Sustainable And Resilient Finance: 2020 Oecd Business And Finance Outlook
29/09/2020 – The 2020 edition of the OECD Business and Finance outlook focuses on sustainable and resilient finance, in particular the environmental, social and governance factors that are rapidly becoming a part of mainstream finance. It evaluates current ESG practices, and identifies priorities and actions to better align investments with sustainable, long-term value especially the need for more consistent, comparable and available data on ESG performance.
The Rapid Growth Of Esg Investing
To kick things off, we first seek to address one of the most rapidly evolving developments at the intersection of business and society: ESG investing. Broadly speaking, this represents an investment process that integrates environmental, social, and governance objectives along with more traditional risk/return metrics. Interest in ESG investing has exploded there are now more than 3,800 signatories to the United Nations Principles for Responsible Investment, representing major asset owners, investment managers and service providers from around the world, with assets under management of almost $30 trillion USD .
What Is An Impact Investing Strategy
An impact investing strategy is an investment strategy that targets companies or industries that produce social or environmental benefits. For example, some impact investors seek to support renewable energy, electric cars, microfinance, sustainable agriculture, or other causes which they believe to be worthwhile.
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Principles For Responsible Investment
The Principles for Responsible Investment Initiative was established in 2005 by the United Nations Environment Programme Finance Initiative and the UN Global Compact as a framework for improving the analysis of ESG issues in the investment process and to aid companies in the exercise of responsible ownership practices. As of April 2019 there are over 2,350 PRI Signatories.
The Equator Principles is a risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in project finance. It is primarily intended to provide a minimum standard for due diligence to support responsible risk decision-making. As of October 2019, 97 adopting financial institutions in 37 countries had officially adopted the Equator Principles, the majority of international Project Finance debt in emerging and developed markets. Equator Principles Financial Institutions commit to not provide loans to projects where the borrower will not or is unable to comply with their respective social and environmental policies and procedures.
Csr And Esg Differences
CSR is a form of self-regulation that most large companies report on yearly. It represents a companys efforts to have a positive impact on its employees, consumers, the environment and the community at large.
In contrast, ESG measures these activities to reach a more exact assessment of a companys activities in the following areas:
- Their response to climate change
- How they treat their employees
- How they build trust and encourage innovation
- How they manage their supply chains
ESG uses metrics, which are tools that measure a companys performance. For example, environmental programs consider how a company performs as a steward of nature. Programs that show how many kilowatts of energy were saved, how many tons of carbon emissions were avoided or the gallons of water that were preserved, are metrics that can be measured.
Social criteria examine how a company manages relationships with employees, suppliers, customers and the communities they conduct business in. Governance deals with a companys leadership, executive pay, audits, internal controls and shareholder rights. Such programs also have targets for improvement from year to year.
ESG covers social issues like a companys labour practices, talent management, product safety and data security. It also covers governance matters such as board diversity, executive pay and business ethics.
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Spotlight On Esg Investing: The Importance Of Understanding Environmental Social And Governance Factors And Their Impact On Investing
The Corporations Role in Society Today
One indication of the growing importance of ESG issues to corporations is that CEOs have become more outspoken on divisive political issues such as voting rights. Thus, in the wake of last years general election and the ensuing efforts in many states to restrict voting rights, the CEOs of corporations like Delta Air Lines and Coca-Cola have spoken out against such legislation. ESG issues also matter deeply to institutional investors. Institutional investors are requesting that companies become leaders in social issues, a new ideology aimed at expanding the corporations role in solving issues of social injustice. Larry Fink, the CEO of BlackRock, stated in his 2021 letter to CEOs that the United States is at a historic crossroads on the path to racial justice, an issue that cannot be solved without leadership from companies. Clearly, the philosophy that a corporations sole responsibility is to pursue profits and enhance shareholder value while remaining silent on social issues is no longer the prevailing ideology. Institutional investors are demanding that corporations play a major role in addressing social injustices.
What Is An Esg Fund
Funds, like ETFs and mutual funds, may consider a wide range of factors that are consistent with their objectives and strategies when selecting investments. This can include ESG, which stands for environmental, social, and governance.
ESG investing has grown in popularity in recent years, and may be referred to in many different ways, such as sustainable investing, socially responsible investing, and impact investing. ESG practices can include, but are not limited to, strategies that select companies based on their stated commitment to one or more ESG factors for example, companies with policies aimed at minimizing their negative impact on the environment or companies that focus on governance principles and transparency. ESG practices may also entail screening out companies in certain sectors or that, in the view of the fund manager, have shown poor performance with regard to management of ESG risks and opportunities. Furthermore, some fund managers may focus on companies that they view as having room for improvement on ESG matters, with a view to helping those companies improve through actively engaging with the companies.
