Development banks lean on technology to drive environmental change

By Dr. Mariusz Podsiadlo, Global Principal, Treasury & Capital Markets at Finastra

As consumers and investors grow more conscious of climate change and global warming, they are aligning portfolios to support sustainability. According to PwC, more than 83% of institutional investors in Europe are planning to increase allocations to environmental, social and governance (ESG) products over the next two years. Additionally, Finastra’s Financial Services State of the Nation survey 2022 finds that almost 9 in 10 global organizations (86%) agree that it’s important for the financial services and banking sector to support ESG initiatives.

As the world comes together to address climate change, and major economies pledge to reach net zero emissions by 2050, development banks around the world have a great opportunity to promote sustainability by financing projects and encouraging private funding in support of climate-related initiatives. However, with a lack of access to a global, unified framework and real-time data, challenges remain.

In search of a common framework

Discussions around ESG investing have been ongoing for nearly two decades, and the number of ESG-related products has risen accordingly. According to KPMG, since 2019 Europe has seen a significant jump in ESG investment products (114%). Yet despite this growth, global ESG reporting standards remain inconsistent, with an array of initiatives containing different methodologies, scoring measurements and standards. The Global Reporting Initiative (GRI), for instance, incorporates a comprehensive set of guidelines for identifying ESG risks, while the Value Reporting Foundation (VRF) offers standards for determining enterprise value. All major market data providers have also developed independent ESG ratings using different criteria.

To add to this, there are regional inconsistencies. The European Financial Reporting Advisory Group (EFRAG)’s proposed Corporate Sustainability Reporting Directive (CSRD) includes an advanced and comprehensive set of guidelines, and the information used to validate compliance must be vetted by third parties. In the US, however, only the SEC has proposed an established set of guidelines, announced in March of 2022 yet pushed back in October 2022 with no new deadline established. In China, regulators and investors remain the primary arbiters of standards and policy, and most experts agree that formal government action is not likely anytime soon.

Multiple rating methodologies and reporting frameworks around the world can result in unfair advantages. A company operating in a stricter regime, such as Europe, could have a lower ESG rating than a similar company in a less strict region, such as the US. Complex supply chains with suppliers across geographies also make it more difficult for banks to accurately assess risk. As such, all eyes are on the International Sustainability Standards Board (ISSB), which aims to develop a comprehensive set of sustainability criteria designed to be compatible with jurisdiction specific standards.

The need for forward-looking data

A common framework is only the beginning, as banks need more rigorous models for assessing risk. Traditional financial risk models rely on historical data to make future projections, but this is unreliable when it comes to predicting future climate impacts. Development banks, and in fact all banks, need forward-looking data and models to accurately assess risk. Various initiatives, such as the Network for Greening the Financial System (NGFS), attempt to facilitate this need by providing climate scenario analyses. The NGFS unites a coalition of central banks and supervisors to develop a series of climate pathways projecting how the economy and the physical environment could evolve under different possible scenarios.

However, accessing and reporting on a deeper level of data in a timely manner, such as for scope 3 GHG emissions, is a big challenge for development banks due to factors such as legacy systems, lack of staff training and resources. The SEC estimates it will take companies 3,400 to 4,400 hours to report on the ESG alignment when its new ESG disclosures are implemented, assuming the necessary internal personnel are already in place. Another challenge is utilizing data and reporting to make a meaningful change. EY indicates that less than 30% of all firms are referencing climate-related matters in their financial statements. Without a clear correlation between climate-related impacts and financial outcomes, organizations lack the insight to take positive action and mitigate financial risks.

Development banks turn to technology

With the lack of clear and consistent metrics for evaluating climate-related impacts, and challenges with effectively utilizing data, development banks are turning toward technology to improve ESG reporting and reduce financial risks. There is a wealth of fintech solutions that can be integrated within banking workflows, which automate the gathering of data such as the amount of fuel used, products purchased and even travel initiated by employees, which is then fed into the company’s calculation engine. Others enable the importing of information directly from internal ERP systems to assess companies based on a variety of data points.

Open platforms and APIs are enabling development banks to establish open risk management platforms and connecting products. APIs simplify integration with core ERP systems by offering nearly plug and play functionality. Once third-party solutions are integrated into the standard risk framework, institutions can leverage climate-related scenarios and take advantage of existing banking book optimization models to guide them down an optimal path towards a net-zero portfolio target. Finding the right platform partner can facilitate these integrations quickly and seamlessly.

As ESG financial risks continue to escalate and reporting becomes mandatory across an increasing number of geographies, development banks, as well as all banks around the world, require an array of tools to gather data and calculate impact. With today’s technology, development banks can identify and manage risks and opportunities more accurately, giving them the opportunity to drive genuine environmental change.

Read more in our recent whitepaper here: https://www.finastra.com/viewpoints/white-paper/search-global-esg-risk-and-reporting-framework