Environmental, Social and Governance compliance in financial institutions

OPINION | Pauline Arinda | A report done by EY for the Uganda Bankers’ Association in January 2024, titled “ESG Framework for Uganda’s Banking Sector,” emphasizes that adopting Environmental, Social, and Governance (ESG) principles should be viewed as a strategic move towards long-term sustainability and resilience, rather than merely a compliance issue.

The financial sector has a unique position to drive positive change by influencing economic activities through its financing decisions. By adopting ESG criteria, banks and financial institutions can significantly promote sustainable development, supported by increasing consumer and investor demand for responsible financial services and regulatory trends favouring sustainability.

ESG criteria has become essential for financial institutions aiming to demonstrate their commitment to sustainable and ethical practices. The complexity of integrating ESG criteria and best practices in corporate governance has led many financial institutions to align their strategies with sustainability and ethics. As investors, consumers, and regulatory bodies prioritize ESG performance, financial institutions must integrate these principles into their core strategies while considering the tax costs of ESG adoption. However, the question remains, “Is it worth the effort?!”

Historically, ESG factors were often sidelined by finance teams and companies. However, as climate-related goals become mandatory, the conversation around net-zero emission targets and broader ESG issues has shifted from aspirational to compliance-focused. Faced with the need to publicly disclose progress towards sustainability goals amidst increasingly technical and complex corporate disclosures, financial institutions may scale back their targets to what is realistically achievable or necessary to meet current regulatory obligations.

A robust ESG strategy includes various sustainability factors, such as reducing carbon footprints, promoting diversity, and introducing employee wellness programs. Good governance practices, including tax transparency and compliance, are integral to a strong ESG profile. Companies adhering to ambitious standards of tax governance can avoid costly penalties and reduce the risk of reputational damage with stakeholders from aggressive tax planning or evasion.

A strong ESG framework can bring tangible benefits to the financial sector by helping to identify and mitigate risks not apparent through traditional financial analysis, such as long-term risks associated with climate change, social unrest, or governance scandals. Early adoption of ESG can position financial institutions as market leaders, potentially reducing regulatory risks and compliance costs. Committing to ESG principles can differentiate financial institutions from competitors, appeal to socially conscious consumers and investors, attract and retaining top talent, and tapping into ESG-focused funds. Implementing ESG measures often leads to more efficient resource use and reducing costs over time. Financial institutions prioritizing ESG factors are perceived as more responsible and ethical, improving their brand reputation, and attracting customers who value social and environmental responsibility. Increased transparency and accountability align financial institutions with global best practices, fostering long-term sustainable development and social success.

However, the benefits of ESG come with challenges. Financial institutions must navigate a lack of standardization, transparency issues, potential “greenwashing,” and regulatory uncertainty. Limited investment options, higher implementation costs, and potential for lower returns could lead to disappointment or misinterpretation of an ESG strategy’s effectiveness. There is also a perception that ESG investments may yield lower returns, though recent studies show competitive or superior performance of ESG funds. Non-disclosure of ESG practices can make it difficult for investors to evaluate performance, and prioritizing short-term financial goals over ESG considerations can lead to conflicts and trade-offs between financial performance and sustainability goals. Reputational harm from non-compliance can lead to consumer backlash and diminished investor confidence, indirectly affecting financial health.

The banking industry in Uganda recognizes its critical role in promoting sustainable economic growth, social development, and environmental stewardship. By integrating ESG principles into operations, risk management, and decision-making processes, the industry aims to create long-term value for stakeholders, contribute to Uganda’s sustainable development, and support a more resilient and responsible financial system. The integration of ESG criteria is feasible and aligns with the evolving financial sector landscape, suggesting that ESG principles can contribute to long-term sustainability and profitability of banks, with careful planning and execution essential to mitigate potential disadvantages.

In conclusion, the feasibility of ESG in financial institutions requires careful consideration of its advantages and disadvantages. Success and growth are increasingly tied to a solid ESG strategy alongside conducting business in a way that provides long-term value while minimizing negative environmental and social impacts.

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Pauline Arinda, Tax Advisor, Ernst & Young

The views expressed herein do not necessarily reflect the views of Ernst & Young