Earth Day & the Carbon Risk Management Mandate

This Earth Day we have a lot to celebrate.  As we see major policy shifts across the world pushing towards a renewed emphasis on smarter climate measures, financial services are leading the charge – with nearly all major banks making pledges to achieve net zero, as well as pledging trillions of dollars towards sustainable investments and initiatives.

With sustainable and environmentally friendly investment portfolios growing around the globe, the business case for ESG reporting and governance solutions is becoming more critical.  While not all investors are aligned in their thoughts on ESG, there is a consensus on its growing implied mandate and importance going forward, and in a large part, is being driven by the Paris Climate Accords and how it is being implemented across the globe.

Domestically in the United States, the SEC has made its own stand on ESG by establishing a climate focused task force marking a new stance in how the government plans to usher in the policy embrace on the key front of finance. Policy guidelines are extending and evolving to regulate organization’s carbon risk exposure. 

ESG policy in effect touches organizations external relationships and leaves the looming question what measures regulators will take to push these new policy agendas. Regulators establishing dedicated resources to push organizations to minimize carbon risk and exposure isn’t for show, it’s something that will be here to stay and only expand further.

Although many organizations have put a great emphasis on ESG recently, far too many are still dependent on manual processes and outdated ESG reporting solutions. Most organizations have their finger on the pulse on the direction of ESG requirements and standards, and some have been making progress with an integrated and automated ESG technology architecture – that not only provides investors with the assurance they need but enables them to increase efficiency and lower the costs of time and labor-intensive manual processes within their own systems and to take advantage of the opportunities many believe ESG will provide.

From the lens of many organizations, failure to implement a sustainable and effective ESG architecture and framework could lead to the organization essentially being locked out of the financial system and investment and financing will only flow to those that can meet ESG reporting demands and standards. As investment strategies and decisions become more influenced by the effectiveness and efficiency of the organizations ESG governance and reporting, capital will continue to flow for better performers and will fall for inadequate performers.

The United States domestic push for carbon risk management is further outlined in the SEC’s first ESG risk alert. While this is a charge led by an American regulator, the precedent and tone has global implications and will be reflected by other regulators through independent guidelines and policy measures of other nation states and trade blocks.

The SEC’s primary priorities take a wide stance on ESG investing and internal management measures for financial services. In review of firms claiming to engage in ESG investing, the SEC will typically focus on:

• Portfolio management. a review of organizations ESG policies, processes and practices and use of ESG-related terminology, due diligence and other investment selection and monitoring processes.
• Compliance programs. a review of the firm’s policies and procedures for implementation, compliance and review of ESG investing practices and disclosures.

The following observations which constitute poor ESG practices were made in recent reviews:

• Inconsistent portfolio management practices, with investor disclosures about ESG approaches.
• Manual, obsolete controls that were inadequate to maintain, monitor and update investor ESG-related investing guidelines, mandates and restrictions.
• Inadequate controls to ensure ESG-related disclosures and marketing are consistent with the firm’s practices.
• Unagile compliance programs that did not adequately address relevant ESG issues and reporting.

The following observations with constitute ESG best practices and procedures were made in recent reviews.  The observations that found organizations that were in compliance with ESG guidelines had agile, organized, detailed, and specific ESG policies across the entire portfolio management process.  Firms engaging in best practices also had compliance procedures and processes with a detailed knowledge base around organizations ESG practices.

As the SEC develops its mandate it becomes clear that new measures will need to be taken to maintain agile and efficient ESG compliance and carbon risk management practices to prevent enforcement action. Organizations will need to implement new policy processes and procedures to embark on this exciting new chapter of sustainable practices.