Chapter 1
Emerging areas of compliance risk
A strong commitment to sustainable finance creates risk.
As more financial services firms make bold commitments to sustainable finance, ESG-related compliance risk is coming under greater scrutiny. For example, the lack of global standards on what constitutes a green and social product; how to deliver advice that meets customers’ financial and sustainability needs within the context of suitability; or how to address the broader emerging internal governance risk associated with the design, pricing, and distribution of products and services. Compliance can assist in determining if the firm has the right controls in place to address these risks and press the organization to have the right skills in place to manage them.
However, CCOs can’t solve the standards by themselves. They need to focus on where compliance risk presents itself (i.e., ESG-related investment funds, sustainability-linked loans, green or social bonds, and ESG-related investment advice).
“A product’s ESG focus should be clearly stated in its name. And then reflected consistently in its objectives, its investment strategy, and its holdings,” said Richard Monks, Director of Strategy, Financial Conduct Authority.1 “This is all about ensuring that a product really does do what it says and matches consumers’ expectations.”
A product’s ESG focus should be clearly stated in its name. And then reflected consistently in its objectives, its investment strategy, and its holdings.
Chapter 2
Managing interactions across sustainable finance
Validating issues remains one of the most complex challenges.
Today, CCOs face a convergence of issues that need to be aligned across the organization. It is no longer possible to think of ESG in a compartmentalized way. As one CCO put it, “A challenge for us is making sure that what we do with ESG in our funds aligns with what we are doing with ESG across the organization, more broadly.” This may not be just compliance with regulations, but with corporate policy and position, which is even harder to assess and monitor. There are reputational issues to be considered, after all.
The complexities go well beyond the scope of compliance – to risk, underwriting, pricing, etc. But, compliance should have an active and visible role in what is taking place and how to address these challenges.
Not all investment funds are alike, so the assessment of ESG and potential compliance risk have to be addressed in different ways depending on the source of risk. This means aligning a portfolio with a specific benchmark, validating a defined amount of assets with guidelines, and embedding ESG into an active investment, including stock selection, proxy voting, and company engagement.
Ravi Menon, Managing Director, Monetary Authority of Singapore,2 commented, “Portfolio managers and analysts need to be upskilled with the knowledge and capabilities to execute and evaluate sustainability investment strategies. They must develop a keen understanding of climate risk and its various possible effects. They must be able to design innovative ESG scoring methodologies, investment strategies, and product offerings.”
Portfolio managers and analysts need to be upskilled with the knowledge and capabilities to execute and evaluate sustainability investment strategies.
Chapter 3
How to deliver consistency across reporting channels
In the context of ESG, compliance cannot afford to watch from the sidelines.
The challenge on ESG reporting is as much about consistency in messaging as it is alignment and conformance with specific standards. Many firms start by asking which reporting framework to adopt. The starting point should be aligning the strategy with purpose and determining how to execute and resource that strategy, assuring that it adheres to commitments and policy. Only then, is the progress reported to stakeholders. Forgetting this can mean firms get side-tracked on disclosures versus designing, executing, and reporting on sustainable, long-term growth.
The pace at which sustainable finance and ESG have shot up the financial services’ agenda has been startling. What felt like a niche issue 12 to 18 months ago, now seems deeply entwined with a firm’s purpose, strategy, growth, and risk management.
CCOs have an important role to play. That’s their intuition and they are not mistaken. It’s time for CCOs to get off the bench, roll up their sleeves and lean in. In so doing, they will bring a lot to the discussion, especially in terms of influencing the direction of strategy and execution by bringing insight into regulatory trends.
Additional article contributors: Khadija Ali, Executive Director
Summary
Sustainable finance has emerged as one of the top three issues for financial services firms. Compliance has a clear and increasingly important role that will require significant cross-functional leadership and the ability to execute strategy with confidence.
