At a time when we are increasingly talking about sustainable change, both in the economy and in our daily habits, the year 2022 marks a turning point when we slowly move from talk to more concrete action. This year, the European Central Bank (ECB) will conduct a climate change stress test of the banks it supervises to identify the weak spots, best practices, and problems encountered by banks in managing climate change risks. This should be seen as a sort of a workout before the requirement for banks to assess and collect data on the sustainability performance of their customers – the borrowers – takes effect.
We must learn to cooperate
Bloomberg analysts have estimated that governments and businesses will need to invest at least USD 92 trillion by 2050 to eliminate the most pessimistic climate change scenarios. Investments of this magnitude would help limit the rise in average global temperature by 1.75 degrees Celsius above pre-industrial levels. Without the necessary investments and reforms, climate disasters such as heatwaves, floods, and wildfires will become more frequent and dangerous, requiring ever more resources to eliminate the consequences thereof.
And although more and more companies are reporting on their sustainability performance in their public statements, the world as a whole has not moved in the right direction, and the effects of climate change are becoming more tangible. Without concerted and consistent action by manufacturing companies, resource extractors, traders, financiers, and other economic operators, the goals set will be difficult to achieve and more likely to remain a utopian fantasy.
The most pressing questions, therefore, are: where should these funds come from, how should they be managed and targeted to avoid funding only the achievement of individual goals while neglecting others or even putting them at greater risk? One of the proposed solutions is to involve the banks in this process, mandating them to increasingly review their investments and loans for their contribution to the sustainability goals.
Uniform rules of the game
As far as sustainability is concerned, the Latvian business environment is still in its infancy. In general, sustainability issues mainly affect large companies, which will have to report on their environmental, social and governance (ESG) performance, including their company's carbon footprint, starting in 2023, according to European Union (EU) and national laws. In addition, the assessment will cover various aspects of the company's operations - the direct impacts of the company, its business partners, and its entire supply chain, as well as the lifecycle of the products the company manufactures.
These are specific and uniform "rules of the game" for all market operators as defined in the EU’s Taxonomy, a new classification system that explains which investments are considered sustainable and will help achieve carbon neutrality over the next 30 years. Banks will continue to review their customers’ financial investment projects and business models for compliance with Taxonomy’s requirements, as this will allow us to measure the development of our loan portfolio in terms of sustainability. Furthermore, the EU Disclosure Directive requires banks to disclose certain indicators in their statements.
Undoubtedly, the process will be complicated enough, so banks have already started collecting their customer data. Already in the first quarter of this year, SEB banka asked a number of its customers for their CO2 data as part of the climate stress test conducted by ECB. In the long term, however, each bank will assess its entire loan portfolio against the definitions and requirements set out in the Taxonomy. Aggregating and assessing this data will become increasingly important for us, as it will also impact the bank's capital requirements in the future.
However, I would like to point out that this should not only be seen as an additional burden, but also as an unprecedented opportunity to attract financing. As long as the company is able to offer a concrete and tangible plan based on reasonable sustainable activities and measurable data, the competition between investors and banks for financing such customers and projects will be very tough. It is therefore in the interest of every company to start collecting such data now.
A comprehensive paradigm shift
In the near future, the role of banks in the green transformation process will be to advise and assist their customers in moving to a greener business model and to promote market development in general in line with regulations. Therefore, all economic operators - at least in Latvia and elsewhere in Europe - will have to learn to cooperate so that everyone benefits in the long run.
It will be difficult to ignore the rapidly developing paradigm shift around the world, as not only financial institutions and business partners, but also consumers, especially the younger generation who prefer truly sustainable products, will scrutinise companies' business models. If companies do not take the issue seriously enough or avoid expensive investments today, they will risk greater losses in the future.
I, therefore, appeal to companies not to delay defining and implementing a sustainability strategy in their company. The changes ahead will affect every company, regardless of its size and scope of operations. And these changes start now.