Environmental, Social and Governance (ESG) investing began with a letter and call to action. In January 2004, then UN Secretary-General Kofi Annan wrote to the CEOs of significant financial institutions to take part in an initiative to integrate ESG into capital markets. Where are we today?
Since then, ESG has evolved and moved from the sidelines to the forefront of decision-making for asset managers and institutional investors. Increasingly, ESG considerations are being integrated into the charters of a growing number of entities, included in their practice and applied to the due diligence process when assessing assets to be acquired.
Consider the numbers: In 2017, ESG investments grew 25 percent from 2015 to US$23 trillion, accounting for about one-quarter of all professionally managed investments globally.1
This growth was fueled in part by the rise in the Socially Responsible Investment Movement more broadly, which is also impacting company behavior with respect to ESG. In a recent study by KPMG International, more than one-third (36 percent) of C-suite and board members surveyed indicated that investor pressure had increased the company’s focus on ESG.2
World economies are facing growing indebtedness and unsustainable asset prices as we enter an unsettling geopolitical reality, where nationalism and populism are creating go-it-alone state mentalities leading to rising military, economic and commercial tensions. At the same time, failure to mitigate climate change and growing cybersecurity breaches continue to grow as threats to global stability.
In this environment, it’s clear ESG criteria are best suited to effectively assess an organization’s resilience, adaptability, long-term sustainability and capacity for growth. This requires a forwardlooking, qualitative and expansive approach to investing, one that examines what-if scenarios and relies less on past performance and historical data as a predictor of future performance.
Creating ESG guidelines is a growing priority for asset managers around the world and across the financial services sector. This is particularly true of institutional investors, such as sovereign investment funds and pension funds. This group is acutely aware of the negative impact to reputation investments that are not viewed as socially responsible can have. As a result, they are rigorous in ensuring the assets they acquire are compliant with human rights, labor rights, corruption and environmental laws, and more than this, that they are compliant with their own internal benchmarks for what is responsible investing.
While the ESG movement is global, some regions are further along the ESG continuum than others. For example, Europe, Australia, New Zealand and Canada are leaders in terms of prioritizing ESG considerations, which can vary from jurisdiction to jurisdiction and from entity to entity.
In December 2017, six sovereign wealth funds came together to create the One Planet Sovereign Wealth Fund Working Group. Its objective: to develop an ESG framework to address climate change and encourage sustainable growth and market outcomes. The framework is based on three principles: to align climate change awareness and influence investment decision-making; to promote value creation by encouraging businesses to address the impact of climate change; and to integrate the risks and opportunities of climate change in the management of investments.3
More and more, investment managers are creating ESG charters and frameworks that require looking at a company’s environment and contamination policies, at the governance structures it has put in place to avoid corruption, at the diversity of its board and whether or not it is taking aggressive tax positions.
Increasingly, institutional and individual equity investors have made the link between ESG information, a company’s purpose, values and strategy and its performance. Studies confirm that having appropriate ESG policies in place is not just about doing the right thing and being compliant with laws and regulations, it’s financially beneficial. Companies with sustainable practices outperform companies that have not integrated ESG considerations into operations.
In Morgan Stanley's latest poll 1,000 individual investors, 75 percent said they are interested in sustainable investing and adopting its principles as part of their strategy and 71 percent believe companies that focus on the environment and social goals will earn better returns.
A poll of 900 board members and business leaders from 41 countries by the Audit Committee Institute reveals that 47% of respondents believe ESG-focused companies outperform competitors4.
The rise in ESG considerations on the part of businesses and investors is happening in tandem with a heightened regulatory environment that has also increased ESG requirements and accounting standards demanding transparency around disclosures in financial statements.
Leading organizations understand that regulatory requirements are just a starting point. In order to deliver strong returns over the long term, it is necessary to be proactive and to go beyond being compliant in creating a robust ESG framework. That’s why they are joining forces and forming organizations such the One Planet Sovereign Wealth Fund and creating their own, more far-reaching ESG requirements.
80% of the world's largest corporations use global reporting initiative standards.
For institutional investors and companies looking to implement and improve ESG considerations, we recommend:
In today's environment where change and uncertainty seem to be the only constants, more and more investors are taking a long-term view and choosing to put their money into companies that act responsibly. ESG investing is already reshaping global markets. This trend is poised to continue making ESG analysis a critical part of the investment process.