Defining the ‘S’ in environmental, social and governance (ESG) is not easy, and for that reason, many financial institutions have tended to focus on the ‘E’ and ‘G’ instead. However, social elements, including human rights, are gaining attention, and regulations are emerging globally to clarify what the ‘S’ involves.
“There is more emphasis on the ‘E’ than on the ‘S’ in ESG,” says Jacco Minnaar, chief commercial officer and member of the executive board of Dutch ethical lender, Triodos Bank. “If you look at sector initiatives, there are many more organisations focused on the environment and climate than on social issues. However, Triodos believes that in order to make the right decisions on sustainability, you have to have a view of the social impact.”
Organisations have naturally gravitated towards the ‘E’ and ‘G’, given their quantifiable nature, says Charlie Bronks, head of ESG at Crown Agents Bank, a UK-regulated bank that provides foreign exchange and cross-border payments services in emerging and frontier markets. “Historically, the significant influence of environmental risks on asset valuations and post-recession scrutiny on governance have made these a priority,” she explains. “These quantifiable metrics made them attractive focal points.”
However, “genuine” ESG leadership transcends mere asset valuation or corporate governance, she adds, and intertwines with the broader societal matrix: “This covers equitable lending, financial inclusivity, employee welfare, and community involvement. Although less quantifiable than a carbon footprint or governance structure, the ‘S’ has vast implications for brand credibility, client trust and stakeholder loyalty.”
The interlinked nature of all three elements in ESG has been highlighted in the responses to a 2021 industry consultation conducted by the UK’s Department of Work and Pensions. Responses indicated that stakeholders in the occupational pension scheme industry recognise that social risks are intrinsically linked to environmental and governance issues. HSBC, for example, stated: “We do not have a standalone policy on social factors as of now, instead choosing to consider them as part of a broader risk category relating to all ESG factors.”
There are many more organisations focused on the environment and climate than on social issues.
In the same consultation, the UK’s Trades Union Congress said social factors should be integrated with environmental and governance factors, as in practice they are often closely linked. The Impact Investing Institute, a non-profit independent organisation, said sustainable reporting should give “stronger consideration” to broader, interrelated environmental and sustainability impact factors, especially companies’ social impact alongside climate.
“A growing body of research is rendering visible links between broader environmental and social impacts: Covid-19, in particular, has shone a light on the social consequences of biodiversity loss.”
Taking a holistic approach
With global discourse underlining the significance of social equity and consumers demanding more than mere profits, financial institutions are taking heed, according to Ms Bronks. “The rise of fintech brings a potentially wider societal impact by placing ‘S’ at the heart of fair and inclusive financial services,” she says. “Progressive financial institutions realise that ESG isn’t simply just about risk mitigation; it is a comprehensive strategy. It is about creating robust financial ecosystems that cater to shareholders and society alike. This holistic vision is the essence of the sector’s future.”
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In October a group of European organisations — including Triodos Bank, the European Association of Public Banks, German credit institution KD-Bank, and German Christian finance institution Pax-Bank — wrote to president of the European Commission (EC), Ursula von der Leyen, urging the EC to create a social investment framework to encourage the financing of social initiatives.
The signatories noted that the EU Sustainable Finance Framework “fails to address the social dimension of sustainability. As it is, the framework focuses on avoiding negative social impacts without giving any guidance on how sustainable investments could positively contribute to social goals [and] ensure a fair and just transition towards climate neutrality. While it encourages investments in environmental activities, this situation exposes the EC to the criticism that it misses the opportunity to tap into the transformative potential of socially minded investors.”
The letter called for a social investment framework to guide investments towards social housing, healthcare and education, and to ensure human rights in value chains. It estimated a minimum gap in social infrastructure investment at between €100bn and €150bn per year, and a total gap of more than €1.5tn between 2018 and 2030.
At present, European investors lack orientation for what constitutes a “social investment”, as well as commonly accepted definitions, the letter stated. “Without this orientation, social investments lack the impact they could have if specific activities would be officially and coherently defined as ‘social’.”
Triodos’s Mr Minnaar says the bank supports the concept of a social investment framework “which we believe will help to focus more attention on the ‘S’ in ESG. This would help to define the positive impact of investments, but we also need definitions of activities that are detrimental to the ‘E’ and the ‘S’.”
While environmental and climate factors are given a high priority, social factors are generally not, he adds. However, the decisions banks make every day have an impact on society.
“Banks should realise that the ‘S’ side of ESG is not a standalone issue — it is … intertwined with environmental and climate factors,” he says. “To be successful in the energy transition we need buy-in from society at large. The benefits of the energy transition cannot be solely for people who are already well-off. In order to be successful on the ‘E’ side, you need to consider the ‘S’ side, too.”
Dynamic role
Ms Bronks believes that banks, often seen as mere capital facilitators, have a more dynamic role to play — particularly in championing social criteria. “Banks possess a significant sphere of influence, given their interactions across the financial spectrum. Integrating social factors into operations and promotions depending on shape and size, can underscore the importance of societal responsibility,” she explains.
Banks can also lead by example. Initiatives promoting workforce diversity, equal pay and community involvement, when highlighted, set a benchmark for businesses, she adds. “Furthermore, through educational initiatives, banks can highlight the business value of social responsibility. Financial incentives can act as strong motivators incorporating social elements into the supply chain or creating social impact programmes.”
Regulators also have a role to play. During a UN Environment Programme Finance Initiative (UNEPFI) webinar earlier this year, the panel discussed the various human slavery acts and other regulations, such as the EU’s proposed Corporate Sustainability Due Diligence Directive, that are now being rolled out worldwide. The UN’s Guiding Principles on Business and Human Rights are being written into regulations and reporting requirements in different jurisdictions.
The UN Human Rights Council endorsed the principles in 2011, saying: “The Guiding Principles make clear that where national laws fall below the standard of internationally recognised human rights, companies should respect the higher standard; and where national laws conflict with those standards, companies should seek ways to still honour the principles of those standards within the bounds of national law.”
During the webinar, Laura Canas da Costa, senior global policy expert at UNEPFI, said human rights had to become a “core part” of banks’ business decisions. “Banks have significant leverage and influence over their clients’ corporate governance practices and how they address human rights in their supply chains,” she said. “Human rights and environmental due diligence must be integrated into their loan decisions.”
Beyond risk
Mr Minnaar identifies three things that banks should think about when considering their role in supporting ESG objectives. “First, if you make an investment or a loan, does it have a positive impact, is it aligned with the desired transition to a low carbon economy and will it contribute to something positive in the real economy?
“Second, every financial institution should have a list of minimum standards, of activities they don’t want to finance or of the tolerance they have for them. And third, ESG risk is really about how sustainability factors translate into a negative financial impact in the future.”
This article is part of the Special Report: Making meaningful progress in sustainability
He believes that most financial institutions are now stepping up on ESG risk, mainly because they are forced to do so by regulators and governments. “It is generally a compliance-driven process,” he says.
However, Ms Bronks believes that financial institutions have the opportunity to lead from the front and be “torchbearers” for the ‘S’ in ESG — they should not wait for a regulatory push. “Starting with introspection, or reversing the impact of what your organisation does, and imagining the societal void without your organisation’s initiatives can be a great first step to measuring the ‘S’ in ESG,” she says.
