By Tahmina Day
Almost every industry event I attend or business outlook that I read presents some ideas and debates around environmental, socially responsible and governance-related practices. While the banking sector has embraced the evolving importance of ESG, identifying one harmonized approach to ESG remains a challenge.
With many regulatory and industry initiatives still underway, some banks have decided to forge their own path to ESG. To do so, banks refer to existing frameworks to gain insights and knowledge for creating a customized approach of their own. However, with a multitude of ESG-related frameworks in place, it can easily become an overwhelming task. Nevertheless, understanding the structure of various frameworks will allow banks to gain valuable perspective into the subject to carve their own paths.
In this article, I will explore the International Finance Corporation’s approach to ESG. IFC, a member of the World Bank Group, is the largest global development institution. IFC provides investments to private companies in emerging markets to advance its private sector development mandate. Having worked at IFC for a decade as a corporate governance officer before joining the community banking sector, I witnessed the organization’s ESG approach and impact firsthand. As a global development institution, the IFC’s practices will not map perfectly to those of FDIC-insured banks, but banks can still learn from the IFC’s mature approach to ESG.
IFC adopted its Sustainability Framework, comprising multiple policies and standards outlining the IFC’s commitment and approach to sustainable development. For the purposes of this article, we will focus on the IFC’s Environmental and Social Performance Standards that are an integral part of the Sustainability Framework and directed toward the IFC clients. The performance standards serve as guidance on identifying and mitigating environmental and social risks.
As an overview of all three dimensions of ESG, we will also look at the IFC’s Corporate Governance Methodology, a structured approach toward assessing corporate governance risks.
The IFC’s performance standards combine eight standards that collectively establish directives on environmental and social risks and impact for IFC clients.
Let us take closer look at the Performance Standards and their core components. Every performance standard has an easy-to-navigate structure that is conveniently broken down to overview, introduction, objectives, scope of application and requirements sections. Below is a summary that highlights a brief overview of each performance standard and its key associated requirements.
Performance Standard 1: Assessment and Management of Environmental and Social Risks and Impacts
PS1 sets the foundation by articulating the importance of a structured approach to assessing and managing ES risks through the Environmental and Social Management System, an ongoing management-led process that embraces engagement between various internal and external stakeholders. The requirements of PS1 include environmental and social assessment and management system; policy; identification of risks and impacts; management programs; organizational capacity and competency; emergency preparedness and response; monitoring and review; stakeholder engagement; external communications and grievance mechanisms; and ongoing reporting to affected communities.
Performance Standard 2: Labor and Working Conditions
PS2 articulates the role of the sound worker-management relationship as a mean to sustainability. It highlights the importance of the balance between the income generation goals and the protection of basic rights of workers. PS2 requirements are broken down to the following components: working conditions and management of worker relationship; protecting the work force; occupational health and safety; non-employee workers; and supply chain.
Performance Standard 3: Resource Efficiency and Pollution Prevention
PS3 outlines the role of the effective and efficient recourse use, pollution prevention, and greenhouse gas’ emission control in alignment with the international technologies and practices. The requirements section of PS3 include resource efficiency and pollution prevention.
Performance Standard 4: Community Health, Safety and Security
PS4 articulates the avoidance and mitigation of the risk to community health, safety and security that may arise from project-related activities. The PS4 requirements’ section includes community health and safety and security personnel.
Performance Standard 5: Land Acquisition and Involuntary Resettlement
PS5 emphasizes potential adverse impact of land acquisition and restrictions at the project level that may result in involuntary resettlements. The components of the PS5 requirements include general requirements; displacement; and private sector responsibilities under government-managed resettlement.
Performance Standard 6: Biodiversity Conservation and Sustainable Management of Living Natural Resources
PS6 recognizes the importance of biodiversity protection and maintenance of ecosystem services. It also elaborates on definitions of “biodiversity” and “ecosystem services.” The requirements section of PS6 consists of general requirements, protection and conservation of biodiversity, management of ecosystem services, sustainable management of living natural resources and supply chain.
Performance Standard 7: Indigenous Peoples
PS7 focuses on Indigenous people—a distinct social and cultural group possessing certain characteristics. It acknowledges the vulnerability of Indigenous people that restrict their access to resources and abilities to participate in growth and development. The requirements section includes general requirements; circumstances requiring free, prior and informed consent; mitigation and development benefits; and private sector responsibilities where government is responsible for managing Indigenous people’s issues.
Performance Standard 8: Cultural Heritage
PS8 recognizance a potential threat to cultural heritage at the client’s project level and articulates a set of requirements to address it: protection of cultural heritage in project design and execution and the project’s use of cultural heritage.
Building on its reach thought leadership heritage, IFC has published various implementation resources and publications for each of the eight performance standards for additional guidance and information.
The IFC’s Performance Standards served as a basis for developing the Equator Principles—a global risk management framework for identifying, assessing and managing environmental and social risks in projects. As of now, 118 financial institutions in 37 countries have adopted the principles. Among the signatory institutions are Citigroup, TD Bank Financial Group, Credit Suisse and Wells Fargo, to name a few.
The Equator Principles apply to all industries, and to five financial products:
- Project finance advisory services
- Project finance
- Project-related corporate loans
- Bridge loans
- Project-related refinance and project-related acquisition finance.
The latest version of the Equator Principles was updated in July 2020. The Equator Principles’ primarily aim is to provide minimum standards for due diligence to underpin prudent risk decision-making.
Corporate Governance Methodology
The IFC Corporate Governance Methodology is applied to evaluate corporate governance across six parameters: commitment to ESG (leadership and culture); structure and functioning of the board of directors; control environment; disclosure and transparency; treatment of minority shareholders; governance of stakeholder engagement.
The methodology represents a compilation and interplay of eight tools that are applied to perform assessment of the IFC clients’ corporate governance practices. The major tool of the methodology is the Corporate Governance Progression Matrix, which allows users to evaluate corporate governance across four levels of maturity: basic practices; intermediate practices; good international practices; and leadership.
The IFC’s methodology was distilled into the Corporate Governance Development Framework, a global framework for evaluating corporate governance risks in investment processes. Currently, 35 development finance institutions have adopted the CG Development Framework.
Building an ESG practice in the absence of one centralized framework can be a daunting task. Any chosen approach should be aligned with a bank’s values, strategic direction, risk appetite, and long-term vision.
Understanding multiple existing ESG frameworks and their applications can guide banks toward the path of developing their own distinct methodologies and practices. While no two organizations are alike, other companies’ lessons learned and industry experience can be a solid starting point in your ESG journey.
Tahmina Day is a VP and enterprise risk program manager for one of the largest community banks in Florida. For more than a decade, she was a corporate governance officer of the International Finance Corporation’s ESG group. Day can be reached at [email protected]m and via LinkedIn.