The topic of sustainability has grown significantly more important in the financial sector as the climate debate rages on and this trend shows no signs of abating, even in the midst of the coronavirus crisis. On the contrary: With growing frequency, financial service providers are now rolling out products aimed at satisfying not only financial but also high environmental and social standards. What is becoming apparent, however, is that there is still a distinct lack of universal standards for these products. The result is that financial institutions are adopting different approaches toward addressing the issue and this, in turn, is making transparency difficult for investors.
Bank clients and investors are increasingly seeking out sustainable financial investments and the past few years have seen the volume of sustainable investments in Switzerland surge. A glance at the figures published by Swiss Sustainable Finance (SSF) reveals that the volume of sustainable investments grew by a factor of ten from 2014 to 2018 (from CHF 71 billion to CHF 717 billion). Of this volume, some 90 percent can be attributed to institutional investors. Yet as KPMG’s latest study “Clarity on Sustainable Finance” reveals, there is a general lack of universal measurement and reporting standards in the area of sustainability. This is giving rise to a situation in which financial institutions are deciding on their own whether and how they want to incorporate sustainability-related considerations into their business models. Accordingly, financial institutions are currently using an extremely wide range of approaches to address the topic of sustainability, which is hampering investors’ ability to adequately compare and contrast investments touted as “sustainable”. Given that the coronavirus crisis has heightened our awareness of just how fragile our economic system is, greater attention will likely be paid to non-financial market risks.
Many market players around the world are increasingly realizing that capital markets themselves are incapable of allocating capital in a way that supports efforts to meet climate goals. Here, regulations are needed to eliminate market inefficiencies. With its “Action Plan on Sustainable Growth” and the “European Green Deal”, the European Union is implementing the world’s most ambitious, comprehensive plan for regulating a number of different sectors. The EU is doing this in a calculated attempt to steer the market by eliminating some of its inefficiencies. The financial industry plays a key role when it comes to financing the transition to a sustainable economic system. Since the consequences of global warming are feared to be irreversible, the EU is focusing primarily on limiting CO2 emissions and meeting environmental goals. And even though we still have no indication of just how heavily the coronavirus crisis will influence the climate agenda, Europe’s politicians seem to be holding on to their main course and timetable.
Legislators in Switzerland are observing developments in the EU but are not (yet) planning to enact any binding regulations in the country’s financial industry. “We are currently seeing financial institutions launch quite a few sustainability initiatives, which is generally positive. However, these plans are either geared toward self-regulation, regulation in individual areas or are based on EU regulations, which is creating a ‘patchwork’ of different implementation approaches,” explains Philipp Rickert, Head of Financial Services at KPMG. “Due to the global nature of financial markets and interdependencies between the financial industries in Switzerland and Europe, we expect the EU’s regulations – or at least their main features – to eventually become the standard on the Swiss market as well.” This is due in part to the fact that the EU’s upcoming regulations will also have an extraterritorial impact in several different areas: Financial institutions in Switzerland that provide services to clients in the EU or manage European investment funds, for example, might fall within the scope of the EU’s regulations and will have to apply them, at least to some extent.
Data and reporting will play a special role in ensuring that regulatory efforts are effective. In that context, transparency is essential for sustainable finance to work. Having complete and reliable sustainability information is crucial for making the right financing decisions. Here, the focus is on information geared toward ESG criteria (Environment, Social, Governance). The inadequate availability, reliability and completeness of this information is a fundamental problem, however, with no quick solution in sight.
While many financial institutions and pension funds might be working on disclosing more sustainability-relevant information, there is both a dearth of binding standards and an overabundance of diversity in the “standards” applied. The result is that reliable data needed to make sustainable investment decisions might not be available at all in certain areas while the lack of standards could also be one reason why companies are not always disclosing all relevant pieces of information that could be important for beneficiaries and investors. Given the current high level of awareness with respect to sustainability-related issues, particularly among younger generations, pressure on institutions to transparently report ESG criteria to the outside world can be expected to grow.
Added to that is a newfound interest in previously neglected social and governance factors, in part as a result of the coronavirus crisis. In fact, the current crisis has laid the fragility of many industries’ value chains bare. The crisis has also revealed that companies which valued the safety and health of their employees, customers and business partners and had clear and efficient decision-making processes were able to respond more swiftly to measures intended to protect against the coronavirus and adapt their business models accordingly.
Pascal Sprenger, Partner at KPMG and specialist on regulatory issues in the financial sector, anticipates that the disclosure of sustainability information will become the market standard in the not-too-distant future and that this information – as has become standard practice in other areas – will be audited by independent third parties.
Since integrating sustainability information into a company’s activities is data intensive, the digitalization trend is likely to continue giving sustainable finance a boost. In part, because younger generations of clients expect transparency without having to fight their way through mountains of data. According to Sprenger, “Financial institutions are well advised to gear the reports they provide to clients more toward the formats used for the user interfaces of modern Internet platforms rather than traditional report formats”.
However, regulation and technology will not be enough to guarantee the success of a company in the sustainability sector. A company’s corporate culture, in particular, serves as an indispensable foundation for any credible sustainability program. The KPMG study also found that financial institutions have a lot of catching up to do, specifically in terms of defining a firm’s purpose and individual responsibility. Especially given the lack of binding standards and uniform terminology, consistency between a financial institution’s corporate culture, strategy and sustainability concept is crucial to its credibility.
“Our observations show that most financial institutions are taking a gradual approach toward implementing their sustainable finance programs. High client demand typically prompts institutions to attach great importance to areas such as sustainable investing at an early stage. This approach, however, can give rise to inconsistencies within the bank, which the general public then perceives as corporate greenwashing. In this age of social media, the risk that poses to a bank’s reputation should not be underestimated,” explains Sprenger. He advocates viewing sustainability not as a regulatory problem, rather as an integral component of the institution’s overall corporate strategy.