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It has been an exhausting yet exhilarating multiyear sprint for the bank management teams and boards that are now being lauded as industry leaders on environmental, social and governance (ESG) reporting.
Despite the obstacles posed by ESG’s novel challenges (see PwC’s 2022 Next in Banking and Capital Markets Outlook), those at the vanguard would likely say it was worth the effort: Internal processes are maturing to handle expanded responsibilities; a new pool of ESG-conscious talent is being attracted by the company’s efforts; and ESG-friendly products are gaining traction.
Even with these positive steps, a growing list of ESG regulations is causing leading bank boardrooms to face challenges in terms of responsibility, board composition, messaging and managing stakeholder expectations. In response, banks likely have to accelerate the pace of internal change as there is a lot of work to do ahead of fast-approaching regulatory mandates.
In this update, we look at several areas that are top of mind for boards, the initiatives needed to respond and the board’s role in monitoring the transition to an ESG-adaptive business model.
Banks likely have to accelerate the pace of internal change as there is a lot of work to do ahead of fast-approaching regulatory mandates.
Active oversight
Enterprise-wide, investor-grade ESG disclosures are essential to meet the Securities and Exchange Commission’s (SEC’s) climate and cybersecurity risk management regulations. Bank management teams are the natural choice to lead the implementation of these changes, but bank boards should play an active role in helping to set strategy, strengthen governance, re-examine risk and improve oversight. In addition, boards of all registrants are required by the proposed regulations to disclose details of how they fulfilled their oversight role in the 10-K annual report.
- Advise on management’s climate scenario analysis and risk modeling: Review the details and challenge it for believability and granularity. Remember that the proposed regulations require reporting at the zip code level. (Risk Committee – Climate risk modeling: What you need to know to get started)
Expanded perspective
New regulations bring the possibility — and the opportunity — of adding expertise to the board. Just as the Sarbanes-Oxley Act of 2002 brought finance expertise to the boardroom of most banks, the growing regulatory requirements around climate, cyber and human capital may spur some boards to decide they need experienced hands in one or more of these areas.
- Determine board composition changes that are needed to achieve ESG expectations: This may include adding a director, increasing board education and/or leveraging outsiders.
External communications
We also expect the shifting regulatory landscape to put more pressure on boards to confirm that a bank’s public messaging and internal controls are aligned. If a bank is already providing ESG metrics externally, directors would be well-served to consider the existing governance structures and confirm that the messaging is clear and consistent across communication channels. Reputational risk, in particular, is rising in cases where a bank’s actions are perceived to be falling short of publicly stated goals. Strengthening enterprise risk management (ERM) may be necessary to protect a brand, yet that has to be done in a way that still allows the bank to seize ESG-related growth opportunities within its target markets.
- Assess if governance and risk structures provide messaging that is clear and consistent across communication channels, while also being aligned with the bank’s strategy. (Nominating & Governance and Risk Committees – ESG oversight: The corporate director’s guide)
The data and disclosure challenge
We believe the board should already be talking to management about a financed-emissions strategy that addresses risks as well as market opportunities. At the same time, boards should urge management to improve the standardization and reliability of the bank’s Scope 3 data, which includes emissions tied to loans, leases and/or investment products. Better data and new internal processes will be needed as the climate and cyber certifications mandated by the proposed regulations require the signature of the CFO and CEO, as well as approval by the audit committee.
- Understand management’s process for determining climate materiality and for achieving investor-grade reporting and controls. (Audit Committee – The audit committee’s role in sustainability)
Compensation question
In an effort to motivate action, many banks are tying management and board compensation, including bonuses, to measurable progress on ESG initiatives. Using the bank’s short- and long-term goals, compensation plans should reflect the metrics that make the most sense for the organization’s ESG roadmap.
- Develop an approach for including ESG metrics as part of the compensation and bonus package for executives and board members. (Nominating & Governance, Human Capital or Compensation Committee – ESG oversight: The corporate director’s guide, page 23)
Conclusion
The more we dig into the SEC proposals and the resulting bank regulatory guidance that’s being written, the more clear it becomes that government agencies are seeking richly intricate information that covers what’s happening inside and outside of an institution — both today and under various future scenarios.
Collecting and verifying the growing amount of required data is a daunting task, and bank board members should urge management to continually make improvements. After all, the implementation of the SEC proposals appears to be a matter of when, rather than if. It should also be clear that stakeholders are pressing banks for more granular data, along with clear evidence that they are working to make a difference in their communities and various industries.
Boards that thoughtfully assess the need for sweeping change may create a rewarding legacy. Today’s changes could put in place the systems that eventually answer society’s pressing ESG questions.
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