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Regulators increasingly require corporates and financial services firms to incorporate Environmental, Social and Governance (ESG) risks into their due diligence and reputational risk management processes...
Regulators increasingly require corporates and financial services firms to incorporate Environmental, Social and Governance (ESG) risks into their due diligence and reputational risk management processes. ESG also brings opportunity: asset managers and investment banks have enjoyed significant returns by moving assets into sustainable funds, while companies who are transparent about their ESG commitments have been profitable. But ESG is often poorly defined, and acquiring the right data to uncover these risks is difficult. In this series of four blogs, we explore the trend towards ESG risk management; break down the factors companies should consider when trying to assess ESG claims; and explain how Nexis® Solutions can help to identify these risks.
Expanding regulations mean ESG compliance is no longer optional.
Until a few years ago, ESG was recognized as a worthy aspiration for companies but rarely prioritized at the expense of profit. Today, mandatory human rights and environmental due diligence has become a regulatory expectation for financial services companies and other firms. It is no longer enough for them to limit their monitoring of third parties to long-standing risks like creditworthiness or exposure to money laundering.
Numerous jurisdictions have brought in–or are planning–legislation requiring companies to demonstrate that they are carrying out due diligence on the ESG record of suppliers, agents and joint venture partners. For example:
Another important development is the EU Sustainable Finance Disclosure Regulation, which has been introduced to improve transparency around sustainable investment products. It requires asset managers across EU member states to disclose whether they have considered ESG factors in their company’s portfolio and their own funds.
ESG brings reputational risk and financial opportunity
Failure to properly consider and manage ESG risks poses a reputational risk to companies. Activist investors are moving money away from firms with poor records, while consumer campaigns boycott products with unethical sourcing in their supply chains. ESG failures put companies and their third parties in the spotlight with negative press and social media commentary, leading to a loss of consumer confidence and revenue.
Carrying out ESG due diligence is not simply about managing risk, but also a financial opportunity. Reuters reported that a record $649 billion was invested in ESG-focused funds in 2021, meaning they now account for 10% of worldwide assets. These investments have generally outperformed the market averages. For example, the MSCI World Index gained 15% last year, while its equivalent for companies with high sustainability ratings rose 21%.
Companies that demonstrate a positive ESG commitment are also enjoying more sustainable profits setting them up for long-term success. Customers, investors and employees increasingly want to buy from, invest in and work for firms that can demonstrate a positive ESG impact. Increasingly, businesses are recognising the concept of a "double bottom line"–that their performance should be measured in terms of positive social impact as well as profit.
How should financial institutions and other companies respond?
Companies of all stripes can mitigate the reputational, regulatory, financial and strategic risks posed by ESG–and exploit its opportunities–by taking the following steps:
Compliance teams face challenges to understanding ESG claims
It is undeniably important for companies to monitor for ESG, but it is not a straightforward task. Challenges include:
Nexis Solutions: cutting through the noise to surface ESG risks and insights
Nexis Solutions helps firms to tackle the challenge of assessing ESG risk head on and surface insights related to ESG risks across our broad range of data, from our news archive to company data to PEPs and sanctions lists. This supports companies’ reputational risk management, due diligence, and data-driven investment decisions.
In addition to our existing data, we have recently added ESG content to Nexis Diligence™ that enables users to confidently incorporate an ESG risk assessment into their due diligence research and reporting workflow, within a single interface of content chosen specifically for fast, cost-effective, and comprehensive due diligence: