Research Report: A Practical Guide to ESG

For years, investors and activists have worked to compel large, public companies to report their stance on environmental, social and governance issues — better known as ESG. And recently, additional pressure has come from bank regulators on one specific ESG risk: climate. Smaller banks, meanwhile, see the writing on the wall and are taking steps to beef up their ESG programs.

As regulated entities, banks are no strangers to many elements of ESG, which Bank Director explores in the newly launched research report Choose Your Path: A Practical Guide to ESG, which is sponsored by Crowe LLP. Board structure and composition, cybersecurity and data privacy, risk management and regulatory compliance are all areas that fall under the governance umbrella. Social elements, which include financial access, diversity and community involvement, also incorporate into day-to-day operations as financial institutions comply with fair lending rules and other regulations. But it’s the ‘E’ for environmental — specifically, measuring greenhouse gas emissions — that frustrates some bankers who would rather focus on serving their communities than spending time and resources on that complex assessment.

In this report, Bank Director provides intelligence for bank boards and leadership teams seeking to better understand the current regulatory and investor landscape, and uncover what’s relevant for their own organizations. Inside, you’ll find:

  • A quick overview of how ESG has become a language of sorts to describe a company’s activities to investors and other stakeholders
  • Where Washington stands on ESG
  • How investors have focused their attention
  • How banks leverage ESG to uncover new opportunities, including how three community banks have identified core areas that are relevant to their own operations
  • Key material matters for banks to prioritize
  • What role boards could play in ESG oversight, and questions directors might ask

“[A]s disclosures grow, [investors] have more information to make comparable decisions, and that will just continue to grow because of the regulatory environment,’’ says Chris McClure, a partner at Crowe who leads the firm’s ESG team.

On Dec. 2, 2022, the Federal Reserve issued a request for comment on proposed principles for institutions over $100 billion in assets. These principles focus on climate-related financial risks: everything from ​​governance and policies and procedures to strategic planning and risk management. It’s in line with similar guidance issued by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.

At least one Fed Governor doesn’t believe the guidance is necessary: “Climate change is real, but I disagree with the premise that it poses a serious risk to the safety and soundness of large banks and the financial stability of the United States,” stated Christopher Waller. “The Federal Reserve conducts regular stress tests on large banks that impose extremely severe macroeconomic shocks and they show that the banks are resilient.”

In 2023, the Securities and Exchange Commission is expected to finalize its rule around climate disclosure, adding another element of compliance for all publicly traded companies — not just the biggest banks. While some exemptions are anticipated for smaller companies, the rule would expect companies to share how climate-related risks are managed and governed, along with the material impacts of these risks on operations and strategy. Companies could be required to measure greenhouse gas emissions — including emissions by vendors and clients — and share their goals for transitioning to a greener economy.

At the same time, governments in conservative states are working to oppose these rules, going after banks and asset managers that they believe discriminate against the oil and gas or gun sectors. It’s a tricky environment to navigate. Increasingly, some disclosure will be mandated, at least for publicly traded institutions. But bank leaders will still determine their own strategies for the road ahead — and banks that are successful will find the path that’s right for their organization.

To access the report, click here.

If you have feedback on the contents of this report, please contact Bank Director’s vice president of research, Emily McCormick, at [email protected].

ESG Disclosure on the Horizon for Financial Institutions

Over the last several years, investors, regulators and other stakeholders have sought an increase of environmental, social and governance (ESG) disclosures by public companies.

The U.S. Securities and Exchange Commission (SEC) has taken a cautious approach to developing uniform ESG disclosure requirements, but made a series of public statements and took preliminary steps this year indicating that it may soon enhance its climate-related disclosure requirements for all public companies, including financial institutions. To that end, the SEC’s spring 2021 agenda included four ESG-related rulemakings in the proposed rule stage, noting October 2021 for a climate-related disclosure proposed rule. The SEC is also sifting through an array of comments on its March 15 solicitation of input on how the Commission should fashion new climate disclosure requirements.

Recent speeches by Chair Gary Gensler and Commissioners Allison Herren Lee and Elad Roisman highlight some of the key elements of disclosure likely under consideration by the staff, as well as their personal priorities in this area. Commissioner Lee has asserted that the SEC has full rulemaking authority to require any disclosures in the public interest and for the protection of investors. She noted that an issue also having a social or political concern or component does not foreclose its materiality. Commissioner Lee has also commented on the disclosure of gender and diversity data and on boards’ roles in considering ESG matters.

Commissioner Roisman has noted that standardized ESG disclosures are very difficult to craft and that some ESG data is inherently imprecise, relies on continually evolving assumptions and can be calculated in multiple different ways. Commissioner Roisman has advocated for the SEC to tailor disclosure requirements, and phase in and extend the implementation period for ESG disclosures. Meanwhile, Chair Gensler has also asked the SEC staff to look at potential requirements for registrants that have made forward-looking climate commitments, the factors that should underlie the claims of funds marketing themselves as “sustainable, green, or ‘ESG’” and fund-naming conventions, and enhancements to transparency to improve diversity and inclusion practices within the asset management industry.

Significance for Financial Institutions
In the financial services industry, the risks associated with climate change encompass more than merely operational risk. They can include physical risk, transition risk, enterprise risk, regulatory risk, internal control risk and valuation risk. Financial institutions will need to consider how their climate risk disclosures harmonize with their enterprise risk management, internal controls and valuation methodologies. Further, they will need to have internal controls around the gathering of such valuation inputs, data and assumptions. Financial institutions therefore should consider how changes to the ESG disclosure requirements affect, and are consistent with, other aspects of their overall corporate governance.

Likewise, financial institutions should also consider how human capital disclosures align with enterprise risk management. Registrants will not only need to ensure that the collection of quantitative diversity data results in accurate disclosure, but also how diversity disclosures might affect reputational risk and whether any corporate governance changes may be needed to mitigate those concerns.

We recommend that financial institutions consider the following:

  • Expect to include a risk factor addressing climate change risks, and for the robustness and scope of that risk factor to increase.
  • Consider disclosing how to achieve goals set by public pledges, as well as whether the mechanisms to measure progress against such goals are in place.
  • Expect ESG disclosure requirements to become more prescriptive and for quantitative ESG disclosures to become more sophisticated. Prepare to identify the appropriate sources of information in a manner subject to customary internal controls.
  • Establish a strong corporate governance framework to evaluate ESG risks throughout your organization, including how your board will engage with such risks.
  • Incorporate ESG disclosures into disclosure controls and procedures.
  • Consider whether and how to align executive compensation with relevant ESG metrics and other strategic goals.