Navigating environmental, social, and governance (ESG) requirements can be a challenge. Regulation is increasing, reporting is inconsistent, and data can be limited. During a recent webinar in our Expand Your Perspective series, thought leaders from across S&P Global gave their opinions on the biggest challenges facing financial and non-financial corporations today.
Question: Given the importance and the dimension of ESG, what are the main challenges or concerns that financial corporations and non-financial corporations are facing with ESG in general and climate-related financial risk management in particular?
Kevin Bourne, Managing Director, Head of Investment Research, S&P Global Sustainable1
I think the most significant challenge in climate reporting is increasing pressure from regulators. This applies particularly to the banks being asked to account for climate change information, not just at the balance sheet level but increasingly in their relationships with individual customers.
And I think that will lead the banks to create differential product pricing regimes based on the climate footprint of individual companies. In the future, I believe a company's climate footprint will be part of the overall cost of borrowing, for example, when they approach their bank.
So I think for the financial institutions, it's the implementation of regulation and a lack of standards. Although in the climate domain, there is a lot more standardization. There's a group called the NGFS, the Network for Greening the Financial System, which includes the leading financial supervisors worldwide. They've all created baseline comparability metrics to enable banks to report similarly. They want to try and avoid some of the current challenges with broader ESG reporting that exist due to this multi-theme range of standards.
For companies, one of the challenges of reporting is that most climate-oriented reporting is focused on their emissions profile. Some companies are being asked, understandably, to think about their emissions profile reporting. A few years ago, the Streamlined Energy and Carbon Reporting (SECR) regime was enacted in the U.K. Many public and private companies now have to report their emissions. By law, they have to cut their emissions and energy consumption in their annual financial returns because the government wanted to start thinking about the climate impact those companies were having.
But I think as this whole subject moves forward for companies, particularly smaller companies, there will be some interesting information asked of them – fundamental things. Where am I located? Location risk becomes an issue with climate change. At what point is the location of your business an impairment to the valuation of your company or your business's ability to function? Those questions are being asked by fund managers and larger companies already.
So I think what we're going to see is from a climate point of view, not necessarily much beyond what are your emissions, basically, what are you contributing to the problem? And I think in the short term, that's going to move towards, “are you exposed to the problem?”
Megan Pillsbury, Vice President of Business Development for The Climate Service, S&P Global Sustainable1
In both cases, I’m thinking more about corporates and their role in providing transparency to investors. An important challenge around reporting is that the standards are pretty open right now, and that's by design, while we learn the best way to do climate risk reporting.
We are starting this journey of figuring out what's material, because materiality can look different in different industries and firms. We don’t want to get too prescriptive on reporting until we know how to be effective in reporting.
This openness, though, makes many companies reluctant to go too far down the path of reporting until they have much clearer guidance and better understand the risks to their own firms. Fortunately many companies are taking the lead on experimenting with reporting frameworks and sharing their experience with the framework developers, so that advancements can be made. Hopefully soon we will have clearer guidance, and more firms will embrace climate risk reporting.
Michael Taschner, Head of ESG Advisory, Executive Director, S&P Global Market Intelligence
I think that the biggest challenge in this topic is that there are too many standards and too much information. That's also what we regularly hear from our clients: too many frameworks, too many deadlines, too little data, and too few standards. So it's complexity, and it's making the proper prioritization of what to do and answering the question of why.
It is important to understand what has changed as recently as 24 months ago. A couple of years ago, the topic of sustainability and corporate sustainability reporting was also a big topic. But it was primarily motivated by a company reporting on their impact on the environment and to the society.
Now it's flipping 180 degrees because a company needs to assess how the environment impacts the company. So how am I affected? What is the financial risk I'm exposed to? This is something completely different, and this is very investor-focused so that investors can manage the investment risks more appropriately. And, of course, issuers must adequately manage their daily business risks.
So it's really about identifying and assessing the materiality of the risk which are impacting the companies themselves. Being aware of which risk I'm exposed to and how do I manage and mitigate those risks.
The risks are currently being priced in. It's about managing risks and quantifying these risks. That's why we are talking about the physical risk. That's why we are talking about transitional risk. That's why integrating these topics in risk management frameworks is of utmost importance in the business operations for issuers, but also for investors to align and be aware of how to deal with these kinds of risks.
I think this is the biggest challenge, to align all of those risks because this is the circle, and bringing that in line is not straightforward. But it is vital and has to be the top topic and top priority of any strategic plan.