in terms of risk and if their insurance will cover them.
The UK turns towards obligation ESG reports and this is torn by investor demand and social inflation
Sarah Crowther, CAD Beachcroft
Liz Robinson, Director – Risk Management for broker Tysers, comments: “ESG is a top priority for most financial institutions; employees, customers, investors, shareholders, activists and some governments are pushing 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 in sectors / companies that are trying to reverse climate change. That is, it may not be enough to just stop investing in polluting industries, there is pressure to FIs to invest in the changes necessary to reverse the damage that has been done.
She adds: “Underwriters are interested in customer perspectives and ESG policies – including the types of clients a bank or insurance company accepts, the type of investments in a fund, or whether cryptocurrencies are part of their exposure – due to the high energy costs for storage / mining and also money laundering / black market exhibitions. “
Robinson continues, “In addition to the environmental regulations that have / will be implemented, there will likely be increased regulatory oversight, disclosure and compliance requirements associated with ESG for financial institutions.
“For example, the UK the government has published its intention to mandate the working group on climate-related financial disclosures TCFD report over the next year. We will likely see similar demands from we, Europe and stock exchanges. 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. “
Basically, she says, the top three areas of interest for financial institutions are:
- Comply with current reporting requirements and create a framework for those that will be needed in the future
- Creation and implementation of a ESG policy and culture throughout the company
- Reduce risks to investment portfolios, businesses and clients to avoid those perceived 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 met by their finance line insurance, the damage to reputation can be difficult to rectify.
As Naomi Hall, Partner at Fladgate, says: “As the litigation finance market continues to grow, so too will the shares of shareholder groups. Although there have not yet been any known complaints to the public in England regarding the breach or the reporting or disclosure obligations relating to ESG, this could be the subject of complaints in the future, in particular in the light of the ESG discussion paper published by the FCA in November 2021, which took note of proposals to introduce new rules to introduce new requirements for sustainable disclosure and product labeling.
“This can lead ESG related trends under S90A FSMA under which issuers can be held liable in respect of published information (other than quotation marks) which contains a misleading statement or dishonest omission in relation to securities. Disputes of this nature are already observed in the we where Exxon Mobil was sued for allegedly deceiving shareholders into downplaying the risks to his business posed by climate change.
Meanwhile, James Wickes, partner of a law firm RPC, adds: “ESG is certainly becoming a real problem 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 more difficult to know if an investment meets the green criteria.
James Wickes, RPC
But, while greater transparency on investment products is sought, ESG measures are advancing, as in the case of a number of insurers demonstrating commitment across their operations, such as net zero liabilities and being fair and inclusive employers – measures that should also strengthen stock prices and customer confidence.
ESG protection can remain implicit rather than explicit in the wording of financial lines, but it is on the agenda. Nadia Bagijn, Head of Financial Institutions at Travelers, comments: “There is a lot of work going on in this area, both from underwriters and brokers. It’s basically about knowing your customer – you can have large financial institutions with a solid background in ESG but they could still lend or invest in companies that are big polluters, for example.
“This is why there is so much talk about greenwashing and therefore brokers need to sit down with their clients and educate themselves 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, work in this area being carried out by JLT, circa 2010.
“ESG risks are growing and not just in the climate domain – diversity and inclusion can also have implications for risks. We can see insurances having more stringent conditions, such as exclusions or reduced coverage for personal injury, emotional distress or discrimination for example. But the right protection will also come if brokers listen to what customers want, speak to underwriters, and are clear about what can and cannot be covered.