Social responsibility has changed the way that many sectors operate, but perhaps none more than financial services. Banks and other firms that operate in financial services are increasingly allowing environmental, social, and governance (ESG) themes to influence their decision-making process. This, in turn, is impacting everything from local communities to the global economy.
The global financial services market was estimated to be worth $25.8 trillion in 2022. The influence of the financial services industry on the economy cannot be overstated, from personal finance to investment banking, which explains why its role in social responsibility is watched so closely.
There’s no shortage of ways in which financial firms demonstrate their commitment to sustainability, chief among which is investing. However, it doesn’t stop there, as social responsibility for the financial industry takes a number of different forms.
Table of Contents
Social Responsibility in Finance
Investing
Socially Responsible Investing (SRI) reflects signs of positive change in society, placing an emphasis on both returns and sustainability in investment decisions. While firms go about it in various ways, common themes are that financial firms tend to pursue ESG concepts and avoid those that are considered harmful to society.
In some ways, investment managers have gone all in with the proliferation of ESG-dedicated investment funds. Assets Under Management (AUM) in ESG-related funds were estimated to be $41 trillion in 2022, compared to $35 trillion just two years prior, according to Bloomberg Intelligence.
Morningstar data tell a slightly different story, as the below illustration shows. While demand for ESG investment products surpassed all other categories in 2021, reaching $2.9 trillion, this amount fell to $2.24 trillion as of September 2022, according to Morningstar, which breaks it down by region.
Investors are flocking to sustainable funds both to satisfy their sustainability standards as well as in search of returns, which were on track to finish flat to moderately lower in 2022 amid a broader economic downturn.
Meanwhile, portfolio managers have responded to that demand by introducing more ESG-focused funds. However, the pace of new funds was expected to slow somewhat as of mid-2022 due to an uncertain regulatory environment for sustainable funds.
There is no one size fits all sustainability criteria, as it looks different depending on the firm. One way that the financial industry determines an ESG asset is based on what’s known as an ESG rating, a score assigned to a company to help investors with their decisions. There is no one set standard, but the MSCI ESG score is one of the more popular models.
Considering that there’s no way to determine a company’s risks as they relate to sustainability on the balance sheet, the ESG score is designed to do the job. The stronger a company’s ESG score, the better it is said to be managing its ESG risks, such as:
- Energy efficiency
- Employee safety
- Board independence
Another way a financial firm might demonstrate its commitment to social responsibility is by avoiding companies active in industries deemed controversial to the cause of fighting climate change. This could mean skipping the oil and gas sector, defense, or companies that participate in deforestation, for example, in favor of greener investments, such as renewable energy like solar or wind power.
One niche under the SRI umbrella is impact investing, a way to target investments that strive to make society a better place while also targeting certain financial returns. Here financial players like private equity firms would specifically back things like renewable energy projects, affordable housing developments, or microfinance institutions, for example.
Thousands of PE firms demonstrated their commitment to socially responsible investing by supporting the United Nations-backed Principles for Responsible Investment (PRI). The impact investing market continues to expand to this day, surpassing $1.16 trillion in total AUM as of 2022, up from just over $500 billion in 2019.
The latest trend among PE firms is to pursue a specialized impact investing strategy rather than taking a generalized approach. Some of the themes include investments whose purpose is to improve access to systems like healthcare, education, and financial services.
BlackRock, the world’s largest asset manager, is behind the Impact Opportunities Fund, which seeks to raise $1 billion. It invests in “projects owned, led by, or serving people of color, with a particular focus on Black, Latinx, and Native American communities in the United States,” according to the firm.
Next up is community investing, where investors specifically target underserved communities, such as low-income housing. The investors earmark a certain amount of funds to finance housing development in these areas as well as toward small business lending and other community-focused projects.
As an example, Wall Street firm JPMorgan has been active in this area across projects such as:
- A $9.4 million construction loan in Flint, Mich., for the development of apartment units meant for tenants whose income is 60% of the area median income (AMI).
- A $12 million New Markets Tax Credit (NMTC) equity investment to build a public charter high school in south LA where hundreds of students will attend.
