By Christopher DelporteChances are, if you’ve been in the banking compliance sector for any length of time, you know that ESG has nothing to do with having the power of corporate clairvoyance. In fact, when it comes to the relatively emergent field of environmental, social and governance issues—often called “sustainability”—it can be a challenge for even the most seasoned compliance professional to conjure a completely clear picture of what ESG means long term for the financial services sector.
ABA’s ESG Working Group meets monthly via Zoom, providing an ongoing forum for discussion of these issues as they evolve. For more information or to participate, please reach out to ABA’s Joseph Pigg at [email protected].
According to the results of a study released earlier this year by PwC, more than half of consumers (57 percent) support companies doing more to advance environmental issues, 48 percent want companies to show more progress on social issues and 54 percent expect more from companies on governance issues, such as complying with laws and regulation and addressing pay gaps).
Many large banks also have signaled big moves in the area of “green” finance. Consider the volume of ESG-related announcements from banks before COVID-19. Goldman Sachs announced it would spend $750 billion on sustainable finance in the next 10 years. Bank of America committed $300 billion to sustainable investments. Since December 2020, JPMorgan Chase has purchased three companies in the area of sustainable investing. The most recent purchase, in June, is intended to help the bank’s financial advisors customize clients’ investments in ESG.
“We’re sitting at a crossroads today—a pretty big one,” says Daniela Arias, audit senior manager for ESG services at Crowe, a Chicago based public accounting, consulting and technology firm. “U.S. financial institutions are dealing with a lot of uncertainty around ESG regulation. We don’t really know the extent to which regulation is going to change the corporate reporting landscape and the related compliance issues. We also don’t know the effect that it’s going to have on the way that financial services industry operates.”
Though there is some level of uncertainty, there are things that experts can predict to help bankers prepare without having to read minds. “ESG reporting gives banks an opportunity to tell their story,” and compliance can make the story “more complete,” notes Joseph Pigg, SVP for ESG and sustainable banking at ABA.
With ESG, banks can approach compliance, risk and litigation, and operational issues with the right level of input and review to avoid overpromising, Pigg says.
Arias agreed that there are benefits for banks to be out in front of their ESG-related issues.
Obtaining data points also creates areas for improvement, Arias says, not just from an environmental or social standpoint, but from an operational perspective. Banks can measure and potentially gain some efficiencies, she explains. “Whether it’s because you’ve decided to reduce the use of paper or reduce energy use—obviously, that creates some cost savings—but it also can come from increases in employee morale or productivity. There are definitely opportunities there as well.”
Effects on multiple fronts
Meg Sczyrba, CRCM, is a longtime fair lending officer who is currently pursuing a master’s degree in conservation. She currently serves as fair lending and responsible banking risk program manager for U.S. Bank in the Portland, Oregon, area. She admits that she’s relatively new to the ESG space—just about a year since she “first heard the acronym”—but she has immediately seen the complementary possibilities at the intersection of ESG and compliance practices.
“ESG is primed to make important differences on a whole lot of fronts,” Sczyrba said during ABA’s 2021 Regulatory Compliance Conference. “Compliance can and really needs to be part of the ESG solution.”
During the conference, Arias, Pigg and Sczyrba discussed many of those fronts, providing detailed insight into two, in particular—social and climate change issues.
“Climate change isn’t something that’s just going to affect future generations,” Sczyrba says. “These risks to our physical environment are impacting our economy today, and that forces changes to the banking industry and, therefore, to compliance. Regulators are really focused on this and I see something pop up in the news nearly every day. For example, [Treasury Secretary] Janet Yellen recently called climate change the biggest emerging risk to the health of the U.S. financial system.”
Environmental topics have a broad reach. They can apply to the way banks manage things such as waste and pollution, or even how a bank might consider the environmental impacts of the borrowers it chooses to finance, Arias says.
Environmental concerns can affect a bank’s ability to “stay in compliance with existing goals as the rate of natural disasters increases or possible litigation risks that result from real estate development decisions,” Arias notes. Open communication and collaboration among ESG, compliance and other bank teams will be key successfully preparing for what climate change is going to bring, Sczyrba says.
“One prime example that jumps out for me is flood insurance,” she says. “We know that flooding events are on the rise and that means more mortgages may wind up—literally and figuratively—under water. Flood rules require verifying whether real estate collateral is in a flood zone, and if so, whether the borrower’s community is participating.” Flood insurance is predicted to get more expensive as insurance companies start mitigating their losses, Sczyrba points out.
