Environmental, social, and governance (ESG) regulations are evolving rapidly, shaping the future of financial services. As we look forward to 2024, financial services institutions (FSIs) must transition from the preparatory phase of understanding ESG frameworks to actively incorporating them into their business models – posing both a big challenge and opportunity for the industry. Here’s what we think the ESG regulatory landscape will look like for next year, and how FSIs can prepare to stay ahead.
From regulation to action
2024 is already shaping up to be a big year for ESG regulation, especially in the EU, where according to Maria Patschke, CEO of ESG Solutions at SAP Fioneer, years of preparation are set to ramp into action. ‘After introducing multiple regulations in the EU over the past three years, the focus will now shift to execution.’
The headline measure in the EU is the Corporate Sustainability Reporting Directive (CSRD), set to be finalised in 2024. This directive will broaden the scope of ESG reporting requirements to encompass all large EU-based companies that meet certain financial criteria (two out of three of 1) a balance sheet total of at least €20m, 2) net sales of at least €40m, 3) 250+ employees) that are almost without exception applicable to banks and insurance companies. In addition, FSIs will soon have to publish their Green Asset Ratio (GAR), a new key performance indicator (KPI) that measures the proportion of a bank’s assets that are aligned with the EU Taxonomy (a classification system that defines which economic activities are considered to be environmentally sustainable). The GAR, introduced by the European Banking Authority in 2022, will become a mandatory KPI for all EU FSIs in 2024.
The EU’s regulatory push is likely to have a ripple effect worldwide. More voluntary ESG frameworks will appear and existing ones, like the Partnership for Carbon Accounting Financials (PCAF) and the Net-Zero Banking Alliance (NZBA), will experience a growth of membership. ‘I expect more countries to introduce similar regulations as the EU, while ESG frontrunners Japan and Korea will most likely have a role-model effect for the Asian market,’ says Maria Patschke.
North America presents a more mixed landscape.
While Canada seems ready to refine its guidance, the United States faces political ambivalence that may affect ESG regulation progress. Climate change is such a politically divisive topic in the US that many states have actually introduced anti-ESG regulation, which punishes businesses (including FSIs) that carry out pro-environment practices such as boycotting fossil fuel companies. The US Security and Exchange Commission’s (SEC) proposed climate disclosure rules are expected to be finalised this year, but, says Patschke, any action will likely be ‘stalled until after the election’ with the environment still considered a vote-loser in some states. FSIs will likely need to wait until after the election before clarity starts to emerge.
That said, pockets of the US show progress which might have an impact further afield. In September, California passed a climate bill which is the first in the US to include Scope 3 emissions – meaning FSIs have to disclose financed emissions. ‘This is big news,’ says Stefan Malchow, Solution Expert of ESG Solutions at SAP Fioneer. ‘Having to disclose Scope 3 will have a very positive effect on supply chain engagement leading to disclosure needs far beyond the borders of California.’
Toward international standardization
Despite regional differences, there is an overall trend toward global standardisation and interoperability of ESG standards.
The International Sustainability Standards Board (ISSB) has laid the groundwork with its IFRS S1 and S2 standards, issued in June of this year. While not a mandatory regulation like CRSD, they are expected to become the global standard for sustainability reporting, designed to ensure that companies provide sustainability-related information alongside their financial statements – all in the same reporting package. Moreover, the ISSB is set to take over the monitoring of climate-related disclosure from the Task Force on Climate-related Financial Disclosures (TCFD). ‘It’s a strong signal of consolidation and increasing international interoperability of standards, potentially simplifying the reporting landscape for FSIs,’ says Stefan Malchow.
However, ‘while we’re seeing the convergence of global standards, interoperability of standards remains a key challenge for large, multinational institutions as well as investors using the standards to compare sustainability related performance,’ says Stefan Malchow.
For FSIs with a global footprint, navigating the convergence and interoperability of ESG frameworks will be challenging. For example, companies with material operations in Europe will have to disclose per CRSD, one of the most comprehensive disclosure standards in the world. It demands “double materiality”, meaning companies need to assess both the impact of ESG on their financial performance, such as credit risk due to increased physical risks associated with temperature rises, as well as their impact on their external stakeholders and the rest of society (for example, providing financing to high emitting companies in the oil and gas sector). This will be particularly taxing for those also complying with frameworks like the TCFD and the unique reporting requirements of other initiatives they have committed to, such as the ISSB, PCAF or fall under the EU Taxonomy – as well as those of any other markets they are operating in.
That’s why we built the Fioneer ESG KPI Engine to not only be compliant with TCFD, CSRD, and EU Taxonomy, but to update in real-time to react to new regulations automatically, ensuring full, continued adherence.
Granular, sector-specific reporting
The ESG reporting landscape is also set to become more granular and sector specific, and we expect a significant pivot towards social and governance factors in 2024 and beyond.
