Business

The colour of money

Integrating environmental and social governance issues into investment decisions sounds like an impossible dream. But, say John Elkington & Jodie Thorpe, important initiatives are leading finance in the right direction.
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In July, the UN Global Compact, in conjunction with the International Finance Corporation (IFC) and the Swiss government, held the third in a series of events in an initiative called “Who Cares Wins”. The aim of the initiative, originally launched in 2004, is to support the finance industry’s efforts to integrate environmental, social and governance (ESG) issues into investment decision-making. And its evolution signals significant changes in the international agenda for the sector.

This year’s effort focused on the role that ESG issues play in emerging markets investments. The event brought together approximately 70 representatives from banks, institutional investors, investment consultants, data providers, stock exchanges, multilateral agencies and governments. The aim was to assess the importance of ESG issues; showcase best-practice in the consideration of ESG issues in asset management and investment research; and identify opportunities for future developments—all in relation to emerging markets.

Stand back and it is clear that this event is simply the latest in a growing range of initiatives that are making the link between a broad range of ESG issues and the global investment and lending activities of financial institutions. Other examples include the Principles for Responsible Investment (focusing on institutional investors), the Equator Principles (project finance) or the Carbon Disclosure Project (risks from greenhouse gas emissions). Together, these efforts suggest that leading firms are beginning to run a very different sort of financial calculation.  

The main drivers for this shift have been fear of damage to corporate reputation, brands and valuations, coupled with a growing recognition of the opportunity to get a better grip on new risks and to both improve client relationships and expand services. Many financial institutions are introducing corporate-level sustainability teams who champion these issues, assessing the need for new policies and introducing them where necessary.  Firms such as ABN Amro, Goldman Sachs and HSBC have moved furthest in dedicating teams to the systematic ESG risk assessment of major finance deals.

In the investment world, early indications show that service providers are demonstrating creativity and innovation in developing new services and analytical capacity around ESG risks and opportunities. There has been a boom in investment in clean-technology with a growing range of indexes, themed funds, private equity vehicles and certificates. Another key area is micro-finance, where commercial products offer both measurable social impact and real financial returns.

Sell-side and independent research providers have also stepped up their capacity on ESG analysis. A growing number of mainstream organisations, among them Goldman Sachs and UBS, are now publishing detailed research reports on “The Materiality of Social, Environmental and Corporate Governance Issues to Equity Pricing”, a process led by the United Nations Environment Programme

Simultaneously, more asset managers now offer products tied to sustainable indices such as the Dow Jones Sustainability Index, the FTSE4Good in London, as well as similar indices on the Johannesburg and São Paulo stock exchanges.  Some major institutional investors such as CalPers (California Public Employees Pension Scheme) are including ESG considerations in their long-term investment decisions to ensure better returns, while a new generation of investors with a long-term focus is emerging. These include Generation Investment Management led by former US vice president Al Gore and David Blood, previously chief executive of Goldman Sachs Asset Management.

Turning to emerging markets, many participants at the “Who Cares Wins” event confirmed—from their experiences as asset managers and investment researchers—that the case for considering ESG issues in emerging markets investments is even stronger than for developed markets. In an IFC-sponsored Economist Intelligence Unit survey presented at the event, 76% of asset owners polled agreed or strongly agreed that ESG issues are an important part of their research, portfolio management and manager selection process, and 84% felt they would become even more important in future. 

Participants at the event cited several reasons for considering ESG issues, including the fact that where there is poor ESG performance in emerging markets, it tends to be worse than poor performance in developed markets. They also noted that ESG issues in emerging markets tend to affect the broad macro-economic and growth climate, and therefore affect investments more broadly. (Think of the impact of the Mattel story on China, Inc.) And, given the increasing exposure of multinationals based in developed markets to events and conditions in emerging markets—e.g. through the supply chain, ESG issues in emerging markets can have a ripple effect through a large part of an investor’s portfolio.

In general, emerging market investors seemed to be more aware of the importance of ESG issues than international investors, who may be seen as ‘opportunistic’—divesting when country risk rises, whereas domestic investors are locked into their economies and therefore more interested in  understanding ESG impacts. In addition, participants from emerging markets felt that social and governance issues are more pressing and ‘material’ (or financially significant) than international investors seem to think. 

Whether in developed or emerging markets, though, as impressive as the recent developments may be, they are as yet insufficient to drive ESG into the financial mainstream. The pressures from short-tempered markets on CEOs and CFOs are intense, and this has led at times to a form of schizophrenia in which much-celebrated corporate-level principles and policies fail to gain traction elsewhere in the business. As a result, ‘business as usual’ is often the order of the day as those on the ground find themselves confronted with conflicting instructions and unaligned incentives.

Real progress will only come with better analysis of ESG risks and opportunities, and further innovation to fill the innumerable market gaps. Most products currently on offer still focus on large company equity, with little coverage of alternative investments. Recently, however, funds and certificates focusing on sustainability themes such as alternative energy or water use efficiency have been launched.  As issues like climate change turn up the heat under financial markets, there will be a growing need to move beyond sustainability indexes to embed an understanding of ESG data in the entire range of mainstream investment products and services.

John Elkington is Founder & Chief Entrepreneur at SustainAbility and blogs at https://www.johnelkington.com.

Jodie Thorpe is the Manager of SustainAbility’s Emerging Economies Program (https://www.sustainability.com/emerging-economies).

This column has benefited greatly from the input of Ivo Knoepfel of onValues, Zurich, Switzerland (www.onvalues.ch/).

Homepage photo by PPDIGITAL