On the agenda: Is there still time for a first-mover advantage in ESG?

An interview with Henrik Nilsson, Partner at Advisense Advisory and specialized in Capital Markets & Risk Management.

Looking at Financial Crime Prevention in the financial sector, what initiatives are currently discussed?

– We see that senior management is coming to terms with the fact that there is no public, supervisory or board acceptance for failure to actively prevent financial crime. When discussing with clients what this means in practice, we can see a gradual shift, albeit slow, in the attitude towards regulatory compliance, moving from check-the-box exercises towards understanding and exploring the benefits from a prudent Financial Crime Prevention program. This is an important shift, and we encourage our clients to carefully evaluate and learn from similar evolutions in the regulatory area. 

Can you give an example?

-In the early days of the Basel capital accords, institutions viewed the regulatory initiative as quite an annoyance. Funding for Basel-projects where limited and done only reluctantly. Sourcing and structuring credit risk data was experienced as cumbersome and the business side did not have these projects in their top-priority list. 

Then, eventually, credit risk analysts started reverting with small samples of data quality controls, often related to collateral structures and so forth, which provided valuable information to business management. Digging deeper into the data, the next round of feedback evolved around higher principles, such as why certain transactions or business lines would or should subsidize the risk of others. At this stage it started to get interesting for the business side to continue investing in the projects even though they were driven by regulatory initiatives and not initiated directly from a business perspective. The business understood that by adding granularity to risk measurements, this would enable them to both structure and price their credit portfolio more accurately, but also understand how to use the models when competing with other banks for business.

“ESG is a mega-trend, irrespective of how you look at it.”

Henrik Nilsson

What does this mean to financial crime prevention efforts?

Financial crime prevention will undergo the same evolution as when the Basel standards got internalised. By moving from a check-the-box mentality to more sophisticated approaches, the output from financial crime prevention programs will become an additional tool for business to attract customers, but also investors, in a competitive market. Providing an effective on-boarding experience is of course the most obvious example, but in the long run, the ability to use data and applying more advanced approaches will be integrated deeper into the infrastructure för financial crime prevention, eventually providing opportunities to lower the costs associated with financial crime, and ultimately offer better prices to customers and higher returns to investors.

Can such an evolution be linked to all the attention around ESG initiatives?

ESG is a mega-trend, irrespective of how you look at it. But one can get a bit surprised by how out of step the industry is moving. While some banks are in the forefront, publicly, and successfully, presenting their views and initiatives, others are still figuring out how to approach this. Everyone understands the importance of addressing the climate crisis. Taking the “E” aspect in ESG as an example, boards should ask management one simple question: “How can we as a bank reduce our brown lending and increase our green lending?” 

“At FCG, we truly believe there is a first-mover advantage to be gained here”

Henrik nilsson

Of course, this is extremely simplified, but there are some merits to this question. First, think about the classification of green / brown. What data needs to be collected to support the measurement of this? How should it be measured, and how do you cater for the complexity that you can see along the supply chain of the client? We need to understand that the taxonomy will provide some directions, but it will surely not provide all the answers once you start to review your portfolio. Who should be responsible for the process and how should it be communicated internally and externally? What impact should it have on capital allocation and pricing? There are so many dimensions and ideas that could be generated if we continued to repeat this question.

Furthermore, at FCG we truly believe there is a first-mover advantage to be gained here. The starting point for ESG initiatives is the internal process perspective, such as how banks can integrate climate changes into their risk measurements, or how to integrate the long-term view on climate scenarios into the relatively short-term horizon of the stress testing framework? Or how to collect and aggregate the data necessary to ensure compliance with disclosure requirements?

We believe that when banks move ahead, by introducing simple adjustments to their risk infrastructure, you can quite quickly be in a position where you have a reasonable, albeit not perfect, updated and ESG-aligned risk view of the counterparties and individual transactions. If the infrastructure is set up appropriately, these changes will flow through in a consistent manner all the way to your business equity- and pricing calculations to be used in the client dialogue. 

The first iteration will not be perfect, but simply by initiating this, the experience and feedback that will be obtained could then be used in refining the approach. Once you have started to implement this and disclose what the initiatives generate, the market will take notice. 

The first-mover advantage comes in to play since customers of the bank are under pressure from so many both public and private sector stakeholders in to demonstrate what they do in relation to ESG. Any bank that can position itself as being in the forefront of ESG initiatives has an advantageous position since the potential borrowers would like to be associated with this type of bank. But we will see what the progress will look like during 2022. What can be said is that ESG, including ‘S’ and ‘G’ as well, is on everyone’s radar as of now.

(Reference: ESG Funds Managing $1 Trillion Stripped of Sustainable Tag by Morningstar (MORN) – Bloomberg)

Henrik Nilsson

Partner & Head of Advisory Sweden

Louise Brown


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