Questions answered in this essay:
Explain the meaning of environmental, social and governance (ESG) issues in relation to lending and institutional investment decision making, giving examples, and consider why they have become increasingly important in recent years.
The financial risks of clim...
Explain the meaning of environmental, social and governance (ESG) issues in relation to lending and institu-
tional investment decision making, giving examples, and consider why they have become increasingly im-
portant in recent years.
The financial risks of climate change have become central to the ESG debate. Explain why climate change
presents risks and why climate change risks may be different in nature from traditional risks.
The Principles for Responsible Banking were published in November 2018. Explain what these Principles are
trying to achieve and what changes might be seen in the banking industry if a large number of banks sign up
to the Principles. What steps, such as changes to the incentive system, might a bank take to encourage conform-
ance with the principles right across all areas of operation.
When assessing the long-term viability and ethical effect of a business or organisation, banks can
refer to an ‘ESG criteria’, ESG refers to the three main factors; environmental (and externalities),
social and governance. ESG standards are used by socially conscious investors to vet investments.
Introducing schemes and frameworks like the Principles of Responsible Banking (PRB) lays the
groundwork for a long-term, sustainable banking system and assists the sector in demonstrating
how it contributes to society. The risks created by climate change are now demanding attention
and serious action needs to be taken before their effects become irreversible and devasting. This
essay will briefly explore how raised concern for ESG issues and the PRB are promoting a higher
level of accountability on banks and the financial system to act in more socially responsible ways.
The increase in interest and importance placed upon ESG issues has been phenomenal in the last
decade, potentially due to legislations like the Principles for Responsible Banking and the Paris
Agreement that legally binds countries and organisations into frameworks that aim to raise
ambitions on ESG issues. Unfortunately, climate change is a reality that we can no longer ignore,
with this energy sources are shifting and there is less motivation for investors to inject money into
out-of-date institutions like oil and gas. Along with environmental issues, social changes such as
longer life expectancies and longer working lives mean that companies must have policies ensuring
discrimination in any form is prevented. Many ESG issues could affect an investor's decisions
when looking into their next investment opportunity, for example, the effect a company has on
environmental issues such as climate change and water pollution, social issues like employee
turnover and customer satisfaction, and governance issues namely executive remuneration and
relationship between CEO and employees. An experiment carried out by a team at the Universities
of Austin Texas and North Carolina tried to prove the argument that the increased interest in ESG
issues during the investment process cannot be explained by the ‘neoclassical’ investment theory
that an investor acts in a way that only takes into consideration the risk and return features of an
investment (Baker, Hollifield, and Osambela (2020)). The results of this study not only showed
that a company’s ESG score affected whether or not an investor was likely to invest with them,
but that the impact was asymmetric, meaning that the negative impact on investor perceptions (due
to low ESG scores) was much greater than the positive impact of a good ESG score. Although this
result may seem positive in terms of awareness of ESG issues in the financial industry, the
limitation is, from this experiment, it appears investors are more concerned about not investing
with companies that cause excessive harm, whereas it would be preferable to see investors wanting
to invest in companies that are actively trying to benefit and make contributions to resolving major
ESG issues, such as climate change and carbon dioxide emissions. However, this experiment was
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