Promises, Promises: Navigating the Reputational Risks of ESG Investment Pledges

By Nir Kossovsky and Denise Williamee, Steel City Re

As the trend towards ESG investment and a low-carbon economy continues, banks are being backed into a reputational corner. Law firms specializing in representing the expanding pool of litigious shareholders are salivating.

On one hand, banks understand the inherent financial risks and challenges involved with making a wholesale move towards a low-carbon economy. The transition to a greener corporate world can’t happen overnight; as long as “brown” assets continue to be profitable, those in bank leadership positions have to balance their green aspirations with their responsibility to shareholders.

On the other hand, while not renewing loans on existing coal mines or fracking sites may improve a bank’s carbon disclosures, it could have social and financial ramifications that disappoint other stakeholders—i.e., causing people to lose their jobs. Still, financial institutions are experiencing pressure from all sides—from ESG investors to social license holders – to divest the fossil fuel industry and adopt drastic “green financing” practices now.

To alleviate these pressures, banks are pledging greener financing initiatives. Almost every large global bank has made some sort of commitment. Goldman Sachs, for example, announced they would spend $750 billion on sustainable finance over the next decade. Bank of America pledged $300 billion.

Bank boards and executives likely don’t fully appreciate the reputational risks posed by the aspirational statements they’re making. They are making promises and raising expectations without the operational or governance systems in place to ensure those expectations will actually be met. Overpromising and increasing the risk of angering and disappointing stakeholders is the very definition of reputational risk.

Banks are in a unique position: integral to every aspect of our economy, well-known brands that work hard to build and retain the trust of their customers and the general public while operating in an environment of intense scrutiny by politicians and regulators at every level of government. Satisfying all the stakeholders calling for greener policies while fulfilling their responsibility to their shareholders is a demanding balancing act fraught with risk. The Business Roundtable pledge, led by JP Morgan Chase CEO Jamie Dimon, and elevating employees, communities, and the environment as stakeholders, was an attempt to strike that balance. Already, though, that pledge is being dismissed by politicians like Senator Elizabeth Warren, who characterized it as an “empty publicity stunt.”

The price of missing expectations is costly, and bank executives and board members could find themselves in a legal hot seat. Federal securities lawsuit filings alleging reputation harm from missed expectations are up 60% over last year, the third year of a rising trend.

This trend stems from SEC regulation S-K that calls for more human capital disclosures, and the Caremark decision that sets the bar for most securities litigation and makes board oversight of mission-critical corporate operations a test of the duty of loyalty. Other cases, like In Re Signet, have made ESG-like pronouncements—historically “immaterial corporate puffery”—now potentially material in the securities arena.

For example, directors’ duty of loyalty were successfully questioned in alleged failures of innovation (In Re Clovis Oncology, Inc., board failure to protect the firm’s reputation for pharmacologic innovation); safety (Marchand v. Blue Bell Creameries, board failure to protect the company’s reputation for food safety); and environmental sustainability (Inter-Marketing Group USA, Inc. v. Armstrong, board failure to protect the firm’s reputation for oil pipeline-related environmental protection).

In other words, aspirational pledges are now being considered by courts with the full weight of a material public disclosure. As wealth managers chase ESG-informed investing and capital markets chase ‘green underwriting’, the plaintiff’s bar chases boards and executives making pledges that appear to be no more than aspirational marketing.

The only way to strike a balance and mitigate these risks is through a robust Enterprise Risk Management (ERM) strategy that’s centered around understanding who your key stakeholders are, what their interests are, and ultimately, what their expectations are. Coincidentally, it is also one of the three key behaviors the world’s largest asset management firm, Blackrock, is demanding of all investee companies in 2021 thus communicating the type of authenticity to its slogan “beyond investing,” that BP failed to accomplish with similar sloganeering a decade ago.

Banks need to create a central intelligence unit with board level oversight to comb through every aspect of the organization to identify stakeholder interests, potential risks and/or exposures. Pledges and communications should be informed by a rigorous and honest self-assessment of the institution’s public filings and operational capacity. Overpromising is costly. ESG pledges must be rooted in achievable goals that a bank’s leadership are confident their institutions can reasonably execute on an operational level. Banks also need to consider transferring or financing risks using the broad range of conventional and parametric insurance products currently available.

Enterprise risk management, when executed properly, will fulfill ESG commitments, reassure stakeholder groups and give marketers, counsel, and investment as well as government relations professionals an authentic story to tell about strong corporate governance. ERM focused on reputational intelligence will provide confidence to ESG funds, institutional investors, bond raters, and government officials alike.

The popularity of ESG investment and chasing ESG ratings is not going to go away, and stakeholder pressures will continue to mount. Investors doubled the size of the ESG sector this year, putting $27.4 billion into ETFs traded in U.S. markets. According to a recent survey conducted by Bank of America relating to ‘Gen Z’—which is just entering the workforce—80% take ESG into account when making their investment decisions.

Bank leadership that is striving to attain the correct balance between stakeholders and shareholders need to lean more into the “governance” portion of the ESG equation; pledges backed by enterprise risk management are the strongest pledges you can make.