A financial institution can manage its exposure to environmental and social risks by developing procedures, E&S risk assessment tools and internal capacity to identify and manage these risks (a Environmental and Social Management System or ESMS). The environmental and social procedures and processes form an integral part of a financial institution’s operational process.
This normally includes integrating environmental and social risk assessment into the financial institution’s overall credit and risk management process. To do so, procedures are implemented throughout the transaction appraisal and monitoring process to understand the environmental and social risks associated with client/investees operations before they become significant or result in an adverse outcome.
A financial institution can implement a Environmental and Social Management System to systematically address environmental and social risks in financial transactions. A Environmental and Social Management System describes the process by which environmental and social risks are considered at each stage of transaction appraisal and monitoring and effectively integrates environmental and social risk management into a financial institution’s existing risk management framework.
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For most transactions with low environmental and social risk, the level of assessment required by a financial institution will be low, while higher risk transactions require a more in-depth assessment against stringent environmental and social requirements. As part of its ESMS, a financial institution may categorize transactions into low, medium or high environmental and social risk categories.
An ESMS helps a financial institution to:
- Identify environmental and social risk associated with clients/investees and understand the potential impact on its portfolio;
- Systematically assess and manage environmental and social risks;
- Implement the necessary steps within its risk management system including documentation and recordkeeping;
- Monitor client/investee compliance with national environmental and social regulations and international best practices and standards;
- Require clients/investees to implement mitigation measures for identified environmental and social risk;
- Identify social and environmental business opportunities; and
- Develop a good reputation among clients/investees, investors and other relevant parties in the financial market.
