Financed CO2-footprint, green finance, low carbon economy. If it sounds familiar, that’s because sustainability is becoming an integral part of our society. The Paris Agreement is often taken as a referral point for financial institutions to be committed to, and held accountable for, meeting measurable sustainability criteria. It is becoming more common for financial institutions to put sustainability as a core part of their strategy setting ambitious targets. The CEO has to answer questions like “What is the plan behind the impact of your investments on sustainability goals?” on the annual shareholders meeting. This blog will explain that a data driven approach is needed to 1) measure the sustainability performance of portfolios accurately and 2) to realize a better understanding of sustainability drivers in your portfolio, allowing you to 3) start steering effectively.
What do you need to measure and why?
The maturity of your data management in the sustainable finance department should be derived from your strategy: explaining changes in sustainability impact in your portfolio and allowing for interaction with clients on how they are rated, requires a different level of data management than an aggregated annual presentation. Although third party vendors may support a fairly elaborated ESG (Environmental, Social, Governance) sustainability framework for your portfolio, convincing and answering clients often requires a more granular approach. So ask yourself as a financial institution: what do we want to achieve in the field of sustainable finance? And what does this imply for our data management? A tailored sustainability program is the answer to make your data management suit your positioning.
A tailored sustainability program offers a clear overview of strategic choices and implications:
- Data quality
Transparency towards clients will often result in more detailed input for the credit review and rating process. This allows also for meaningful distinctions between companies in the same sector, as their supply chains usually differ. In turn, this also increases the need for protocols and verification. Think of questions on whether the client applies the same methodology on sustainability indicators (for example numbers of jobs created in low-income areas or percentage of employees earning living wage) and whether data of the client is plausible.
- Data governance
For instance, data gathering may become a joint process between the financial institution and client. When the client has access to relevant sector benchmarks, it usually improves acceptance and enables him to gain a better understanding. Clients often set their own targets, also towards partners in the supply chain. Although data insight and accuracy improve, strong governance is needed: as to who can approve data/manual overrides and to track where sustainability data came from.
- Data lineage
Increased accountability and portfolio steering on sustainability impact requires insight in key parameters underlaying the rating model. Like what is driving the rating of the shipping sector of soybean farms? How to determine the quality and market conformity of those parameters? When an external vendor rates the portfolio, these questions become even more pressing, as meeting portfolio targets also depends on the accuracy of these parameters. Often the maturity level of vendor solutions differs significantly between different sectors, and portfolios are not evenly distributed among sectors as well. So it becomes paramount to have the right contracts in place, allowing you to strike the right balance between needed insights in the quality of your vendor’s parameters and modelling the rating of clients of your key sectors.
Coming back on the CEO question, we suggest the following the three steps to get started. Using an agile approach, the idea is to have a clear focus and scope on the sustainability areas that deserve priority. By collaborating closely both internally and externally, the plan behind measuring the impact is being shaped. The result is a clear data management approach serving as foundation for your sustainable finance department.
What does an agile start typically look like?
- Assessment of stakeholder requirements
The starting point on measuring sustainaility performance is often as challenging as it is important: external stakeholders, like shareholders and supervisors, focus on the framework financial institutions are using to report sustainability impact. Internal stakeholders want to understand how (potential) clients are rated and identify for instance their top-10 CO2-footprint clients. While the first group focuses on the comparability of sustainability performance, the other group focuses on portfolio steering, tracking key performance indicators and setting goals. The first step is therefore to link the different requirements of stakeholders to data reporting capabilities.
- Start small and scale up
Sustainability reporting may have a broad scope (ranging from SO2 to human rights) and different angles (from risk assessment to footprints calculation) are used to measure the performance. Investment & loan portfolios of financial institutions cover many sectors. The importance and relevance of certain sustainability criteria differ per sector. If you also consider that a client in your portfolio may be active in multiple sectors, you can imagine that it is quite an exercise to get it right. A roadmap is typically established, because the data management implications of reporting on the different topics in scope are quite challenging. First you need a data management framework based on a coherent methodology. Secondly start with priority sectors and review the impact internally on plausibility and verifiability. It also realizes auditable standards on data governance, quality and reconciliation.
- Promote sharing your sustainability impact methodology internally
From our experience, sustainability impact measurement significantly improves if meaningful distinctions are identified among clients, even in the same sector. Consider for instance differences in supply chains. If it’s done in a controlled manner that involves client responsible stakeholders, the demand on data management increases to provide well documented and auditable key parameters. Collaboration with business departments on determining meaningful distinctions among segments in the portfolio realizes more ownership of sustainability data at business lines within financial institutions, as understanding and acceptance of the rating model used is raised. This in turn is necessary to have more accurate data provided in the initial application process that drives the aggregated sustainability performance on a portfolio level. Insufficient trustworthy and consistent data in the first stages of the application process is probably the single most important hurdle to accurate reporting on a portfolio level. A digital sustainability framework makes the pathway for measuring the impact of portfolios on sustainability.
The bottom line is that improvement of data management helps you bring sustainable finance from ambitious targets to accurate measurements. This, in turn, allows you as financial institution to steer on the values of your portfolio and take decisions that benefit the environment and society.
Co-author: Rob van Dijk