In our economic system, financial institutions are trusted intermediaries in managing risk. And when it comes to risk, the now ubiquitous ‘ESG’ is both embraced and criticised in equal measure –as a way of looking at ‘non-financial’ risks and as an investment screening and marketing opportunity.

Against this backdrop, it has been argued that the strategic, action-oriented E&S should be separate from G to decouple the ‘what’ from the ‘how’ of effective oversight.

When governance crashed back into the headlines recently as SVB and Credit Suisse stumbled and confidence in the banking sector’s risk management wobbled, it triggered an uncomfortable flashback to the credit crisis of 2008. This reminder of the fallout when governance goes bad is perhaps timely in light of the question marks over the usefulness of ESG as a risk management framework more broadly.

In our analysis, we prefer to think of E&S as representing the ‘sustainability’ of business more comprehensively while the G is there to distribute responsibility and ensure accountability.

Our recent study, ‘Governance of sustainability in the largest global banks,’ has only served to reinforce this assumption. In this report, we set out to examine the approach of 30 of Europe and North America’s leading banks – that is to say, how they incorporate environmental and social risk in their banking activities. How do these issues become part of a bank’s strategy? Do they have people on the board with relevant experience? Do they have dedicated committees? How robust are the standards used and how is their implementation overseen?

Maturity matters

One of the most important, recurring themes in our study is that different stages of sustainability maturity require different governance solutions and result in different governance outcomes. Firms that are positioned at different points on the “maturity spectrum” do things differently, from strategy development and risk integration to the board’s mandate, structure, and composition. Directors need to keep a watching brief on where they are on this spectrum and implement change as they “surf along the curve”.

More broadly in the world of investing, maturity has revealed significant practical shortcomings in the ‘lumped-together’ ESG configuration. For example, the skills and toolkit needed to understand and analyse E&S are very different from those needed to drive governance change through engagement. The result is that some ESG people are good at E&S and others are good at G, but rarely do you find a balance of talents on the investor side.

The separation of E&S from G means that everyone could play to their strengths: management would be left alone to get on with building resilience into the business operating model, ensuring that it can withstand environmental shocks in the supply chain or the interruptions caused by extreme weather, workforce walkouts or even a global pandemic.

It also requires identifying sustainability opportunities in a systematic way and incorporating them into the strategy of the firm. The board or a board-mandated committee meanwhile assumes the oversight of management action, which feels right given the existential nature of the threats but also the size of the opportunities involved.

The environmental and societal shocks that just keep coming in recent times need dynamic, robust oversight, not endless box-ticking. One of the findings of the study is the excessive amount of “noise” in current ESG reporting.

For companies, including banks, it should be less about glossy sustainability reports and more about demonstrating how E&S fits within the overall corporate strategy and risk appetite: how does my objective on greenhouse gases footprint reduction fit with the objective of expanding or maintaining ‘dirty’ activities—whether they are my own or those of my clients, as in the case of banks?

Corporate governance officers should not have E&S responsibilities—this should be part of strategic planning and owned by the front line: group leadership and each of the businesses, as needed.

As the understanding of E, S and G matures among market players, it is important to allow for a review of the reasons they were bunched together in the first place.

In our view, E&S should be firmly put within the orbit of traditional equity analysis which should start focusing more on shareholder welfare, a concept different from shareholder value. G, on the other hand, should be recognised as a separate area pertaining to the analysis of organisations—therefore, requiring a different angle and skill set.

It is about how to better direct and control companies so that they fulfil their strategic aspirations—including E&S. It might be a difficult break-up, but a separation of E&S from G would lead to better outcomes all around.

David Risser is managing director of Nestor Advisors at Morrow Sodali.