What does the S of ESG mean to your organisation?

July 2022

The ‘social’ or ‘S’ elements of ESG are rising in prominence, having played a secondary role to environmental and governance factors for some time. This historical lack of focus is partly due to the fact that environmental and governance issues are much more clearly defined. Regulations in these areas are better developed, and data - while not without its challenges - is easier to measure and quantify.

However, as a combination of changing consumer preferences, employee attitudes and emerging regulation prompts firms to increase their focus on social issues, more businesses are realising that social issues should be an integral component of their sustainability strategy. In our view, an organisation’s purpose can only be fulfilled if environmental and social challenges to the business are considered together.

So where should firms start in measuring and managing social risks, and incorporating these issues within their broader ESG strategy?

Defining and prioritising

Clearly defining what to include within the ‘S’, aligned to your specific business values and purpose, is the first task. The below graphic sets out some examples of the considerations which make up social factors:

Firms should first define which elements of each of these themes they want to include in their social strategy, and which they want to prioritise. This will be different for each firm and informed by their purpose, strategy and sustainability targets and commitments. Diversity and inclusion (D&I), and products and services are both likely to be areas of particular focus for financial services firms.

Regulators have stepped up their policy work on D&I, providing stronger incentives for firms to take action. The FCA recently issued a policy statement requiring listed companies to report information and disclose against targets on the representation of women and ethnic minorities on their boards and executive management, and a further PRA-FCA consultation on D&I is expected this autumn. The level of progress to be made in FS is significant - PwC’s March 2022 report on gender diversity highlights the sector has one of the highest gender pay gaps (with a median average gap of 26.6% in 2020, compared to 12.1% across all other UK sectors), and that progress to close that gap since reporting requirements began has been slow.

In addition, products and services link closely to the FCA’s work to require firms to design inclusive products and services that improve consumer outcomes. Many firms are already progressing work in this space, by working more closely with consumers and relevant charities to understand consumers’ needs and to make products and services more inclusive under the FCA’s vulnerable customers guidance. A number of firms are also looking at financial inclusion and access more broadly - another priority issue for Government and the FCA (which can be seen through their work on access to cash and other issues). For example, some organisations are working with groups that have historically been largely excluded from financial services, such as those experiencing homelessness or recently released prisoners, to help them access products and services.

But as the FCA’s recent review of its vulnerable customers guidance highlights, fully embedding these changes across the whole business, and securing senior leadership buy-in and accountability, can be challenging. The required improvements that the FCA flags in its review, such as being able to demonstrate clear lines of senior accountability and evidencing that vulnerability features in the considerations of senior and executive committees, contain important learnings that firms can apply to their work across other social issues.

Embedding social considerations across the business

As the above graphic illustrates, many social factors will cut across multiple areas of the business, from HR to finance and product design. It’s therefore crucial that, led from the top of the organisation, social considerations are embedded within business strategy development. This will help to ensure social factors are ingrained in decision making across all functions and practices, fostering a cohesive approach which aligns with the company’s overall vision and goals. This will provide leaders at the next level down with clarity, and allow them to consistently apply these considerations to the issues that matter to them, to deliver on their strategies - across sustainability, D&I, people, products and services, and elsewhere. Taking this approach will help mitigate reputational and regulatory risks.

By putting the right strategy and data governance in place now, firms will also be well positioned to adjust and develop how they collect and disclose data as regulatory initiatives in this space evolve, and pressures grow from stakeholders for greater transparency. There are various regulatory initiatives that are requiring FS firms to embed ESG considerations into their organisations. These require firms to consider their own 'S' credentials as a corporate, and to assess the 'S' credentials of corporates they are exposed to through investments or lending activities. In the banking and insurance sectors, the PRA expects firms to fully embed climate considerations into their risk management frameworks, while asset managers are facing a range of initiatives requiring them to integrate ESG considerations into their investment due diligence and products (e.g. SFDR, EU Taxonomy and UK SDRs).

Regulators are developing additional initiatives which will require firms to have access to more granular data on social factors. The EU, for instance, is exploring whether to develop a social taxonomy which would - similar to the existing green taxonomy - require certain corporates to disclose to what extent their activities meet the taxonomy’s criteria, and require financial market participants to do the same for the assets they invest in.

Going above and beyond

But many firms aren’t waiting for regulation to develop before making progress on social factors. Organisations are increasingly going above and beyond what they’re required to do, to show they’re doing the right thing for their employees, customers and investors. We’re increasingly seeing firms aligning social commitments with their business strategy in quantifiable terms - for instance, by linking remuneration of senior management to progress on social issues such as diversity, employee engagement, and health and safety.

For those which are already required to measure and report on environmental factors, there are efficiency gains to be made in looking at the same issues across social factors at the same time. As part of this work, firms should consider the social impacts of environmental-led decisions, to ensure their transition to net zero is a just one. For FS firms, that could involve:

considering how the decisions of corporates that firms are exposed to (through lending or investment activities) to pull out of fossil fuels could impact employment levels in certain communities
ensuring they still offer a range of products that meet the needs of all their customers, when re-calibrating their product range to increase their focus on supporting the transition to net zero.

To conclude, while regulation and market maturity on social considerations are still evolving, there’s a clear direction of travel and growing pressure from policymakers, regulators and wider stakeholders for firms to progress work in this space. Doing so creates opportunities for firms across a number of areas, including improved reputation and trust, employee attraction and retention, and investor relations. Financial services firms have a strong regulatory foundation in terms of governance and operating model, which they can use to enhance this work.

By defining social priorities now, embedding them in the firm’s strategy and considering effective governance structures, firms will be well placed to meet the challenges and capitalise on the opportunities ahead as the social agenda continues to develop.