“Since we need to ensure it’s maintained for the life of a loan, banks will want to have strategies in place for how to handle borrowers who can no longer afford insurance,” she says. “We know that climate change is causing some property values to decline, so banks will need to ensure that appraisers factor that climate vulnerability into their estimates. And, again, I think there’s a good partnership possibility here with compliance and ESG.”
Sczyrba explains that financial strains from home repairs and projected increased insurance and tax rates could push more borrowers into default, which will affect compliance with the Real Estate Settlement Procedures Act. “We’ve seen the stress the pandemic put on loss mitigation, and we need to be prepared for future natural disasters that could further strain those systems,” she says.
Fair lending and the Community Reinvestment Act are not immune from the effects of climate change. Low-to-middle-income and minority customers have fewer resources saved to weather the proverbial and actual storms that we’re going to see more of, says Sczyrba. The Federal Reserve noted that most counties impacted by past climate change have CRA-eligible tracts, and the president recently signed an executive order on banking and climate change that spotlighted how vulnerable minority communities are also considered.
“That’s something that we as compliance officers need to prepare for, including on the underwriting front,” she says. “We’ll need to ensure their underwriting accounts for added climate change expenses to avoid allegations of predatory lending. On the flip side, climate change may actually provide us with some opportunities under CRA. Those are opportunities we’d probably prefer to not have, but they do exist. Regulators have indicated that banks can get credit for community investment to reduce climate change vulnerabilities.”
Addressing environmental risk and impact
Considerations such as these overlap with how a bank’s operations affect the people and the communities around it, Arias says.
“Social brings an interesting and complex set of issues to the table, because I think it’s one of those areas that intersects with other aspects of ESG very heavily,” she says. “One example is environmental justice—the idea that environmental law and policy needs to protect people from all races, income, color and origin in the same ways.”
There have been many environmental stewardship efforts, historically speaking, that have left out and maybe even harmed a lot of underrepresented and low-income communities, Arias says.
“That’s easily a topic that transcends the spectrum of ESG because we have to think about addressing environmental risk and impact, but we also need to consider whether there’s a possibility that an environmental stance might be at odds with social goals,” she notes. “There’s a complex intersection there to think through and think about it from a compliance/risk perspective. What considerations must be made by a bank to ensure compliance with fair-lending practices, while also reducing operational risk? And especially when we know that, overwhelmingly, low-income or minority communities tend to be the most vulnerable to climate change.”
Sczyrba says that learning about environmental justice issues from banks’ social partners will help inform and strengthen fair-lending programs, citing her experience with food deserts and the fact that pollution tends to be more problematic in areas with heavy minority concentrations.
“Those are things we probably haven’t thought much about as compliance officers,” she says. “It’s going to make it a lot more difficult for us to lend in those areas, so it is actually important to try to learn about it. Compliance officers can help by sharing their minority mapping to compare that against environmental justice maps to help put all of this into perspective. And if our social partners are out there making a difference in the community, and hopefully we’re helping them do that, that will—in turn—help us reduce our redlining risk.”
Compliance professionals that work in fair lending have probably completed a redlining risk analysis, Sczyrba notes, because there are specific economic indicators at play that will be different for each market.
“If we’ve done our jobs well on this analysis, we should be aware of the problems that exist in each market so we can help target a solution,” Sczyrba says. “We should share our findings to help our ESG partners understand what kind of programs are going to be most helpful in each community. So, for example, if minorities are being declined for credit, maybe we want to look at a financial education workshop or a potentially even pilot a program that’s going to consider alternative credit worthiness standards.”
Clearly there is a lot to unpack in the field of sustainability. Experts agreed that the regulatory environment is going to definitely focus more on ESG issues.
“We see the SEC focusing a lot on this,” Arias said.
The Securities and Exchange Commission recently sought comments on how it should regulate around ESG disclosure, mind you, not whether they should, but how. But at the end of the day, some of these disagreements or points of view are somewhat nuanced because what is certain is that the pathway is moving toward more regulation on ESG. This is going to affect compliance. Specifically, as it pertains to banking, we’re seeing that punctuated by the recent executive order from President Biden essentially calling for regulatory bodies to begin assessing the impact of climate-related financial risk on the U.S. financial system, but then also begin assessing how it’s going to be incorporated into their overall oversight activities.”