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Today’s global financial leaders, from central banks to financial regulators, are increasingly focused on issues surrounding climate change and sustainability. There’s also been a shift in attitude from policymakers and legislators who are now recognizing the significant role the financial system must play in getting companies to take steps necessary to take the economy towards net-zero emissions.
The risk of climate change on both global and individual economies may only be a threat right now. However, if that climate risk begins to take form, there would be a considerable impact on asset values, especially with the current understanding of climate risk exposure across various industries – and could result in a significant downfall in asset prices. It’s time to break down the key insights companies must focus on in order to unlock ESG data and how AI technology can be used to redirect capital from carbon-intensive to green investments.
1. The regulatory environment
The tools developed to tackle the global financial crisis are now being used by regulators to address the problem of climate risk management and the development of green finance. With so many of these initiatives in progress, the industry will soon see an influx of ESG-related conduct and prudential requirements – which will then be accompanied by new reporting and management requirements, including monitoring and oversight.
While organizations may have questions about the implications and impact of these incoming rules and regulations, one thing is clear: It’s time to move beyond the adoption of ESG practices. Businesses need to have the ability to prove these efforts. In fact, “following the unprecedented market and policy momentum behind ESG in 2021, investors, corporate boards, and government leaders have raised expectations for progress on climate pledges in 2022,” according to recent reports.
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As financial institutions take practical steps toward implementing sustainability in their services and activities, companies must follow suit – especially considering sustainable corporate practices are increasingly garnering investor and acquirer attention. That said, many companies are proceeding with caution to avoid accusations of greenwashing, leaving many businesses hesitant to advance ESG plans. This is often due to not having a clear path forward or being afraid of “not getting it right” in the public eye. It’s more than just adopting a new business model and investment strategy; it starts with analyzing back-office activity and assessing the impact of climate risk on the existing business.
2. The vital role of data
In a data-driven world, it’s no surprise data plays an essential role in financing and measuring the impact of the transition on asset values. Sustainability data at a product level includes precise environmental impacts and financial investment outcomes, such as equities, bonds, loans and derivatives. This is key to assessing climate risk exposure, informing green investment decisions and securing the flow of capital. Although most companies have an abundance of data, the key challenge they face is in yielding consistent, standardized and usable product-level data.
What makes this so challenging? Well, up to 90% of enterprise data is unstructured, making that data useless to most companies. By unlocking the hidden value of that data, it could then act as an input for pricing engines, risk management tools and more – a component of the data that is so core to the financial services industry. But to do that, firms must first lay the groundwork for ESG data and leverage the right tools and technology that has the power to unlock the value of data.
3. The foundation of ESG data
Beyond the essential (and somewhat obvious) role data plays in this arena, it’s critical to understand the groundwork for ESG data. The insights hidden in this data are informing major financial decisions, and the need for this data is governed by an uncertain regulatory environment and founded in industry-lead standardization efforts. Around the world, regulators are setting the standards for product-level sustainability data through regulations like the European taxonomy for sustainable activities, the U.K.’s green taxonomy to help tackle greenwashing and the U.S. SEC’s recent proposals to support mandatory climate disclosures.
Beyond the regulatory environment, private organizations are also developing industry standards and best practices – further proving green initiatives play an increasingly large role in financing and funding opportunities. For example, the Equator Principles are guidelines to help lenders and other financial services firms better understand the impact and climate risk of their activities when financing projects.
What’s more, global industry associations, like the International Capital Markets Association (ICMA) and the International Swaps and Derivatives Association (ISDA), are also leading efforts in setting up standards for adopting sustainable practices and measuring those efforts. These associations are leading the way in defining and classifying these ESG-related initiatives as well as setting the standard for industry-wide best practices.
4. The advantage of technology
With an understanding of the importance of data combined with the foundation that drives ESG data, organizations must also leverage technology to unlock the value of data. Financial institutions, lenders and issuers are increasingly incorporating tools into the legal and contractual documentation that governs the financial instruments and trades into which they enter – essentially ESG data is fueling modern financing and investing.
Anticipating a regulatory framework in the near future, it’s important for both financial services firms and corporations to adopt the best practices, principles and standards developed by industry leaders – and investing in the climate tech that powers a data-driven ESG proposition. To achieve this, businesses must analyze their contracts and documentation and proactively incorporate ESG-related data points into key business decisions.
Technology offers a significant advantage because the data that measures sustainability impact and assesses climate risk resides within contracts and documentation. Whether these documents are old or new, organizations need a way to quickly extract the data and transform it into impactful metrics and reports that can be used for decision-making. If firms wait to begin this work until regulations are enforced, they will be at a disadvantage. With thousands of documents to analyze, firms should leverage the power of AI technology to extract, classify and interpret the data trapped in their documents – enabling smarter business decisions, eliminating manual processing and optimizing data flow quickly and accurately.
As environmental, social, and governance (ESG) issues continue to direct the executive agenda, it’s essential for both financial services firms and corporations alike to understand the evolving regulatory landscape, the role of data in measuring green initiatives, the foundation of the data that drives ESG efforts and the benefit of leveraging AI technology to inform better financing and investment decisions.
Lewis Z. Liu, Ph.D. is cofounder & CEO of Eigen Technologies.
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