ESG in the financial sector - underestimated risks and untapped opportunities
ESG in the financial sector
Why financial institutions are still underestimating ESG-related risks and opportunities.
We have seen a sharp increase in the attention devoted to ESG issues in recent years. More and more financial institutions see significant risks in ESG issues, but also opportunities. In this blog post we explain why we believe Dutch financial institutions are still underestimating ESG-related risks and opportunities.
Recent years have seen a steady increase in attention devoted to ESG issues. This is illustrated by, among other things:
- a recent survey the Dutch Central Bank (DNB) conducted among the largest pension funds and insurers - which showed that all the institutions surveyed now have their own sustainability strategy 1 ;
- the sharp increase in assets under management in more (socially and environmentally) responsible investment funds in Europe to almost € 750 billion in 2018, from less than € 500 billion in 20142 ; and
- the inclusion of ESG risks in the EIOPA stress test for pension funds3.
ESG risks are hurting Dutch banks, insurers and pension funds
This growing attention has been partly prompted by the increasing impact of such issues. We are seeing more and more examples of ESG issues affecting financial institutions. In January 2018, NN Group had to pay out € 89 million for storm damage4, and such instances are likely to become more frequent due to climate change. In 2017, financial institutions including ING and ABN AMRO got a wake-up call because of their share in the controversial Dakota Access pipeline due to possible human rights violations5. And since 2015, pension fund ABP - as one of the larger shareholders in Volkswagen - has suffered significant financial damage as a result of the emissions scandal. The cost for Volkswagen now stands at more than € 30 billion6.
Dutch financial institutions are therefore now trying to control these risks more effectively
The DNB says the majority of Dutch financial institutions have implemented a sustainability strategy1, partly to manage their ESG-related risks. As part of such a strategy, they identify significant ESG-related risks and define instruments to measure and mitigate those risks. Global warming is currently the most widely recognized and generally considered to be the most material ESG risk.
We are seeing a trend of a growing number of institutions trying to reduce their exposure to risks directly related to greenhouse gas emissions. For the most part, they are doing this by setting up CO2 budgets and/or by reducing investments in, or the financing of, coal-fired power stations.
At KPMG, however, we still see a lot of room for improvement
Although most Dutch financial institutions have identified the most important ESG risks and have drawn up sustainability strategies to address these risks, at KPMG we still see considerable room for improvement when it comes to managing ESG risks more effectively.
This is also evident from the same DNB study, which shows that only 36% of the institutions surveyed have defined clear indicators and targets as part of their sustainability strategy, and barely 20% measure the impact of their strategy1.
On top of this, we see little integration of sustainability strategies and the management of ESG risks. This is evidenced by the fact that:
- the majority of Dutch financial institutions identify global warming as a significant ESG risk;
- some of these try to control this risk by measuring the carbon footprint of their portfolio;
- but there are very few institutions with vision of their ESG-related risk appetite, or that measure this risk and set risk limits.
We believe the fact that so few institutions have clear and effective strategies on this front is due to the complexity of many ESG risks, a lack of valid and reliable data that provides insight into this risk, and a lack of experience at institutions in the thorough analysis of this type of risk.
However, despite the data limitations and uncertainties, it is still possible to make an adequate estimate of the magnitude of such risks, for example using dynamic risk assessments (DRA), scenario analyses and/or stress tests.
“The likelihood that millennials will choose to invest doubles if the value proposition includes social responsibility”.
What is more, there are still considerable opportunities
We also see two categories of ESG opportunities for financial institutions.
The first category stems from the fact while the awareness of ESG issue is on the rise among financial institutions, it is also on the rise among their clients (society at large). Between 2015 and 2018, the proportion of the Dutch population expressing concern about climate change increased from 70% to more than 80%6. Dutch citizens are increasingly taking sustainability into account when making choices between the providers of products and services. Between 2013 and 2018, the proportion of Dutch people who say they do so increased from 30% to 48%7. This also applies to financial products. Between 2014 and 2018, the ‘sustainable’ Triodos Bank saw growth of close to 50%8, while the large Dutch banks as a whole saw barely any growth in that same period9. Another example of these opportunities is the fact that NN Group's ‘assets under management in responsible funds’ increased by more than 50% in 2018.
We expect the opportunities in this area to increase in the years ahead, as underlying trends add greater visibility and urgency to ESG issues such as climate change.
The second category of opportunities stems from the fact institutional investors are not taking ESG risks seriously enough, with the result that they are generally underestimated. We believe that there are still significant opportunities on the financial markets. Institutions that are ahead of the game on this front can take advantage of this failing in the market.
This blog post is the first of a series of three posts on the importance of ESG integration for the financial sector. The upcoming blogs will focus on: increasing pressure from stakeholders and laws and regulations.
1 Op waarde geschat? Duurzaamheidsrisico's en -doelen in de Nederlandse financiële sector, DNB (2019)
2 Morningstar Direct, Morningstar (2018)
3 EIOPA, Occupational Pensions Stress Test 2019, EIOPA (2019)
4 NN Group reports 1Q18 results, NN Group (2018)
5 ING verkoopt aandeel in omstreden Dakota-oliepijplijn, FD (2017)
6 VW shrugs off 1 billion euro legal hit with higher SUV sales, Reuters (2019)
6 Duurzaam denken is nog niet duurzaam doen, I&O Research (2019)
7 Dossier Duurzaam 2018, GfK / b-open (2019)
8 Annual Report 2018, Triodos (2019)
9 Statline, DNB (2019)[MPB1]
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