02 ESG Overview
Environmental, Social, and Governance (ESG) criteria are a set of standards used by socially conscious investors to screen potential investments. Environmental criteria considers how a company safeguards the environment, including corporate policies addressing climate change etc. while Social criteria examines the management of relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. Investors are increasingly leaning towards applying ESG factors as part of their analysis process to identify material risk and growth opportunities. Although ESG metrics are not commonly a part of mandatory financial reporting, companies are increasingly making disclosures in their annual report or in a standalone sustainability report. Numerous institutions, such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are working to form standards and define materiality to facilitate the incorporation of these factors into the investment process.
Environment
Environmental criteria includes corporate climate policies, energy use, waste, pollution, natural resource conservation, and treatment of animals. It helps evaluate a company’s Environmental risks and how to manage them.
Considerations may include direct and indirect greenhouse gas emissions, toxic waste management, and Environmental regulations compliance.
However, companies and investors often lack a common framework for assessing their ESG risks and opportunities, exposing them to higher levels of financial risks.
For example, Alaskan oil and gas operators are facing long-term, existential threats to their infrastructures from thawing permafrost.
Social
Social Criteria looks at the company’s relationships with stakeholders.
Several factors like a company’s strengthsandweaknessesindealing with Social trends, labour, and politics can affect a company’s financial performance leading to short – long term challenges.
Geopolitical events are another major factor which comes under the category of ESG investing and conflicts like these can prevent companies from producing or distributing their products.
For example, Walmart Inc.’s move to stop selling certain guns and ammunition following a shooting at two of its stores in 2019 has helped the retailer to establish itself as a socially conscious company and also increase its attractiveness to ESG focused investors.
Governance
Governance criteria is related to the Governance factors of decision-making, from sovereigns’ policymaking to the distribution of rights and responsibilities among different participants in corporations, including the board of directors, managers, shareholders and stakeholders.
The often-forgotten Governance factor amid considerations of other factors has caused large corporates to suffer significant financial damage.
For example, Volkswagen’s emissions test scandal, and Facebook’s misuse of data have led them to suffer significant financial damage.
03 Evolution of ESG
ESG investing is growing exponentially as more and more investors and issuers are using ESG to support their investment decision-making. The practice of ESG investing dates back to the 1960s as socially responsible investing, with investors refraining from including stocks or entire industries in their portfolios based on business activities such as tobacco production or involvement in the South African apartheid regime. However, sustainable investing in its current form is recently gaining market momentum, driving large inflows in ESG-focused products.
According to a Lipper report, inflows into ESG-focused products have seen an average compounded annual growth rate (CAGR) of 27% in global assets under management (AUM) over the last 6 years. Particularly there has been a significant jump in AUM during the COVID-19 pandemic period.
Growth of AUM for ESG-centric Products in the Last Few Years
Pandemic’s Impact on the Future of ESG Investing
While ethical considerations and alignment with values still remain primary motivation for ESG investors, ESG investing has also evolved in recent years to consider financial materiality as well. Today institutional and retail investors align their investment strategies around socially responsible themes. Even certain public sector organizations look to incorporate ESG factors into the investment decision- making process alongside traditional financial analysis to generate long-term value.
The graph shows a J.P. Morgan poll with 50 global institutions, (a total of USD12.9 trillion in AUM) on how they assess the pandemic to impact the future of ESG investing.
04. Core Pillars Shaping the Future of ESG Investment
The growing evidence that sustainable corporate practices link closely to performance is focusing investor and acquirer attention on ESG scores.
The combined score of E, S & G affects one’s license to operate as a business within the external world. This is the reason global corporate giants like Walmart and McDonald’s have named sustainability as a key priority moving forward. Financial institutions like Deutsche Bank has made vendor sustainability ratings mandatory.
This trend is poised to continue in the coming years, as a new report from Broadridge Financial Solutions predicts that ESG assets will tip $30 trillion by 2030.
However, in the modern internet age of unlimited information and transparency, labeling something as ESG-related without proper evidence or valuable insights is no longer accepted by investors.
The 5 core intersecting pillars discussed below would shape the future of ESG investment.
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Investment research is increasingly focused on sustainable outcomes. The financial community realizes that a sustainable transition calls for double materiality assessments that account for the ways E, S, and G intersect.
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Importance of Environmental, Social and Governance
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