Fund managers focusing on ESG generally examine criteria within the environmental, social, and/or governance categories to analyze and select securities.
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The Problem With Ignoring Supply Chains
Nearly every companys operations are backed by a global supply chain that consists of workers, information and resources. To accurately measure a companys ESG risks, its end-to-end supply chain operations must be considered.
Our recent examination of ESG measures shows that most ESG rating agencies do not measure companies ESG performance from the lens of the global supply chains supporting their operations.
For example, Bloombergs ESG measure lists supply chain as an item under the S pillar. By this measure, supply chains are treated separately from other items, such as carbon emissions, climate change effects, pollutants, and human rights. This means all those items, if not captured in the ambiguous supply chain metric, reflect each companys own actions but not their supply chain partners.
Even when companies collect their suppliers performance, selective reporting can arise because there is no unified reporting standard. One recent study found that companies tend to report environmentally responsible suppliers and conceal bad suppliers, effectively greenwashing their supply chain.
More broadly, without accounting for a companys entire supply chain, ESG measures fail to reflect global supply chain networks that todays big and small companies alike depend on for their day-to-day operations.
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What Is Esg Investing
ESG Investing refers to investing which prioritizes optimal environmental, social, and governance factors or outcomes. ESG investing is widely seen as a way of investing sustainablywhere investments are made with consideration of the environment and human wellbeing, as well as the economy.1 It is based upon the growing assumption that the financial performance of organizations is increasingly affected by environmental and social factors.2
The principles of ESG investing are nothing new. Hundreds of years ago, religious and ethical beliefs influenced investment decisions. Muslims established investments that complied with Sharia law, which included prohibitions on weapons. The first ethical unit trusts in the US and UK were developed by Quakers and Methodists.3 Today, the growing prominence of corporate social responsibility and social sustainability has led to increased investor awareness about ethical participation in the market. ESG investing may have officially entered mainstream investing discourse following the release of the Principles for Responsible Investments 4 in 2006 a set of United Nations guidelines for the incorporation of ESG factors into business policy and strategy.5 The PRI have over 2,000 signatories and are widely considered the official point of reference for all things ESG investing.
Capitalizing On A Socially Responsible Future
The recent uptick in investor demand for ESG suggests investment management firms should take action today to maximize the ESG opportunity. The future wave of growth in ESG investing will likely not be driven by screening out sin stocks but could instead be fueled by managers using high-quality ESG data to increase the opportunity for alpha. A burgeoning ecosystem of customized ESG products and platforms presents investment managers with opportunities to further their value proposition to clients.
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What Are Environmental Social And Governance Criteria
Environmental, social, and governance criteria are a set of standards for a companys operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a companys leadership, executive pay, audits, internal controls, and shareholder rights.
Esg Investing And Aesg Investing Working Together
Investment in global ESG funds have risen to over $1 trillion and is continuing to grow, as it should. Because of the ease in creating a passive ESG portfolio through quantitative metrics and ESG scores, passive ESG will always get the lion’s share of ESG assets. But if real ESG change is going to happen, AESG investment strategies should also get a piece of these assets. Because there is a limited number of investors who have the skillset, characteristics and inclination to actively engage with management of portfolio companies, AESG investment strategies will always be a small subset of aggregate ESG assets. But it will be an increasingly important subset, and those who engage in AESG investing will add a much-needed active component to ESG investing. Furthermore, passive ESG funds and AESG funds are not mutually exclusive and can have a symbiotic relationship. AESG investments will expand the universe of potential ESG companies for passive ESG portfolio managers to invest in. These are companies that did not traditionally satisfy ESG screens but are now recognized as ESG companies because of the activist component to bring about change. To the extent they are included in screens for the trillions of dollars of passive ESG assets in the marketplace, these passive ESG funds can now play a role in effecting change by investing in stocks of companies that are engaged by an AESG investor and supporting the active ESG investors in achieving their ESG goals.
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The Importance Of Environment Social And Governance Factors To Current Investment Trends
When did ethical and sustainable investment strategy become a serious consideration for shareholders, investors and asset managers?
Global investment focus of shareholders, investors, and investment managers is shifting. We are currently seeing the transfer of wealth to millennials, environmental disasters, costs and risks increasing, and improved performance of operations through sustainable practices.
The importance of environmental, social and governance factors, in investment decision making, as Boston Consulting Group point out in their recent article Investors Care More About Sustainability Than Many Executives Believe, that 75% of senior executives in investment firms see ESG factors as materially important to their investment decision. The disconnect is evident that only 60% of companies have a sustainability strategy, and just 25% have developed a clear business case for sustainability.
ESG incorporates a wide range of impacts on the risk and return values of an investment. These issues may be surrounding regulation changes, business ethics, or direct impacts on financial, operational, strategic or reputational risks. Examples of such risks are:
Environmental: natural resources, waste, climate change, pollution, and clean technology.
