How physical risk is driving ESG in banking

When thinking about the banking sector, Environmental, Social and Governance (ESG) might not be what first comes to mind, but this is changing. Within the last five years, ESG has emerged amongst the top 10 corporate-governance priorities in most corporate boardrooms globally, with a particular emphasis on physical risk issues for banks.

The impact of physical risk

66% of major global companies have at least one asset at high risk of physical risk under the high impact climate change scenario in 2050.

Physical risk issues arise if economic activities are threatened by failure to achieve climate-related objectives, and the risks are both prevalent and powerful.

Firstly, the destruction and economic disruptions caused by physical risk spill over into the financial sector. Natural disasters can cause the collapse of residents’ houses and enterprises’ factories and threaten human health and lives. Residents and enterprises might then not be able to repay loans, borrow more money from banks, or take out their bank deposits in order to maintain their living standard and production (Adebisi and Matthew, 2015; Amin et al. 2019). Additionally, climate change along with forest land use, carbon dioxide emissions, and temperature change may exhibit impacts on bank performance through natural disasters (Levy et al. 2016; Cortés and Strahan 2017).

According to a German insurance company, natural disasters cost the global economy £210 billion in damages in 2020, and as stated by the Bank of England in 2019, the world would see an abrupt drop in asset prices and losses of up to $20 trillion if financiers did not address and reduce climate change.

ESG is good for business

Banks benefit from acting in ways that are good for the environment, and by implementing an appropriate strategy, correct policies and technological capabilities, ESG initiatives can be utilised to their advantage.

According to recent research from BlackRock, one in five investors are more interested in sustainable investing because of the pandemic and intend to double their allocation to sustainable and impact investing over the next five years.

Additionally, with 76% of consumers saying they would discontinue relationships with organisations who treated employees, communities, or the environment poorly, banks can benefit from ESG implementation and create additional businesses opportunities.

Moreover, the millennial generation, which is regarded as the most socially and environmentally conscious generation, is set to receive a transfer of inheritable wealth of $68 trillion by 2023. They are known to endorse banks that prioritise ESG initiatives, again reflecting how corporations can utilise ESG to their advantage.

M&A activity

Notable transactions within this space include:

  • Four Twenty Seven (advised by Goldenhill International M&A Advisors) a leading provider of data, intelligence, and analysis related to physical climate risks, were acquired by Moody’s Corporation in June 2019.
  • MSCI, a leading provider of critical decision support tools and services for the global investment community, acquired Carbon Delta AG in 2019, to expand their climate risk assessment capabilities.
  • Jupiter, the global leader in climate analytics for resilience and risk management, announced a $54M Series C Financing in October 2021. The new investment will be used to accelerate the company’s rapid expansion in sales and support to meet increasing customer demand.
  • The climate risk calculations provider The Climate Service were acquired by S&P Global to bolster their ESG data products in January 2022.

Although in 2021 many corporations did set sustainability goals and published ESG data, regulators and the general public increasingly criticised sustainability efforts. As a result of the rising pressure to demonstrate this as a priority, ESG will be high on the agenda for banks throughout 2022 and beyond.

And, with ESG higher on the public’s agenda as well, banks need to be ensure a transparent methodology and capacity to measure results is implemented, with failure to do so resulting in potential damage to both reputation and revenue.