Analysing the Usage of Corporate Environmental, Societal and Governance Data in the European Union Banking Sector

Abstract

In the current environmental conditions, with the rise of sustainable finance concepts like Environmental, Societal and Governance (ESG), firms in the financial sector have found new ways to drive sustainable change. Banks in particular play a key role in promoting sustainable practices both within their organization and also have a significant effect on the global economy. However, banks have had difficulties integrating ESG practices in their sustainable credit distribution products to corporate clients.
Due to the qualitative nature of ESG data, even with the involvement of regulatory bodies, there are no established standardized processes for ESG integration. Literature exhibits a clear knowledge gap on the utilization of ESG data in the credit risk assessment process. Furthermore, the primary barriers faced during this process have been attributed to comparability, materiality, accuracy, and reliability of ESG data quality with the lack of comparability having the most significant impact. Hence, based on the knowledge gap identified, the following main research questions were formed:
“How can banks in the EU effectively utilize corporate ESG data during the sustainable corporate financing process?”
By fusing a thorough literature review and 11 interviews of professionals from the banking industry, consultancies, and asset management companies, a process flow diagram was mapped highlighting the different phases of the sustainable corporate financing process. The main phases were comprised of: Opportunity, Due diligence, Determining need for ESG data, Sourcing ESG data, Corporate Sustainability Assessment, Setting KPI’s and Decision. Furthermore, during this process the primary barriers were classified as Data Quality Barriers (Lack of Materiality, Lack of Accuracy, Lack of Comparability and Lack of Reliability) and Integration Challenges (Lack of Data, Sourcing Data, Quantification of Data). Given the relevance of the comparability barrier, its effects were studied in more detail and was followed by proposing a conceptual framework bolstered by stakeholder theory, legitimacy theory and institutional theory to solve the barrier of Lack of Comparability. The relevant dependent variables in this framework were identified as: Data Harmonization Initiatives, Standardization Efforts, Industry Collaboration, Regulatory Interventions/Compliance and Client Engagements. As directed by the conceptual framework, banks were recommended to adopt the dependent variables Data Harmonization Initiatives, Standardization Efforts and Industry Collaboration and were further advised to help clients adhere to compliance. Furthermore, stakeholders' motivation and regulatory incentives were highlighted as key determiners in addressing the barrier. A processual validity approach was adopted to ensure validity throughout the research process which additionally consisted of validating the generated process flow and conceptual framework by relevant experts.
The outcomes of the explorative research showcased the intricacies in the sustainability credit risk assessment and the stakeholders involved while highlighting the interrelation between the barriers identified. Though the lack of a comparability conceptual framework was proposed to be a barrier with significant effects, during the interview analysis it was revealed that the advent of the Corporate Sustainability Reporting Directive (CSRD) would have a significant effect on this barrier and that challenges like sourcing ESG data and lack of ESG data would be more relevant in a few years. Although the conceptual framework accounted for this, some of the limitations in this research study were the inability to recruit more interviewees and also the inability to gather interview data from an external data provider to retrieve a true holistic approach. For future research, studies are recommended to research the effects of the implementation of CSRD and to study the state of other pressing barriers.