The UK Government announced at COP26 its intention to make the UK the world’s first net zero aligned financial centre. This will include mandatory publication of transition plans to net zero, financial services firms will need to develop and disclose these plans.  The regulatory burden is also increasing, and firms will be supervised on the credibility of their plans.

Additionally, firms face the risk of greenwashing allegations due to lack of timely and credible ESG data and structural misrepresentation as to how ‘green’ their portfolio and investments actually are. Put together, this is a major change to how financial services providers do business.

To help with this complex transformation, we will be sharing advice in this series on key considerations for firms, starting with the drivers for transformational change and the role that financial services play in driving the ESG journey. We have set out some recommendations on where firms should start.

What is currently on the regulatory agenda?

Regulation is the biggest driver of action within the financial services sector, and the ESG regulatory horizon is a complex one. Firms are getting ready for Task Force on Climate-related Financial Disclosures (TCFD) reporting and the introduction of UK Sustainability Disclosure Requirements (SDR), which is part of the UK Government’s Green Finance Strategy.

SDR will build on the TCFD recommendations. We expect it will eventually be in line with global standards being developed by the newly formed International Sustainability Standards Board (ISSB). In the meantime, the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA) have revealed their intention to increase supervision and stakeholder engagement within financial services this year.

Increased reporting and disclosure, driven by regulation, will shine the spotlight on firms’ portfolios and investments and on how they conduct themselves as corporate citizens. As a result, firms will face greater risk of serious reputational and financial damage, for instance, from allegations of greenwashing.

So, there’s a compelling reason for integrating ESG into how you do business. It needs to be embedded into your risk and control functions, as well as regulatory and reporting frameworks. Adapting to such a fundamental change is not easy, but it is necessary to stay on top of evolving risks. It can also help your organisation take advantage of the climate-related opportunities on offer.

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What is the role of financial services in this journey?

Transition to net zero cannot happen without finance. As government funding will not be enough, the private sector has a large role to play in plugging the funding gap.

It’s easy to see this as a burden, but this obligation also opens many opportunities for financial services to lead the transformation. Additionally, the financial industry is instrumental in funding the transition of other sectors and guiding capital flow to greener sources. From where we stand, to get to net zero, 28 years may seem like a long time but without acting now, there is a real danger of being left behind. Successful transition to net zero will only be achieved through a collaborative, hands-on approach from all stakeholders in the economy, including government, industry and customers.

Where do we start?

Immediate priorities:

In the short-term, firms will need to define and disclose their transition strategy. To do this, the drivers for change and their existing direct and indirect emissions will define the target and transition plan.

  • Understand drivers for change: Whether it is regulation, customers or other factors that are driving business transformation, firms will need to have a clear understanding of the scope of each driver and set clear transition objectives to tackle this need.
  • Perform a diagnostic review: To identify their current carbon footprint and set net zero targets, firms will need to analyse their existing portfolios for the level of ’brown’ (heavy carbon-emitters) vs ’green’ (e.g. as defined in the EU Taxonomy and soon in the UK Taxonomy) assets and calculate current Scope 1, 2 and 3 carbon emissions. This isn’t easy as data is not widely available outside of the largest listed firms, particularly in relation to defining supply chain impacts on overall business emissions.
  • Design your strategy: Firms will need to set their 2030 and 2050 carbon emission reduction targets and devise plans to achieve them. There are many pathways – green financing, investment in green assets, carbon offsetting, green product development and most importantly, the broader opportunity for finance and industry to collaborate on effective transition roadmaps.
  • Get your house in order: It is vital for firms to design a target operating model and know how to achieve the strategy operationally, identifying and accounting for any risks and dependencies while developing the operational plan.

Supporting priorities:

Firms will need to think about how significant their business transformation will be: how can they make their business model climate resilient and adaptable to changing circumstances? Monitoring processes and realistic KPIs should be established to ensure that plans remain on track and can be adjusted for unexpected changes.

  • Transform your business: A transition strategy cannot be successfully achieved without some business transformation. For some, this may be wholesale change (e.g., financing or investing in carbon intensive industries). For others, this may be incremental (e.g. a building society with a predominantly savings and mortgage lending operating model). Assessing the target operating model early in the journey is vital to achieving this strategy. Many firms are already tapping into market opportunities that late adopters will be missing out on.
  • Establish a monitoring process: While you may have targets for 10 to 30 years down the line, it will be impossible to achieve those without proper internal monitoring from an early stage. Identifying systemic risks to your organisation and supply chain, setting interim metrics, KPIs and embedding ESG into the risk management processes will all help ensure you remain on track.
  • Build resilience: Developing climate resilience is a priority to make your business adaptable to the changing regulatory and risk landscape. You also need a reporting and controls framework that can withstand regulatory pressure and is aligned to your ESG policies and standards.

This is already a long list of considerations, each with its own complexity. Starting to think about where you are on the journey, what to prioritise and how to improve the effectiveness and efficiency of your ESG transformation, will only help make your journey load lighter. In upcoming articles, we will continue to talk about some of the key considerations for firms on this ESG transformation journey and start to develop a practical approach for implementation.

Market leaders in financial services are already implementing many of the actions outlined above. Reach out to us at ukfmfsesg@kpmg.co.uk if you have questions on the above or are looking for support on developing a transformation roadmap for your organisation.

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