Social: health and safety, local community, human rights, and human resources.
Governance: compliance, regulation, reporting, conflict of interest in employee, shareholder or board levels.
Know Your Own Esg Policies
ESG has some pretty clear boundaries, especially in comparison to ethical investing or socially responsible investing, but that doesnt mean it fits perfectly with your beliefs. Values differ from person to person, so take a little time to identify some of the values most important to you, and see if any fall outside of what ESG entails. If they do, make sure youre looking for investments that also incorporate those ideals. For example, Muslim investors may want to ensure that their investments comply with Islamic law.
» Is sustainability just a label? Learn about greenwashing
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What Is A Socially Responsible Investment
Socially responsible investing , also known as social investment, is an investment that is considered socially responsible due to the nature of the business the company conducts. Common themes for socially responsible investments include socially conscious investing. Socially responsible investments can be made into individual companies with good social value, or through a socially conscious mutual fund or exchange-traded fund .
What Is Esg Investing Really
Before going too far into the challenges of defining objectives and acknowledging tradeoffs, it is important to point out that despite its rapid penetration throughout the financial landscape, ESG investing still means wildly different things to different people. To some, ESG investing may simply resemble an earlier iteration called socially responsible investment which largely focuses on the avoidance of undesirable industries . Here, one is still trying to maximize standard risk/return metrics, but subject to some important investment exclusion restrictions. At the other extreme is true impact investing, where a steward of capital is endeavoring to engender an explicit social or environmental outcome that is potentially quite divorced from any pecuniary return. And, of course, ESG can reflect everything in between. Taken together, this wide variation in intention, coupled with an imprecision with which ESG is defined in practice, begs the question what really are the objectives of ESG integration? We provide a few thoughts:
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Can Esg Investing Live Up To The Hype
Despite the financial value creation potential, others have cautioned that there is an important confusion between recent realized investment returns and prospective, forward-looking expected returns.3 If there is a rapidly growing demand for ESG or socially responsible investments , then the prices of those assets will increase, generating outsized, albeit temporary, returns. In the long run, assets that are demanded for their high ESG ratings will instead carry lower expected returns going forward perhaps because investors enjoy holding them for their non-pecuniary impact or because they may help to hedge important downside risks. Under this argument, the purported outperformance of ESG funds during the COVID pandemic is instead a manifestation of a sizable demand-driven repricing that will eventually yield lower returns in equilibrium.
Even if one holds the most optimistic view of ESG, there are several challenges in implementation. First, even in the best case scenario in which ESG integration helps to mitigate risks and/or generate superior risk-adjusted investment returns we remain very far away from any consensus on sustainability accounting. Specifically, there remains a tremendous degree of disagreement among ESG data providers. How can we credibly manage where we cannot agree upon what to measure? A critical next step for the evolution of ESG investing will be an evolving consensus on sustainability accounting.4
Environment Social And Governance Investing Is On The Rise Learn What Esg Investing Is And The Key Factors To Know When Investing Ethically Capital At Risk
When you think of investing, what image springs to mind? If its the ruthless, Gordon Gekko-esque figure of the 80s and 90s, push it aside. Over the past decade, investing has gone and got itself a conscience.
The value of an investment is no longer just about how much money it can make you but also about the positive impact it can have on the world. And thats where ESG investing comes in.
ESG or Environment, Social and Governance investing, for those not keen on acronyms has been gaining popularity particularly over the last 12 months. A 2020 survey by Big Window showed that 69% of investors considering ESG factors had started doing so within the last 12 months.
And its not just the younger generations getting involved either, the 2020 study found that 48% of those considering ESG factors in their investments are over the age of 45. But what does putting your money into ESG funds actually mean and how can you be reassured your money is actively doing good? Heres what you need to know about ESG investing.
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Understanding Socially Responsible Investment
Socially responsible investments include eschewing investments in companies that produce or sell addictive substances in favor of seeking out companies that are engaged in social justice, environmental sustainability, and alternative energy/clean technology efforts.
In recent history, socially conscious” investing has been growing into a widely-followed practice, as there are dozens of new funds and pooled investment vehicles available for retail investors. Mutual funds and ETFs provide an added advantage in that investors can gain exposure to multiple companies across many sectors with a single investment. However, investors should read carefully through-fund prospectuses in order to determine the exact philosophies being employed by fund managers, along with the potential profitability of these investments.
There are two inherent goals of socially responsible investing: social impact and financial gain. The two do not necessarily have to go hand in hand just because an investment touts itself as socially responsible doesn’t mean that it will provide investors with a good return, and the promise of a good return is far from an assurance that the nature of the company involved is socially conscious. An investor must still assess the financial outlook of the investment while trying to gauge its social value.
