Implementing ESG principles in trading and risk management

Embracing ESG requires a holistic approach that combines innovative data analytics and ethical considerations to optimise returns while managing risks responsibly.
8 Aug, 2023

As firms navigate the evolving landscape of the ethical, social and governance implications of climate change, they are presented with opportunities and challenges. By incorporating climate change modelling into their strategies, firms can attract socially responsible investors and align their activities with global sustainability goals. However, they must also address the associated risks, such as regulatory compliance, reputation management, and exposure to climate-related financial impacts. Effective forecasting frameworks and robust due diligence processes are essential for identifying and mitigating potential climate change risks.

This survey was conducted during a webinar hosted by Quantifi and Tata Consulting Services on ‘Navigating ESG & Climate Change: Opportunities, Challenges, and Modelling Strategies’. The guest speakers were Susan Urkevich, Head of Sustainability, Wholesale Credit & Lending at HSBC, Amitav Borkakoty, Enterprise Credit Risk Director at Lloyds Banking Group, and Navin Rauniar, Sustainability Partner at Tata Consultancy Services. More than 160 individuals from across the financial services industry registered for the webinar and were invited to participate in the survey.

What are the primary challenges financial institutions will face in implementing ESG principles in trading and risk management?

As financial institutions increasingly adopt Environmental, Social, and Governance (ESG) principles in their trading and risk management practices, they will encounter several challenges. These challenges can vary depending on the specific institution and its existing processes. Overcoming these challenges requires commitment, investment in ESG research and expertise, collaboration with industry peers, and continuous adaptation to the evolving landscape of sustainable finance and responsible investing.

Among the respondents, 36% consider the lack of standardised ESG frameworks and metrics as a primary challenge. The lack of standardised frameworks and metrics leads to varying criteria for measuring and reporting ESG performance, making it challenging for firms to compare and evaluate risks and opportunities accurately across different investments. The absence of clear and uniform metrics complicates the integration of ESG considerations into risk management models, thus further hindering the implementation of comprehensive ESG strategies. Furthermore, without standardised frameworks, transparency, accountability, and regulatory consistency are compromised, impacting investors’ ability to make informed decisions in an ESG-conscious landscape. Standardisation is crucial for providing clarity, comparability, and reliability in ESG assessments, allowing firms to navigate the complexities of sustainable and responsible investing more confidently.

The European Commission is proposing to regulate ESG rating providers. Do you support increased regulation of ESG evaluations?

The regulation of ESG evaluations has been a subject of interest and debate in the financial industry and regulatory circles. ESG ratings are used by investors, including banks, to assess the sustainability and ethical impact of potential investments.

On 13 June 2023, the European Commission proposed new rules regarding the transparency and integrity of ESG rating practices. The proposal addresses concern about the dependability, comparability, and transparency of ESG ratings. If approved, it would establish new regulations for an unregulated market in Europe, mandating that EU and third-country market participants who commercially provide ESG ratings acquire authorization and oversight from ESMA. The majority (79%) of respondents either strongly or somewhat support increased regulation.

Banks and financial institutions have been supportive of increased regulation as they believe that more standardised and transparent criteria for ESG ratings can help prevent “greenwashing” – a situation where companies may overstate or misrepresent their environmental or social initiatives to appear more sustainable than they are. A regulated framework for ESG rating providers could enhance the credibility and reliability of ESG data. Greater clarity about which ESG ratings track will help firms across all industries improve their compliance efforts. It will also help banks fund companies and projects that promote a sustainable future more effectively.

On the other hand, there is concern among some firms that increased regulation could introduce additional compliance costs and bureaucratic hurdles. Additionally, the debate on what specific criteria should be used to evaluate ESG factors and how to effectively measure them has been ongoing. Only 6% of the survey respondents are opposed to increased regulation.

What opportunities do you believe ESG initiatives will bring over the next 12 months?

In 2023, businesses have been confronted with the far-reaching consequences of the pandemic, the possibility of a recession, and the challenges posed by climate change. As a result, their focus has shifted from mere profits to a broader perspective encompassing societal well-being. Customers, investors, and employees now expect businesses to actively contribute to creating a sustainable society. With the United Nations’ ambitious 2050 carbon-neutral target in sight, businesses are compelled to rethink their strategies, placing ESG initiatives at the forefront of their agendas. Looking ahead, ESG will serve as a core pillar for progressive and forward-thinking companies.

The survey revealed that 30% of respondents believe that ESG initiatives will lead to increased public awareness of ESG issues. This indicates a growing interest in promoting sustainable practices and ethical business conduct. As this awareness continues to grow, businesses will face mounting pressure to prioritise ESG principles, not only to remain competitive but also to uphold their commitment to responsible and impactful practices. Ultimately, this heightened awareness creates a ripple effect, inspiring collective action towards a more sustainable and equitable future.

A significant proportion of respondents (27%) expect ESG initiatives to create new revenue streams and business opportunities. This underscores the transformative potential of sustainability focused practices in today’s business landscape. By embracing sustainability-driven practices, businesses can meet consumer demands, gain a competitive edge, access new markets, foster collaborations, comply with regulations, achieve cost savings, attract responsible investors, and enhance their reputation. ESG-driven innovation presents a path towards a more sustainable, socially responsible, and economically viable future for businesses and society alike.

Finding balance: optimising returns while embracing social responsibility

ESG presents a unique set of opportunities and challenges for trading and risk management in financial markets. The growing demand for sustainable investments opens up new avenues to explore ESG-focussed assets, such as green bonds. Integrating ESG factors into investment strategies can also lead to long-term risk reduction and improved portfolio performance.

However, challenges arise from the complexity of measuring and assessing ESG risks. Lack of standardised data and disclosure can hinder accurate risk analysis, making it difficult for traders to make informed decisions. Additionally, ethical considerations and potential reputational risks demand meticulous due diligence when selecting ESG-compliant assets. Embracing ESG requires a holistic approach that combines innovative data analytics and ethical considerations to optimise returns while managing risks responsibly.

Let's talk!

Speak with one of our solution experts