ESG Risk for Banks in Agriculture Should Be Mitigated with A Reportable Framework
ESG stands for Environmental, Social, and Governance and can be used to describe a company’s business practices or investment philosophy. But as a report by the United Nations Principles for Responsible Investing (UNPRI) points out, “A definitive list of environmental, social, and governance issues does not exist.” Instead, financial institutions are left to their own devices or have to rely on third-party scores when it comes to assessing ESG practices and risks.
In the ag finance sector, these challenges could be addressed by using a standardized reporting framework that can be used repeatedly and adapted over time. Adhering to a standardized framework can help ag banks, lenders, and Farm Credit institutions stay competitive and avoid greenwashing in agricultural finance.
This post will explore the current state of ESG risk for banks, and how the right tools can help ag professionals identify and mitigate those risks.
ESG Risk for Banks is Two-Fold
The most relevant ESG risk for banks comes in two forms: the actual material risk to portfolios, and the risk of litigation due to unpreparedness. When it comes to the first type of risk, PricewaterhouseCoopers explains:
“Addressing all ESG concerns at once is impossible even for the most forward-looking and well-intentioned companies. The key to success is…. the understanding of which ESG risks are relevant to a company’s sector and overall operating context…. Industry and geography are two leading criteria for identifying a long list of potentially material issues.”
In ag finance, these risks often revolve around water and climate issues, which are key to determining a farming operation’s long-term viability.
Understanding physical risks – such as drought and flood risk – as well as associated regulatory issues, can help ag lenders and Farm Credits understand the likelihood of loan defaults.
For example, in California, the Sustainable Groundwater Management Act (SGMA) is intended to address groundwater depletion by restricting pumping allocations in some GSAs. Since these restrictions will vary from one GSA to the next, lenders and other institutions will need to perform a water risk assessment on a parcel-by-parcel basis to ensure that growers will have sufficient water supplies for their crops.
The second aspect of ESG risk is related to market and regulatory issues, as ag finance institutions navigate the changing nature of ESG reporting requirements and climate risk disclosure. Some countries are already introducing stricter reporting requirements, and even in places that don’t require it, investors have come to expect it. One recent study found that “50% of retail investors want their financial advisors to communicate more about ESG investing,” which accounts for $8.7 trillion in U.S. investments.
Simply put, ag finance professionals who take the time to understand the nature of ESG risk for banks will be more competitive than those who don’t. They’ll be better prepared to meet reporting requirements, fast-track the de-risking process, and build resilience in their business.
They can lessen their reputation risk and risk of reporting non-compliance by having a consistent ESG reporting framework.
What is an ESG Reporting Framework?
An ESG reporting framework is essentially a way of standardizing how data is collected, analyzed, and reported. Organizations like the Sustainability Accounting Standards Board (SASB) are working to standardize these metrics. As one board member explains:
“The board developed a matrix of potentially material factors for business leaders in 11 industries and 77 subsectors…. Take the social issue of animal rights. It may be a major economic issue in some industries, such as poultry or food production…. But it may be less of an issue in other industries, such as consulting or mining.”
Currently, the proliferation of competing ESG reporting frameworks can result in a lack of consistency and make it difficult for financial institutions to properly account for risk.
By developing and committing to an ESG framework that’s comprehensive, consistent, measurable, and representative, ag finance professionals can streamline their reporting practices and reduce their risk.
What an ESG Reporting Framework Requires
The benefits of a successful ESG reporting process are many, from reduced operating costs to improve worker and stakeholder morale. But as McKinsey notes, “even as the case for a strong ESG proposition becomes more compelling, an understanding of why these criteria link to value creation is less comprehensive.”
In order to properly account for ESG risk for banks in the agricultural sector, an effective ESG reporting framework must include:
- Real measurements that measure real, unaltered, and un-skewed data. Goals and plans must be measurable and the ESG data and reporting that comes with them must be representative. Measurable progress proves that a company is following through and progress that is real will lessen a business’ own material risks.
- Standardized goals and a business-centric plan. A successful ESG reporting framework should include not just historical data, but forward-looking metrics and business targets that take industry-specific risks and challenges into account.
- Reviewable and repeatable. Just as any scientific experiment must be reviewed and repeated before it’s accepted as fact, an ESG reporting framework should be supported by industry experts.
The Task Force on Climate-Related Financial Disclosures is backed by 1,000+ global organizations in both the public and private sector, while the Principles for Responsible Investment’s Reporting Framework is backed by the U.N.
GIS Tools and Technology for ESG Reporting
ESG reporting yields unique requirements for data acclimation tools that can integrate data sets from throughout an organization, as well as directly from borrowers or from elsewhere in the supply chain. One of the challenges that ag finance institutions face is integrating data sets that are delivered in incompatible formats or that require manual processing.
The benefit of using GIS software for data management is that it matches the geospatial nature of risk and provides context to other bank data. For example, lenders can assess not only the financial risk of a borrower, but environmental and physical concerns such as access to water resources or water rights.
This gives financial institutions a competitive edge, by allowing them to develop their own reporting and risk mitigation strategies that are uniquely suited to their portfolio, while still aligning with industry-standard reporting requirements. GIS tools make it possible for lenders to add context to their data management practices, reducing portfolio risk and building resilience in their business.
The Bottom Line
ESG reporting frameworks can address two of the key concerns related to ESG risk for banks in the agricultural sector. The first is identifying and mitigating the material risks in a lending or investment portfolio, and the second is maintaining regulatory compliance and meeting the expectations of investors and other stakeholders. GIS software can help with this process by improving operational efficiency and strategic decision-making.
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