Environmental, Social, and Governance issues are increasingly becoming the priority for financial boards around the world. Even though these topics have been on the industry’s radar for decades, interest in recent years has peaked in the sector. Critical insights from climate researchers, along with the spread of the Covid 19 pandemic, have put the world into fast gear. Critical movements against racism have also stayed at the center of attention of leading nations around the world. This transition has forced companies to prioritize employee well-being, diversity, and public health as critical factors during corporate decision-making. The purpose of ESG integration is to explore optimal pathways that balance economic prosperity and social impact.
Across the financial industry, the decision to integrate ESG factors into investing has helped companies benefit from significant growth. Estimates suggest that a significant percentage of global managed assets are directly impacted by ESG factors. Especially during the past few years, ESG focused products and services have been devised to offer viable products to address increasing public demand for ethical investment avenues. The current pathway has provided a clear path forward for the financial services industry to pave the way to a sustainable lower-carbon shift.
Challenges for Boards Around the World
Despite the positive direction observed in the ESG market, it is challenging for mutual funds and financial companies to integrate ESG products into financial services. The primary challenge for global boards is to explore the answer to the lack of accepted reporting standards. It can be challenging for companies to compare ESG progress without having common metrics to evaluate the growth trajectory. Currently, different agencies adopt variable evaluation mechanisms, which make it complex to have a uniform comparison standard.
Based on our positioning and engagement with the global financial services industry, DIF has identified the following key challenges for global directors to address regarding ESG issues.
Incorrect Marketing of ESG Integration
The greenwashing phenomenon is increasingly being witnessed around the globe as companies attempt to benefit from the positive impacts of ESG marketing. The process occurs when companies intentionally or unintentionally market products as being ESG friendly using technical marketing barometers to benefit from an increase in sales. DIF analysis points to several funds that have remarketed themselves as ESG funds to benefit from increased shareholder interaction after the rebrand. Lack of established industry standards complicate the investment process and make it challenging for end-consumers to have clarity over the quality of their chosen products. Directors need to ensure that ESG products are effectively labeled through a comprehensive vetting procedure. Issuers are also referring to 3rd parties to corroborate ESG offering and establish an independent layer of verification for labeled products.
3rd Party Risks in ESG Implementation
Currently, most companies are relying on 3rd parties to assist them with ESG integrations. These parties include subadvisors and services providers. Companies need to develop internal expertise regarding ESG integrations to ensure that they are able to mitigate the risks that emerge from working with 3rd party companies. Implementing a comprehensive ESG framework requires adherence to established standards requirements. The board of directors needs to explore ESG with relevant stakeholders and elevate their internal standards to completely comply with established requirements. Over 20% of existing directors express 3rd party risks as their primary point of concern with ESG integration.
Lack of Board Oversight on ESG
Fund boards need to have stronger involvement in ESG elements of the company. Aside from complying with fiduciary requirements, ESG elements also make up a significant element of the company’s competitive strategy in the market. Existing input from fund managers and directors showcases that board involvement is currently amongst the most ignored issues at leading companies.
Risks of Proxy Voting
Implementing a comprehensive voting structure is essential to communicate shareholder values and address ESG progress requirements. Even though proxy voting is a fiduciary requirement, there is also major reputational risk involved with the voting process. It is currently a major challenge for company boards to devise deliberate voting policies to prevent proxy voting on critical company proposals and developmental steps. Moreover, the growth of social media has further amplified the reputational hazards associated with the process.
Failing to Capitalize on ESG Prospects
Even though the general industry-wise trends with ESG integration are highly positive, these results cannot be achieved without having a comprehensive ESG strategy. Without having a clear marketing and operational strategy, companies cannot attract new customers and stakeholders in the ESG domain. Developing trust in the customer segment is a significant competitive advantage that can help companies grow faster than competitors.
Implementing Higher Mandatory Disclosures
Financial organizations are constantly facing pressures from core stakeholders to increase operations standards. Managing ESG issues and engaging with the sustainable financial market is a key requirement for the board of directors.
The current standards implemented in the corporate landscape are insufficient to meet the requirements of ESG integration at the corporate level. Substandard ESG disclosures can have a detrimental impact on company reputation and standards. Directors need to explore mechanisms to provide accurate disclosures to fund managers and financial advisors to validate the trajectory of the companies.
Conclusion – Looking Ahead
Boards need to recognize the importance of sustainability and ESG elements in the company’s marketing and branding. ESG implementation has become a significant competitive requirement in today’s digital era. Companies need to align their operational directives with complying with their mission statement and core business strategy to deliver leading performance.
DIF consultants emphasize the importance of accountability across ESG integrations. Boards need to establish core metrics to ensure that trackable progress can be made towards authentic ESG implementation. In practical terms, the board of directors needs to prioritize ESG as a critical business requirement instead of treating it as an additional element of business progress.