Financial institutions also have a role to play in explaining how profit and purpose can be complementary. Environmentally conscious companies do not just protect the planet, they protect financial performance too. At EY we call this value-led sustainability.
As the region’s institutions decide how they will carve out their role in decarbonization, EY teams recommend that they take several actions.
Take a risk-based approach
When considering transition risk in clients or portfolio companies, institutions may need to broaden their view of stranded assets. As emissions are priced in over time, stranded assets will encompass not just coal generators, but also ships, any vehicle relying on a combustion engine and inefficient buildings.
Institutions also need to choose the right methodologies to evaluate the alignment of portfolios with net-zero objectives. For example, asset managers need to decide how to price climate risk into due diligence to ensure more sustainable returns in portfolio management. But this is not just about calculating emissions for different asset classes and divesting or engaging accordingly. Asset managers must ask themselves: we do more good by simply allocating resources away from higher-risk carbon emissions sectors — or by supporting transition plans in high-emitting sectors?
Similarly, banks must strike the balance between financing the development of climate solutions and financing the accelerated phase out of high-emitting physical assets. The sector’s support will be essential to help browner, more carbon-intensive assets and companies transition to net-zero. These businesses will need capital to make the fundamental operational changes needed to transition. Insurers, lenders and investors will play a crucial role in making that capital available and in incentivizing and supporting their clients and investees as they transform.
Deciding where to play and how to balance decarbonization strategies requires complex risk/reward assessments. Many institutions will need to upskill to calculate the best risk-based approach for their portfolios and organizations.
Manage stakeholders’ expectations
A number of external stakeholders, including investors and regulators, are scrutinizing financial institutions’ decisions and actions. Managing stakeholder expectations requires active engagement to understand what good looks like and then sustaining the conversation with regular updates and check-ins.
It’s important to engage early. Are investors expecting to be offered net-zero impact funds? What sort of disclosures, standards and taxonomies will regulators expect — now and in the future?
Already, the Singapore Exchange has adopted the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) among its listing requirements. With around 1,000 financial institutions adopting TCFD recommendations, standards of climate-related financial information are improving and increasing rapidly.
Understanding government expectations is also vital, especially when it comes to financing and investing in the energy transition. Financial institutions need to understand the renewable energy mix planned for each country, how energy access and affordability will be managed, and where and how government incentives will come into play.
Likely projects requiring private finance include: interconnection infrastructure, storage, infrastructure to support electric vehicles or hydrogen generation, and even carbon capture projects. In many cases, it will take government, financial institutions and real economy leaders to come together to prioritize where finance should go to best support the energy transition.
Address greenwashing
Greenwashing is a market distortion that poses a risk to successful green projects, putting it in the spotlight of many of the region’s financial service regulators. In late 2021, for example, the Competition and Consumer Commission of Singapore invited researchers to bid for grants investigating sustainability-related issues, including greenwashing. Litigation over spurious environmental claims is also becoming increasingly common, using not only national laws, but also decisions now provided by multilateral bodies.
It’s essential that green finance supports projects with a genuine impact. Otherwise, financial services brands will find trust is quickly eroded.
Avoiding accusations of greenwashing starts with being transparent about how an institution defines sustainable investment, responsible investment or decarbonization. Each financial institution may have a different view. Some are taking an ESG reporting approach. Others a thematic approach, balancing investments into, for example, climate change, water efficiency and energy efficiency.
But institutions may need to spread an even wider net when considering green investment. According to the Asian Development Bank1, Southeast Asia has five green growth opportunities:
- Productive and regenerative agriculture: using precision agriculture, biotechnology innovation, micro-irrigation and carbon sequestration to improve yields and reduce emissions while enhancing biodiversity
- Sustainable urban development and transport models: improving the environmental sustainability of cities and their transport systems by reducing carbon footprints and emissions while enhancing livability
- Renewable energy and energy efficiency: facilitating the phase-out and early retirement of coal-fired power plants, scaling up renewables and storage, developing interconnected grids, and saving energy through demand-side energy efficiency measures
- Circular economy models: investing in waste processing facilities to turn bi-products into usable and valuable end products
- Healthy and productive oceans: improving and sustaining mariculture and aquaculture to replenish fish stocks
Institutions need extensive technical and environmental knowledge to ensure they are genuinely operating in a green manner. This means investing in staff training, reviewing inhouse processes, and ensuring boards include directors with specialist skills in sustainability, climate change and environmental matters.
It also requires laying down a proper control environment and building the right culture, where everyone is aligned with the decarbonization objective.
Address data challenges to integrate ESG into financial institutions
Confidence about impact requires quality data. Sometimes, greenwashing can be inadvertent. Institutions may have the right intentions but lack the data-driven approach needed to assess the ESG performance of portfolio companies.
It will take time and effort to make quality ESG data available. Institutions should work with their ecosystem to encourage the following:
- Reporting that shows a deeper understanding of correlating sustainability factors — such as how biodiversity impacts climate change
- Better linkage between sustainability metrics and financial information, with reporting data pushed continually into the organization so sustainability risks and impacts are considered in all decisions at all organisational levels
- A reporting move from outputs (risk assessments, goals and initiatives) to outcomes (demonstrated actions or impact addressing the problem)
- Meaningful assurance over sustainability implementation and impact
