Exploring the role of Sustainability and ESG in the Financial Sector
On March 27th, the Budapest Fintech Meetup, in cooperation with OTP Lab and Sprintform, hosted a discussion on Sustainability and ESG's role in Finance. The panelists included Christian Müller, a strategist within the Climate Strategy Team at Barclays CIB; Ákos Lukács, who leads the Climate Change, Sustainability, and ESG Advisory Services at EY Hungary; and Gergely Pókos, who leads the Green Program Directorate at OTP Group and is responsible for running the ESG program on Group level. András Berczeli, the Managing Director of Sprintform and the main organizer of Budapest Fintech Meetup events, moderated the discussion. The event discussed how ESG is transforming bank financing, and how ESG-related risks and opportunities are incorporated into their investment practices.
One of the key questions raised during the discussion was how ESG transforms bank financing from a corporate lending investment decision perspective. Christian provided some historical context, noting that ESG started as an exclusionary tactic, allowing investors to exclude certain businesses that did not comply with their moral values or had controversial governments backing them. However, ESG has since evolved to include traditional financial materiality alongside traditional financial analysis, with investors now incorporating ESG-related risks and opportunities into their investment practices. Additionally, more investors are focused on values and beliefs and are interested in getting socioeconomic benefits and financial returns. While there has been some backlash to ESG, Christian noted that there is still a linear growth in investing trends towards ESG.
For banks like OTP, which finance a large part of the regional economy, Gergely emphasized the need to initiate conversations with businesses to become more sustainable and commence their transition plans. Given the number of uncertainties, he described this as a marathon rather than a 100 meters sprint. However, these conversations should lead to planning investments toward projects that promote sustainability. Gergely also noted that he does not believe there should be a seperate ESG credit, but rather that banks need to consider what types of risks and opportunities exist in a given investment situation. Sustainable finance must involve more than just the usual financial assessment; it must also consider the environmental and social impact.
The panel also discussed how the economy could be "greened" or become greener through financing and the financial sector's role in achieving sustainability and climate goals. Ákos said that environmental, social, and financial factors are combined and considered in ESG, creating a new taxonomy universe. Though no single taxonomy exists around ESG globally, Ákos highlighted the different taxonomy applied in Big4 companies' ESG reports. Regardless of the non-standard taxonomy, ESG-related investments will be even more booming. In Europe, the EU has long-term plans from each member state, which are then submitted to the European Commission, adding to the joint plan (pledge) of the EU. Ákos noted that the private sector should be better connected to these plans' creation, and he hopes that the inclusion of businesses can be part of future government-set ESG targets: He hopes governments will set new targets till 2050 with consulting with the financial markets and the key players of the private sector to leverage public funded climate action with private finance.
Regarding ESG-related target settings, Gergely believed it is a complex and huge procedure. It requires governments and organizations above governments, trillions of euros of investments, and an extremely long time horizon to 2050, making it difficult for the private sector to adapt these targets and start doing something practical with them. The industries in which banks can make a clear cut between what is sustainable and what is not are energy, real estate, and transportation. Gergely explained that over 70% of greenhouse emissions in the Southeast Europe region come from these three sectors. Banks financing sustainable options in these industries can solve 70% of the problem.
Christian brought in the ’energy trilemma’ between security, sustainability, and affordability, and in the past 6-12 months, markets saw a skewed approach towards security and affordability. Christian added that although there is no clear-cut solution to the recent energy crisis and companies are looking to adapt their sustainability strategies, we see significant effort from European energy companies to stay in a leading position regarding emissions reduction and sustainability.
The topic of ESG backlash was deeply discussed at the event. According to Ákos, even the name ‘ESG’ has its controversiality, given that the environment is prioritized over sustainability, which should be the primary factor. Although companies have established internal operations and monitoring activities related to ESG, these functions face backlash due to unfavorable economic circumstances. Business stakeholders should lead the ESG initiative, with banks calculating asset ratios to ensure they make money on sustainable funds and investments. The panelists agreed that more work needs to be done in this area.
Christian discussed the recent questioning whether it’s possible to create long-term value through ESG. Deloitte's recent study on the correlation between ESG scores and market capitalization values indicates that market value / EBITDA and ESG are almost correlated. He also shared the importance of setting up a climate strategy department for benchmarking portfolios, measuring client actions, and where possible adopting a stewardship role to help target companies in their transition efforts.
Transition is the most critical factor enabling results in ESG programs; however, it is often disregarded. Gergely's view on transition is that banks need to adapt to collecting non-financial information, not solely relying on collecting financial information, which they have done for thousands of years. For example, if a client has a large power plant burning coal, transitioning to gas is a step toward sustainability, even if it could be more optimal. He also shared that divesting alone will not solve the problem.
Regarding the transition efforts to achieve net-zero goals, Christian shared important steps could be linking executive compensation to climate or ESG KPIs. Other steps could include allocating for a dedicated green CAPEX/OPEX and engaging in third-party verification of ESG-related efforts and goals. Ákos pointed out that there is a need for a unified approach towards the transition in different countries, with no agreement being reached since 2015 in connecting climate finance of developed and developing countries under the Paris Agreement.
In conclusion, the discussion highlighted the importance of sustainability in finance and banks' role in promoting sustainability. As investors increasingly consider ESG-related risks and opportunities, banks must adapt and initiate conversations with businesses on becoming more sustainable. The private sector should be better connected to government-set ESG targets, and banks should focus on financing sustainable options in the energy, real estate/construction, and transportation sectors to help solve the majority of the problem of greenhouse emissions. Companies need to prioritize sustainability, and banks need to calculate asset ratios to ensure they make money on sustainable investments. Overall, the conversation demonstrated the urgent need for sustainable finance and the potential for banks to be critical players in this new and complex field.