Is there enough ESG transparency and accountability within finance?

Is there enough ESG transparency and accountability within finance?

The past few years have seen a lot of progress towards Environment, Social and Governance (ESG) practices. Countless banks and financial services have proudly highlighted their efforts in the space and outlined how they are trying to achieve greater sustainability. However, questions remain about whether there is enough transparency and accountability to ensure that real progress is being made.

A study from IPSOS claimed that 69% of consumers are opting for eco-friendly products and services. However, Lanistar, a financial technology software developer, believes that the FinTech sector is helping others meet their sustainability goals but is not doing enough to curb its own climate impact.

Jeremy Baber, CEO of Lanistar, argued more FinTechs are offering ESG-leaning initiatives, such as carbon footprint analysis or leveraging AI to combat environmental impact. However, many are not looking internally. “Despite their success in facilitating a net-zero market for others, finTechs should not dismiss the importance of taking responsibility for their own carbon footprint. FinTechs are often not associated as one of the leading global GHG (Greenhouse Gas) emitters mainly because they lack the same physical infrastructure as traditional finance. Although more recently, their oversight in addressing carbon emissions and the progression of unsustainable practices such as crypto mining has become apparent.”

To ensure that FinTechs are not failing to address their own impacts on the environment, Baber urges companies to invest into collecting and reporting on sustainability metrics. These can be incorporated within business models and then published to bolster transparency with the consumer.

However, it is not just FinTechs that should be looking to bolster their accountability and transparency, the whole financial sector could benefit from more clarity. Mark Woodward, an investor director at several ESG companies, said, “We’re really in the foothills of sustainability transparency in the financial sector. Transparency and accountability are increasing, but consistency is a major issue in terms of what people are being transparent about.” He argued that transparency and accountability processes need to be aligned so everyone can understand their significance and real-life impacts.

“If one firm is following a certain set of standards and measuring a certain set of things, but another firm is following and measuring entirely different things, how are they comparable? In this scenario, benchmarking is very difficult.” Progress is being made on this front, Woodward said. For example, the UK’s Sustainability Disclosure Requirements make it mandatory for UK firms with sustainable funds to complete regular reports. However, this still leaves a level of ambiguity around what will be captured by the regulation. “Transparency is just the starting point, there’s got to be some kind of agreement about what firms are being transparent about. Otherwise, none of the rhetoric being used to market financial products as ‘green’ is of any use to the consumer.”

ESG is often dominated by the environment aspect, often leaving social and governance as forgotten factors. This is something Ildiko Almasi Simsic, a social development specialist and author of What Is A Social Impact?, believes is also happening around accountability of ESG practices.

She said, “The financial sector is required to disclose a lot of information under the ESG umbrella, however, it is largely their environmental indicators that cover both corporate management of the issue and portfolio related impacts. The ‘S’ in ESG is largely focused on a bank’s own workforce and provides very little insight to how bank funded portfolio projects and assets are managed on the ground. What I mean is how the bank is checking portfolio assets for legal compliance on employment terms, occupational health and safety and potential risks related to inadequate working conditions. The recent push for supply chain transparency will change this to a certain extent, although the current iteration of the new EU directives will likely exclude the financial sector.”

An end to greenwashing

Greenwashing has been a big problem in the past. This is a process of releasing misleading information or claims regarding a company’s impact on the environment. Last month, the European Parliament voted for anti-greenwashing measures in a bid to ban generic environmental claims. The regulation aims to stop firms using phrases like ‘eco’, ‘climate neutral’, environmentally friendly’ or ‘biodegradable’, without providing proof.

In a similar move to this, Switzerland’s Federal Department of Finance (FDF) recently stated it intends to build regulations that will challenge greenwashing within finance. Elsewhere, Australia’s ACCC revealed draft guidelines designed to enhance the reliability of green claims made by businesses.

Woodward believes these anti-greenwashing measures are incredibly important for the financial sector. These measures will do a great deal at helping the average consumer examining ESG-oriented financial products. “The everyday consumer is unlikely to know the difference between a product or service that is carbon neutral where the company is genuinely trying to reduce its environmental impact and where they’re actually doing very little,” he said. By requiring proof, it can help consumers better know what each product is really doing.

He added, “Moving to a position of greater transparency where businesses have to show their pathways and talk about the action they’re taking can only fuel progress towards consumers being able to make informed decisions about their investments.”

Echoing a similar sentiment, Simsic was also optimistic about a greater fight against greenwashing. She said, “Regulations like this are becoming increasingly important for a number of reasons. The ESG and sustainability industry is often criticised for the lack of standardisation and lack of well-defined scope. I believe that this is partly the reason why companies could inflate their environmental or social impacts to the extent where customers, watchdogs and shareholders had to look into disclosures and verify claims.

“A 2021 study looking at ESG branded funds and what assets/investments they have on their portfolio actually found very little differences when compared to traditional funds. This is partly due to portfolios needing non-ESG assets to have financial returns and partly because of the definitions that allow for ‘mislabeling’ of assets.”

David Duffy, the co-founder of  corporate governance education platform Corporate Governance Institute, welcomed the new regulations around greenwashing but is hesitant if they will be enough, particularly in the EU. He said, “The thing that really makes a success of regulations like this is enforcement, which is difficult in a bloc like the EU despite its ambition for sustainability. Enforcement means 27 member states fully implementing strict regulations and penalties that respect EU law and are as strong as each other to ensure consistency. So, while the principles may be in place, we need to see results on the ground to back it up.”

He added that greenwashing is one of the biggest sources of confusion and frustration for regulators and investors alike. “If greenwashing is allowed to continue its rampant behaviour, that frustration and confusion will only grow and dissuade stakeholders from the importance of ESG altogether.”

While regulators are increasing their oversight of ESG practices and trying to ensure greater transparency, there is a question as to whether industry peers should call each other out. Simsic believes that this should be the case. “Peers and the industry should definitely step up to collectively raise the bar when it comes to sustainability.”

Simsic already sees the industry indirectly self-regulating through enhanced due diligence to include any potential reputation risk associated with previous activities. Banks and funds are also backing up commitments by investing in ESG experts to ensure policies, strategies and activities are managed adequately. On top of this, industry associations, professional organisations and collective initiatives have set up voluntary standards, guidelines, best practices, methodology documents and other tools to support each other.

“Peers are important because they have better subject matter expertise and are more familiar with the operational context than regulators. While regulators take a snapshot in time for their evaluators, peers can observe and support continuous improvement. The FI sector faces certain challenges that are very much industry specific and requires collective efforts to solve.”

Woodward also sees the industry needing to take an active role in accountability and ensuring they are not greenwashing. He concluded, “Boards of businesses and directors of private companies all have a responsibility to hold firms to account. It’s up to leaders of the fintech and financial services industries to accelerate action from every corner, not just representatives of the biggest companies who are likely to fall under the regulator’s eye most often.

“I think collaboration is the key to sustainability. Working with industry peers affects change because together, you have a unique understanding of the relevant challenges facing your industry. If you’re willing to be transparent about the issue, you can accelerate positive change much faster than in isolation. The result isn’t just a faster resolution to those challenges, it’s a potential improvement of the reputation of the entire fintech and financial services industries.”

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