- A $90 million construction loan for the development of a transit village with affordable housing in Oakland, Calif.
ESG Fund Risks
One thing investors should look out for on their way to social responsibility is misinformation. This mostly involves traditional funds that have either been rebranded to give the appearance of an ESG fund, a practice dubbed greenwashing in the industry.
This might not be as sinister as it sounds, as a lack of regulatory clarity as it relates to ESG could be to blame in some instances.
Regulators are tightening the reins here, creating a narrower path for the eligibility of ESG funds. This led to a decline of over 80% in ESG reclassifications and a 60% drop in completely new ESG funds last year through October, the most notable declines of which were in Europe, Jefferies data reveal.
Climate Finance & Issuance
Socially responsible investing is also evident in the debt capital markets, where green bonds are one of the latest trends. These are debt instruments issued by governments or corporations with a promise to direct the proceeds raised to sustainable causes that will have a positive effect on the environment and mitigate climate change. Projects might involve:
- Renewable energy
- Clean transportation (electric vehicles, etc.)
- Energy-efficient buildings
- Wastewater management
- Climate change mitigation
Green bond issuance fell approximately 25% in 2022 but was on track to recover in 2023, according to S&P Global. Catalysts include greater clarity around legislation as well as the interest rate expectations, coupled with a full pipeline due to last year’s slowdown.
President Biden’s Inflation Reduction Act is favorable toward green bond issuance. Goldman Sachs says that this law will fuel “$386 billion in energy and climate spending” over the coming decade, thanks largely to $265 billion in relevant tax incentives.
As an example, PNC Financial in early 2023 closed its latest green bond, the $1.25 billion in proceeds from which were going toward green projects focused on transitioning to a low-carbon economy. In addition, funds would support the UN’s Sustainable Development goals across renewable energy, green buildings, and clean transportation.
PNC has been issuing green bonds since 2019. The firm has committed $30 billion to environmental finance, fueled largely by client demand.
Responsible & Ethical Banking
Another way the financial industry is showing social responsibility is through responsible banking. There’s no one size fits all, with banks pursuing several different strategies to have a positive impact on society and the environment as a whole.
Their commitment to socially responsible issues can be found in the policies that they set and the actions they take, leaving it up to the consumer to find the bank whose ESG cause aligns with their standards.
Banks or credit unions might be dedicated to community development by providing financial services to low-income households or small businesses that might not otherwise have access. They can be designated as Community Development Financial Institutions (CDFIs). These banks made it possible for small businesses owned by Hispanic Americans to survive during the pandemic.
Other banks, in their pursuit of social responsibility, might qualify as minority depository institutions. These companies are not only owned by minorities but also serve this segment of the population in the community. Yet another group of responsible banks might build their strategy around creating policies and pursuing activities that fight climate change.
Ethical banking is similar but tends to represent the steps firms are taking to thwart behavior deemed harmful to society or the planet. For example, you won’t find these banks providing financing to companies operating in sectors like oil and gas drilling that are known to contribute to emissions in the environment. Ethical banking could also mean avoiding other sectors like tobacco, defense/weapons, etc.
Social Responsibility in Finance
Social responsibility is important in any sector of the economy, but banks have a particularly unique role. Their decisions on the way they invest, the projects they finance, and the activities they pursue make a difference in combatting climate change. Consumers are increasingly demanding it, and banks are responding in a way to build trust with the world.
Conclusion
Social responsibility in the financial industry has become a significant factor in shaping the way banks and other financial firms operate. With the increasing influence of Environmental, Social, and Governance (ESG) themes on decision-making processes, the industry’s commitment to sustainability and responsible investing has had far-reaching impacts on both local communities and the global economy. Financial firms are actively pursuing socially responsible investment strategies, incorporating ESG concepts into their decision-making, and avoiding investments in industries deemed harmful to society.
The rise of ESG-dedicated investment funds and the expanding market for impact investing are indicative of the industry’s dedication to positive change. Additionally, green bond issuance and responsible banking practices further highlight the financial sector’s efforts to address climate change and support social and environmental causes. As consumers demand greater accountability and ethical practices, the financial industry plays a crucial role in building trust and driving positive change for a sustainable future.
