Delano sat down with ABBL sustainable finance adviser Julien Froumouth to talk about the challenges and opportunities ahead for risk managers in Luxembourg.
Tracy Heindrichs: Media has described ESG as a “new component” of risk management. Can risk managers do their job without taking ESG into consideration these days?
Julien Froumouth: ESG factors are posing new challenges for banks and risk managers in their day-to-day job because they now have to include them to better assess whether a bank might be exposed to risk within its own activities.
This is a complete shift in risk managers’ minds because they have to consider non-financial information, not only from a historical but also a forward-looking perspective. Banks must consider factors on a mid- to long-term basis, while usually they do strategic planning for 3-5 years maximum.
So now, risk managers have to upskill themselves to have the right expertise and knowledge first, then start a discussion with management and then dig in further within the regulation and the tools that exist to capture this new information so they can define what would be applicable within the different business lines from a front-end perspective.
Each aspect of ESG has its own unique risks that come with it. How can risk managers unify the measurements then?
Each component requires specific expertise. Climate is where the data is usually more easily accessible. So usually, the first move within the banks is to take on climate issues. Then they will expand the ‘G’ part and then the ‘S’ part. The ‘S’ is already kind of embedded in the DNA of most banks as part of their AML issues and own KYC processes. For the social aspect, human rights issues are clearly growing in importance along with the CSRD [Corporate Sustainability Reporting Directive], which has been highly debated for a couple of months now.
We see more and more banks digging in the ‘S’ aspect to make sure that they have a human rights policy or robust data collection processes: it pays to get the right antidote prepared to address human rights issues.
We see more and more banks digging in the ‘S’ aspect to make sure that they have a human rights policy or robust data collection processes: it pays to get the right antidote prepared to address human rights issues, because just like with environmental issues, civil society, especially since the war in Ukraine, is looking further in the social aspect. It’s a risk for banks’ reputation and they clearly want to address it.
2023 is also the year where major SFDR reporting requirements will be implemented. What specific challenges are there in getting the reports published and how is this changing the job of risk managers?
The challenge is to collect the right data, especially for banks because they rely on data provided by asset managers and which they then have to aggregate to make sure they’re presenting the right data to their clients.
They also have to deal with the Mifid II amendments, so banks are still collecting data to be able to properly classify the products they are offering, and they have to make sure that the products match client sustainability preferences.
2023 will probably be a transition period for banks where they will collect all those preferences without being sure that they could offer compatible products until they can collect all the data needed to properly adapt the products to the client preferences.
For risk managers, this data will be very useful because they will be able to use it to properly assess the ESG level of risk for their products in accordance with the old sustainability risk management policy of the bank and to underline which products will be exposed to ESG risks. It will also be a useful tool for risk managers to play their role of advisers to the business, to de-risk to a certain extent their most exposed positions within a given portfolio.
If [risk managers] wait until they have all the pieces of the puzzle to start revising the processes and policies, they will probably only start in three years’ time and will already be late .
Any words of advice for risk managers at the start of 2023?
Risk managers should start talking with their management and tackling the subject piece by piece. Climate is the first piece. We know that there will be much more to come in the next months, and if they wait until they have all the pieces of the puzzle to start revising the processes and policies, they will probably only start in three years’ time and will already be late. So, we are highly advising the banks to start already, to start small without fearing all the risks of greenwashing. You just have to be consistent with what you claim.
So: don’t promise too much, work hand in hand with the business, start with what you can assess, start collecting the data. It’s a learning exercise. Use the existing tools, try new tools provided by the market--not free-of-charge maybe but those provided by open source and thinktanks maybe--as a learning exercise. Risk managers have to really use what has been published by institutions like the ECB or the FCA about best practices.
ESG risk is clearly linked with greenwashing, it’s part of the risk and is one of the main priorities of the EU. So this is where risk managers have to upskill themselves.
Those best practices are of course not applicable to all business models so I would highly recommend all risk managers to read them, identify those that are the most relevant for their own business types and start to apply them. Ask questions to the ABBL and the regulators… We know that the [financial regulator] CSSF is strongly supportive in this area--they know that it’s a complex issue and they will welcome the questions to see how they could support the ABBL to provide answers.
Also, the European banking authorities recently published their newly revised workplan in terms of sustainable finance. ESG risk is clearly linked with greenwashing, it’s part of the risk and is one of the main priorities of the EU. So this is where risk managers have to upskills themselves with these new elements if not done yet, or they could be overwhelmed by all these new requirements in the near future.
It's not just about ticking the boxes on compliance issues, it’s clearly a new way of thinking for businesses, I think, and risk managers would have, in my opinion, a role to play: the way they will address ESG risk will also be a way for them to kind of play a certain advisory role to the management because they will have access to new data which would also be helpful for the business to recommend the best products and the ones that will make sense for addressing client demand.
Julien Froumouth spoke at the ABBL & Alrim risk management conference on 16 December 2022.