Environmental, Social, and Governance (ESG) factors are fundamental criteria for global investment decisions. Current financial industry practices demonstrate that organizations must give ESG its due importance. In PwC’s 2023 Global Asset and Wealth Management Survey, approximately 80% of asset managers estimated that ESG assets would account for half of their portfolio mixes by 2027. ESG risks, including climate change effects and governance breakdowns, directly damage long-term asset values and endanger the stability of financial systems.
Using passive ESG screening methods as the sole ESG evaluation approach is inadequate for meeting current market needs. Financial institutions can directly affect corporate behavior while actively monitoring ESG risks through their engagement methods, including direct dialogue, proxy voting, and stewardship activities, to access long-term value.
This article offers practical guidance for financial institutions looking to move beyond basic compliance toward more purposeful, outcome-driven ESG engagement. By actively participating in corporate sustainability efforts, financial institutions can not only protect the value of their portfolio assets but also meet evolving regulatory expectations and address the growing demands of ESG-conscious clients.
Why ESG Engagement Matters for Financial Institutions
Safeguarding Long-term Investment Value
Active ESG engagement enables financial institutions to reduce vulnerabilities across their portfolios. Companies with strong ESG practices often exhibit lower capital requirements and improved operational performance. By engaging portfolio companies on ESG issues, financial institutions can enhance risk management and support more sustainable, long-term returns on investment.
Mitigating Systemic Risks Associated with ESG Failures
Weak ESG practices create major systemic risks that affect various operational areas:
- Climate-related Financial Risks:The Bank of England’s Prudential Regulation Authority found that banking institutions as well as insurance providers lack proper systems for climate risk assessment and management with regard to both flooding events and extreme weather conditions, and hence require internal climate risk evaluations. Positive ESG engagement efforts with companies can also help ensure more robust ESG risk management systems capable of withstanding climate-related financial shocks.
- Insurance Sector Strain: Extensive damage from climate-induced disasters has resulted in the insurance sector withdrawing from high-risk areas, forcing individuals as well as governments to bear financial consequences.Active participation by investors can influence firms to use stronger climate resilience approaches, thereby minimizing long-term risks for insurers and the larger economy.
Key Pillars of Strategic ESG Engagement
Constructive Dialogue
Effective ESG engagement must be grounded in solution-oriented, constructive communication. For financial institutions, this means framing engagement as a value-building exchange—highlighting how improved ESG practices can reduce risks, lower the cost of capital, and enhance long-term returns for stakeholders.
Double Materiality Approach
Organizations must assess ESG issues from two perspectives—how ESG factors impact financial performance, and how business activities affect society and the environment. Engagement strategies should be guided by both financial and impact materiality, informed by proprietary ESG data, sector-specific insights, and deep thematic expertise.
Independence
Maintaining full independence is essential for credibility. Financial institutions must avoid conflicts of interest by ensuring that ESG engagement teams do not provide advisory services or manage financial assets for the companies they engage with. A truly independent ESG evaluation requires that all research, ratings, and data collection be performed internally.
Transparency and Reporting
Engagement efforts must be accompanied by regular, detailed disclosures tracked by clearly defined KPIs—covering activities undertaken, results achieved, and the next steps to be taken.
How Financial Institutions Can Build Effective ESG Engagement Frameworks
Internal Alignment
Effective ESG engagement requires strong internal coordination. Financial institutions must align their investment, compliance, and stewardship teams with shared ESG priorities. Without this collaboration, engagement efforts can become inconsistent and less effective.
Data-driven Engagement
A robust engagement strategy must begin with data-driven insights. Members of the Climate Action 100+ initiative have effectively used ESG data to influence companies such as Shell and BP, pushing them toward net-zero targets and more detailed climate transition plans.
Reporting and Transparency
Both regulatory frameworks, such as SFDR and CSRD, as well as sound governance practices demand consistent transparency. Institutions such as Norges Bank Investment Management (NBIM) lead by example, publishing comprehensive details on their engagement approaches and performance outcomes. When companies openly disclose both their progress and challenges, they foster stakeholder trust and position themselves as leaders in ESG.
Challenges in ESG Engagement and How to Overcome Them
One of the major challenges for financial institutions is the lack of standardized ESG metrics, which makes it difficult to measure real progress. With ESG ratings varying significantly across providers, market uncertainty increases. To address this, institutions should prioritize sector-specific material issues and develop internal ESG evaluation frameworks rather than relying solely on third-party scores.
Greenwashing also poses a significant risk. A study conducted by the European Commission found that over 42% of environmental claims made by companies were exaggerated or misleading. To mitigate this, financial institutions should conduct rigorous due diligence, engage independent data verifiers, and establish escalation protocols for addressing superficial or unsubstantiated sustainability claims.
Additionally, resistance from corporate boards can hinder ESG engagement. According to EY’s 2023 Global Board Risk Survey, only 55% of directors felt confident managing ESG risks. Investors can overcome this by collaborating with peers and leveraging collective initiatives, such as Climate Action 100+, to drive more meaningful ESG commitments among companies and move beyond performative pledges.
Future of ESG Engagement for Active Investors
Active ESG engagement has become a cornerstone of long-term value creation. By engaging directly with companies, active investors gain greater influence over corporate behavior, enabling them to reduce exposure to ESG-related risks and identify new opportunities for sustainable growth.
Both regulatory and client expectations continue to rise. Frameworks such as the SFDR, EU Taxonomy, and SEC climate disclosure rules demand more than basic compliance—they require demonstrable, outcome-oriented ESG actions. In parallel, institutional clients and millennial investors increasingly expect transparency, authenticity, and measurable impact.
Looking ahead, financial institutions must provide strong leadership and in-depth ESG expertise, committing to meaningful, actionable changes. Those that embed ESG engagement into the core of their investment strategies will be best positioned to meet evolving standards and safeguard portfolios against systemic sustainability risks.