Currently, the most advanced portfolio-related KPIs are climate focused: financed emissions, physical risks, and financing for activities related to climate mitigation and adaptation. For the EU taxonomy, technical screening criteria are being released and put into practise for other environmental objectives, such as circular economy and pollution prevention. ‘It signals an increased focus on more detailed and quantifiable data availability for non-climate-related environmental objectives,’ says Arne Sievers, Senior Sales & Business Development Manager of ESG Solutions at SAP Fioneer.
There is also CRSD sector-specific guidance on the horizon. ‘Most FSIs are already required to publish sustainability reports. But those obligations are still based on the Non-Financial Reporting Directive (NFRD). In 2024, an extension to the CRSD will increase the number and complexity of those publication obligations,’ says Kirsten Behnke-Schoos, Head of Solution Sales of ESG Solutions at SAP Fioneer. FSIs will need to adapt quickly to a more comprehensive, sector-specific reporting structure.
Biodiversity efforts are also expected to grow substantially. ‘My recommendation for FSIs? Start integrating it into your loan and investment decisions now,’ says Maria Patschke. With the emergence of frameworks and standards like TNFD (Taskforce on Nature-related Financial Disclosures) and PBAF (Partnership for Biodiversity Accounting Financials) we already see some frontrunner FSIs adopting these standards in similar ways as their climate-related disclosures and KPI measurement.
The challenge – and opportunity – for FSIs
‘Data remains the biggest challenge: sourcing accurate information to produce the required KPIs is daunting,’ says Arne Sievers, particularly given the rapid pace of regulatory change. In the face of increasing reporting requirements and the need to create completely new reports, FSIs need systems that can quickly pull the right information from the right place, whether internal, client-side, calculated or from external data providers. Calculating the GAR for an FSI’s portfolio, for instance, is not a major challenge, but the processes required for this and the existing lack of flexibility in most FSIs’ IT architecture makes it difficult.
This is where our ESG KPI Engine can help. By providing full visibility into ESG-related portfolio data, it enables FSIs to make sustainable, cross-departmental decisions based on all the necessary data, whether from internal or external sources. And, due to its architecture-agnostic approach, it can be deployed in any existing infrastructure.
The implementation of ESG standards can open new business avenues for FSIs that approach the transition as an opportunity and a contribution rather than a hurdle. ‘Regulations and business opportunities are closely coupled. If you shine in front of the regulator, you are likely to be very well positioned to also start leveraging business opportunities and consequently drive positive impact,’ says Annika Doehrn, Head of Project Management of ESG Solutions at SAP Fioneer. ‘Take the GAR: the higher the ratio, the more taxonomy-aligned business or lending has been originated by the lender. FSIs that are forward thinking will start thinking about extending their workflows to create their own sustainable finance frameworks.’
The numbers back this up. Companies that implement policies and practices to address sustainability experience stronger financial performance, generating higher equity returns and a reduction in downside risk. Commercial banks that adopt a strategic focus on ESG outperform their rivals too, according to a recent report from Deloitte. Non-compliance carries not only the immediate risk of fines or sanctions, but also the gradual erosion of stakeholder trust.
Adapting to new realities
A proactive stance, with high-level management engagement and a tightly integrated ESG function, is essential for FSIs.
Given the many aspects that ESG touches across a bank – from data and IT, finance and reporting, credit risk, strategy and steering, all the way to the front office – cross-divisional collaboration will be crucial in breaking down silos and integrating ESG data across functions. ‘ESG champions are needed within each function that serve as subject matter experts for respective areas of expertise and help drive change throughout the organisation,’ says Arne Sievers. ‘It’s important not to look at upcoming regulations like the CRSD in isolation, but factor in the overlaps and dependencies with other use cases and regulations.’
Technology will play a pivotal role in this transformation. Automation and solid, auditable data systems will enable FSIs to not just meet but exceed compliance standards, while providing transparency and identifying any blind spots in the organisation. This demands IT infrastructure that is flexible and adaptable, and FSIs will need to consider whether to develop in-house solutions or acquire external ones, anticipating that regulatory changes will continue for the foreseeable future.
There are already plenty of success stories, as FSIs start to recognise the massive opportunity in embracing ESG KPIs and integrating them into operations, and helping their customers transition to lower carbon emission business models. Danske Bank, Citigroup, Morgan Stanley, and others have set up internal teams specifically to advise and finance companies through their transitions, setting benchmarks in sustainable financing. Rabobank is providing its customers with insights into the emissions of their purchases. HSBC has developed a green supply chain finance programme with Walmart. And JPMorgan has launched a solution enabling investors to access and integrate ESG data from multiple providers so they can better incorporate ESG into their private and institutional investment decisions. It is at the intersection of regulatory excellence and business opportunity where FSIs can make the most impact.
Beyond compliance: Sustainability as a driver of growth
Looking toward 2024, the complex ESG regulatory landscape offers fertile ground for growth.
Financial institutions must look beyond compliance, using it as a foundation and prompt to create a more responsive, automated IT infrastructure and open up new transition finance business avenues. SAP Fioneer’s technology and expertise equip institutions to make this pivot, transforming ESG regulation from an obligation to an opportunity for innovation and leadership.
Those that do are poised to lead the charge towards a future where financial success, customer experience, and sustainability are inextricably linked.