ESG in financial services

The Swiss stock market bears many resemblances to Australia’s ASX. Its home is a relatively small country in terms of population and GDP, punches above its country weight in terms of market capitalisation and representation in global pension plans, is highly weighted to a few key industries and very large companies, requires a high standard of disclosure, and is subject to a relatively sophisticated corporate governance system.

Our Swiss sister firm, HCM (see HERE), have conducted research on the effect of ESG on the Swiss financial services industry. They sought to explore the ESG considerations implemented in strategy, governance and remuneration, paying close attention to challenges and future goals.

HCM surveyed the ESG considerations implemented in the top 25 companies of the SPI Financial Index. Interviews with selected CEOs and chairpersons of Swiss financial service companies were also conducted to obtain a more in-depth look into company practices and processes. Through this research, they have come up with a 4-step checklist for companies, particularly in the financial services sector, to bolster their ESG approach. Because of its applicability to ASX-listed companies, we have summarised this below.

1. Define the key ESG topics

Every company must effectively define relevant ESG topics so they know what they are dealing with. ESG has a very broad definition and this often paralyses decision makers on where to begin. Interviewees cited the lack of any comprehensive code or regulation towards ESG as a hindrance to such initiatives.

To determine the key ESG topics that the firm faces, a materiality assessment is required. This would consider stakeholder feedback, industry, business model, strategy and culture to identify the main factors for the firm.

According to the survey, 52% published a materiality assessment with the key ESG topics defined. Social diversity was a factor within all assessments. Governance was seen within 85% of the assessments. Environmental factors were only disclosed in 38% of the assessments and are more commonly seen in insurance industries.

These topics and factors have to be considered from an organisational perspective. Do they relate to an external product or service or to an internal process? The interviewees learned that oftentimes, the product side is more developed than internal processes of the company.

2. Formulate strategy and governance

The next step involves effectively integrating goals and initiatives for the ESG topics identified in the company strategy. This must cascade from the top where there typically is no clear governance and strategic decision-making structures around ESG.

Only 52% of the companies surveyed disclose practising active management of ESG at the executive level. Likewise, ESG strategy should be a part of the discussion in board meetings. Only 36% of the firms surveyed follow this practice with 28% of the companies reviewed also having a separate board committee to tackle ESG issues.

These are signs that ESG measures are not yet a priority within board and executive circles, and this tone from the top acts as a signal for rest of the company on the importance placed towards ESG.

3. Get employees on board, so not just tone at the top

Employees often see ESG as a burden with more forms and KPIs to fulfil. This makes the engagement and communication of such goals difficult as it oftentimes would be met with eye rolls and cynicism. Some of the questions regarding ESG in the offices are the questions concerning flights for business meetings or the staff restaurant going vegetarian. This highlights the focus that needs to be put on engaging employees to have a more open consideration towards ESG.

This would have to start from the beginning. Employee contribution programs, joint workshops, or employee surveys to foster organisational support and employee commitment. This could contradict the idea of the tone being set from the top. However, with a strong governance process and strategy in place, this would provide the support needed to make any initiative from the staff a success.

By training staff and giving them a louder voice on ESG matters, it brings the added benefit that client-facing functions would be able to engage in more of such discussions with customers. This would help to gain the trust of those looking to have more ESG elements in their investments.

4. Hold management accountable

To ensure management is accountable for the ESG and is not providing lip service, they would have to be incentivised to act accordingly. The updated voting guidelines released by the top proxy advisors and statements released by the likes of BlackRock have pointed to having such ESG factors being a component of variable pay.

In HCM’s analysis of the top 100 financial services in Switzerland, they found that 52% of the banks and insurers disclose a link of ESG initiatives to variable pay. The link is most commonly found in their short-term variable pay. The categories most commonly are social topics, relating to employment practices (64%) and customer treatment (27%) and governance (55%).

Companies also struggle to come up with ESG KPIs because they perceive existing ESG KPIs to be an unreliable measure. This could be aided by having the long-term goals broken down into annual concrete targets to help focus the executive. This relates to the challenge of measuring such ESG accomplishments. Linking the achievement to ESG market indices helps to establish an external benchmark and reliable source. However, it may not address the ESG topic of concern in a sufficient manner. This creates the need for the use of board discretion in current times as companies seek to establish more reliable comparison methods.

The full report and breakdown can be viewed HERE.

© Guerdon Associates 2024
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