Financial sector can provide vital impetus for driving ESG adoption

December 17, 2024 in Finance, Opinion, Policy by Editor

Arinda believes by adopting the ESG criteria, banks and financial institutions can significantly promote sustainable development, against a backdrop of rising consumer and investor demand for responsible financial services and regulatory trends favouring sustainability.

The financial sector is in a unique position to drive positive change by influencing economic activities through its financing decisions writes Pauline Arinda.

A January 2024 report, ESG Framework for Uganda’s Banking Sector’, compiled by EY Uganda for the Uganda Bankers’ Association (UBA), emphasized 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.

By adopting the ESG criteria, banks and financial institutions can significantly promote sustainable development, against a backdrop of rising consumer and investor demand for responsible financial services and regulatory trends favouring sustainability.

For financial institutions aiming to demonstrate their commitment to sustainable and ethical practices, adopting the ESG agenda is essential. However, the complexity of integrating ESGs into their corporate governance also means they have to realign their strategies but considering the tax costs, the question arises: is it worth the effort?

Historically, ESGs were often sidelined. However, as climate-related goals become more pressing, specifically the conversation around net-zero emission targets, today there is definite shift from aspirational to compliance.

Faced with the need to publicly disclose progress towards sustainability goals, on top of other technical and complex corporate disclosures, financial institutions have had to scale back their targets to what is realistically achievable or necessary to meet changing regulatory obligations.

These include reducing carbon footprints, promoting diversity, and introducing employee wellness programs. Good governance also covers tax transparency and compliance as integral for a strong ESG profile.

By adopting these standards of good governance however, companies can avoid potentially costly penalties and reduce the risk of reputational damage with stakeholders.

A strong ESG framework can also 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 ESGs positions financial institutions as market leaders, potentially reducing regulatory risks and compliance costs. Committing to these principles can differentiate financial institutions from competitors, appeal to socially conscious consumers and investors, attract and retain top talent, and tap into ESG-focused funds.

It also often leads to more efficient resource use and reduced costs over time. Financial institutions which prioritize ESG factors are perceived as more responsible and ethical. This improves their brand reputation, and attracts new customers who value social and environmental responsibility.

Notably, increased transparency and accountability aligns these financial institutions with global best practices, fostering long-term sustainable development and social success.

However, the benefits of ESG adoption comes with challenges. Financial institutions will navigate through lack of standardization, transparency issues, potential ‘greenwashing’ and often regulatory uncertainty.  Greenwashing is the deliberate move to mislead the public to believe that an entity is doing more to protect the environment than it really is.

Adopting ESG may also mean limited investment options, higher implementation costs, and potential for lower returns. This can 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.

On other hand, non-disclosure of ESG practices can make it difficult for investors to evaluate performance. But prioritizing short-term financial goals over ESG considerations can lead to conflicts and trade-offs between financial performance and sustainability goals.

At the same time, reputational harm from non-compliance can lead to consumer backlash and diminished investor confidence, indirectly affecting the institution’s 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.

The feasibility of ESGs in financial institutions requires careful consideration of both the advantages and disadvantages. However currently, future 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 impact.

 Pauline Arinda is a Tax Advisor at EY Uganda and the views expressed here are her own and not necessarily those of the company.