ESG investing consists of investing in ways that promote sustainable investments made with the intention of generating measurable social and environmental impact alongside financial returns. It is important to consider ESG track record when deciding whether or not to invest in a specific company or fund. It’s a risk management move that factors in the following ESG issues:
- Environmental risk: Business activities that negatively impact air, water, land, ecosystem and human health increase environmental risk. ESG factors include environmental reporting or disclosure of managing resources, preventing pollution, reducing carbon footprints and climate impact.
- Social risk: Companies can impact society through promoting safe and healthy work environments, protecting human rights and labor management. Social-positive outcomes increase productivity, brand loyalty and morale.
- Governance risk: Company governance activities such as executive compensation, protection of shareholders’ interests and rights, corporate risk management, increasing diversity and improving business practices make positive steps toward avoiding unpleasant financial surprises and frauds.
Recent trends of ESG investing:
Worldwide, ESG-classified investment has swollen by more than a third since 2016 and accounts for assets worth more than trillions of dollars. Investors are becoming wary of the financial impact of the regulations on high-carbon emitting industries and other such efforts being made by governments across the world. In June 2019 the Canadian government made an announcement that it plans to “ban harmful single-use plastics as early as 2021.”
The biggest challenge for ESG investors is the absence of standardized ESG regulations. It is a fairly new concept and there is no conclusive methodology to define its different components. The interpretation and analysis of ESG vary across different investing communities and jurisdictions. It is important to create and monitor a fair marketplace for ESG investing. Investors should have access to relevant information, comparable across different corporations and national boundaries. An institutional investor or enterprise’s claim for ESG status must be backed by precise and objective methods of ESG evaluation.
Integration of ESG into investment decisions is hindered by a lack of universally-recognized guidelines, and it could greatly benefit from clarity in implementation and legality of the said rules.
Growing inclination towards ESG investing is quite apparent, as can be seen by 345 large asset owners signing the UN Principles for Responsible Investment. More and more credit rating agencies have started accounting for ESG considerations. Its increasing importance can also be realized by the fact that 49 stock exchanges across Europe have agreed to publish ESG disclosure guidelines.
The ever-looming threat of environmental issues like water scarcity, climate change coupled with the advancement of science and technology has resulted in initiatives like the RE100 coalition, where more than 150 large companies have pledged to source 100% renewable energy. The rise in production of electric vehicles, reusable plastics and other environmentally conscious initiatives are clearly indicative of a gradual paradigm shift, and ESG investing seems the best way forward.
Atul Rai, Regulatory Solutions, also contributed to this article.
Written by Zenil Shah
Senior Associate, Regulatory Solutions