Non-financial risks have always existed but have never been accurately quantified. They encompass environmental, social, and governance risks. Over the past decade or so, some companies have incorporated them under the umbrella of CSR (Corporate Social Responsibility), which supplements balance sheets and other financial statements.
In recent years, the international ESG (Environmental, Social, Governance) indicator has gained prominence and aims to incorporate dozens of qualitative and quantitative criteria aligned with numerous standards, as well as the degree of corporate engagement, to account for risks related to the energy transition, physical/climate risks, environmental compliance, certain social aspects, and corporate governance.
The resurgence of climate issues, the growing public interest in living in a sustainable economy and a more equitable society, and the proliferation of international summits reflect the financial sector’s commitment to addressing this issue.
Following the Paris Climate Agreement (COP21), France has become a pioneer in the development of greener growth through Law No. 2015-992 of August 17, 2015, on the energy transition. This law sets the objectives for a new French energy model and supports green growth by reducing France’s energy bill through the development of carbon-free energy sources.
In particular, Article 173 requires institutional investors to transparently disclose in their annual reports how they integrate ESG criteria and their involvement in the energy transition and climate change mitigation into their investment operations.
Non-financial risk indicators for a portfolio
Many international organizations have developed relevant indicators for measuring climate-related risks or E, S, and G criteria. Among them, the Task Force on Climate-related Financial Disclosures (TCFD)* regularly publishes recommendations in this regard. These recommendations are followed by various providers of non-financial data, which make numerous indicators available to investors (between 100 and 400 per company).
Whether it concerns ESG indicators**, carbon footprint, the rate of brownfield activity, the level of involvement in high-profile controversies**, or ethically controversial activities**, calculations are based on information provided in companies’ annual reports, various corporate publications, reports from authorities and the media, and court rulings, as well as direct calculations, estimates using statistical models, or extrapolations by industry sector.
Consequently, these indicators reflect companies’ level of transparency and their willingness to disclose the information needed to calculate them. However, using this raw data presents certain limitations. Incomplete, insufficient, or missing information results in indicators with biased scores.
Investors also need the universe covered by data providers to be as comprehensive as possible, and they consider tens of thousands of listed companies to obtain an interpretable and reliable result.
The fund structures in which these indicators are calculated are sometimes complex or multi-tiered, requiring significant research and development efforts.
The Rise of Responsible Finance
Younger generations are concerned about the state of the planet. This issue has become a major one, even though it represents only the beginning of a shift that promises to be much more significant.
If investors and asset managers want to limit the impact of climate change—which is becoming increasingly evident—and if standards in this area continue to tighten, then yes, we are gradually entering the era of responsible finance. This form of finance will profoundly change the economy as we know it in the medium term, since divestment from companies that fail to make efforts will force them to rethink their business models. But for this to happen, standards must be better defined, enforced, and applied equally to all.
Today, there are several certifications and labels designed to identify responsible and sustainable funds. Examples include the SRI (Socially Responsible Investment) label and the TEEC label for “green” funds (Energy and Ecological Transition for the Climate). Nevertheless, it is obviously important to pay close attention to the actual investments made by funds certified by these labels and to remain vigilant against “greenwashing.”
Finally, the current shift in our consumption patterns and economic system must necessarily be driven by political actors (to shape the system) and economic actors (to implement it). Studies estimate that 70% of today’s students will have jobs that do not yet exist. Many opportunities will be created in the areas of climate risk and non-financial performance measurement, particularly in the financial markets. Moreover, new positions combining knowledge of financial products (analyst, quant), statistical analysis, and the measurement of environmental, social, and governance indicators are already emerging. Bridging the gap between the highly technical professions of finance and more human aspects (social, governance) can only bring greater meaning to financial professions, which can sometimes sorely lack it.
Finally, the current shift in our consumption patterns and economic system must necessarily be driven by political actors (to shape it) and economic actors (to implement it). Studies estimate that 70% of today’s students will have jobs that do not yet exist. Numerous opportunities will be created in the areas of climate risk and the measurement of non-financial performance, particularly in market finance. In fact, new roles combining knowledge of financial products (analyst, quant), statistical analysis, and the measurement of environmental, social, and governance indicators are already emerging. Bridging the gap between the highly technical fields of finance and the more human aspects (social, governance) can only restore meaning to finance careers that sometimes sorely lack it.
Next Steps in Non-Financial Disclosure
Today, the market for non-financial information is immature and largely unstandardized. There are many corporate data providers that use different algorithms. The diversity of financial products makes it difficult to calculate a single indicator that can be used to understand the direction or risk of a portfolio or investment strategy. How can we differentiate or compare the risk of a bond, a stock, sovereign debt, a convertible bond, or a derivative?
Europe is set to standardize the future of non-financial reporting in the coming months, and the Basel Committee is expected to meet on this topic to discuss the next directive to be issued in the coming years; all financial institutions will be required to follow its recommendations.
The United Nations has issued its own recommendations regarding the SDGs (Sustainable Development Goals), which are expected to apply to countries with clear targets set for 2030. These goals are currently being adapted for companies that are beginning to report on these 17 defined sustainable development goals.
In conclusion, climate change is not just a passing trend but a global commitment to restore the planet we are gradually destroying. This historic effort must involve all economic stakeholders, and the financial sector will be a driving force in ensuring swift action and meeting the deadlines set at international summits. Many new jobs are expected to emerge in this field in the short term, such as research and development analysts.
