Sustainable Investing and the Growing Relevancy of ESG Integration

Erica Russell, Legal & Regulatory Analyst.

Sustainable Investing and the Growing Relevancy of ESG Integration

In the wake of the Covid-19 pandemic, it has become apparent that companies can no longer operate independently from societal and environmental issues as investors recognise that these present clear financial risks. Covid-19 has thrown new light on the interdependencies in human and natural ecosystems and it is impossible to look at the global health crisis and its knock-on effects, without consideration for environmental, social and governance (ESG) factors. The current crisis has reinforced Willis Towers Watson’s belief that long-term sustainability issues have a material impact on financial and non-financial risk and outcomes. Thus, there is a greater emphasis placed on the integration of ESG factors into the investment process and there is little doubt that the Covid-19 crisis has accelerated this trend of a more sustainable approach to investing.

ESG FACTORS AND THEIR GROWING RELEVANCY 

The current crisis emphasises the relevancy of considering ESG factors with respect to company performance and investment returns. Sustainable investing, i.e. the integration of these factors into analysis and decision making has seen a significant rise over the past couple of years. It is now estimated at over US $30 trillion. The Covid-19 crisis has not ceased this growth, in fact, it has seen a steady increase in inflows and better-than average returns since the start of the pandemic. The European Fund and Management Association (EFMA) recommends improving the availability of ESG data and the relevance of non-financial reporting. They suggest that a review of the Non-Financial Reporting Directive (NFRD) could result in more meaningful, comparable, reliable and publicly available ESG disclosures on investee companies, which are essential to assess sustainability risks and opportunities.

The three European Supervisory Authorities (EBA, EIOPA and ESMA – ESAs) have consulted on proposed ESG disclosure standards for financial market participants. The aim of which is to strengthen protection for end-investors and make sustainable investing a more viable option. Those corporations that fail to transform their business models will be replaced by others that have the adaptive flexibility to thrive in a new world that values smart, clean, and healthy activities.

SUSTAINABLE INVESTING – AN OPPORTUNISTIC OUTLOOK 

The COVID-19 pandemic could be a potential catalyst for ESG investing. It has elevated the importance of how companies operate and focused the world’s attention on public health. According to research firm Morningstar, investors worldwide injected $45.6 billion into ESG funds in the first quarter of the year, compared to outflows of $384.7 billion for the overall fund universe.

Not only is the drive toward responsible investment economic, but it is also societal. In turn, this will influence large asset managers to align more and more of their assets under management ‘’with some sort of ESG or responsible investments approach’’ according to John Ditchfield, co-founder of Impact Lens.

Positive signals are also emanating from regulators. In Europe, the European Commission has focused on a Sustainable Finance Strategy and on establishing a long-term framework to achieve climate neutrality in the EU by 2050. The investing community will play a pivotal role in supporting these initiatives by allocating capital towards constructing a stable and sustainable recovery, which will be financed primarily in the bond markets.

The AFME fully agrees with the European Commission that the COVID-19 pandemic has further demonstrated the need to strengthen the sustainability and resilience of our economies and societies. The transition to a more sustainable economy will require significant investment efforts across all sectors and will be an important lever in supporting economic growth and innovation in the coming years. It is therefore vital that the delivery of the various elements under the EU Green Deal, including unlocking sustainable financing, are aligned with the strategy for the economic recovery post COVID-19 crisis.

In 2018, the European Union released an action plan to encourage integration of ESG factors on a wider scale. In addition, the UK’s Financial Conduct Authority (FCA) has followed suit by starting a discussion around the opportunities and risks that the transition to a low carbon economy presents in the UK’s financial services markets.

The European Capital Markets Institute (ECMI) in cooperation with the International Swaps and Derivatives Association (ISDA) reported that derivatives markets can contribute to the transition towards a low-carbon economy by enabling the EU to raise and channel the necessary capital towards sustainable investments.

Notably, in 2019, the CFA UK, a professional membership body for investment professionals, launched a new ESG investing qualification. This further instils the importance of analysing and integrating material ESG factors into operations.

AMAFI is also currently working on developing a grid to categorise financial instruments according to ESG criteria. Awareness, consumer demand, and the regulators are aligning the stars for a more responsible investment world. Over half (52%) of the regulatory notices Corlytics have tracked since 2019 on ESG and Sustainability have been published by the EU Regulators alone.

WHAT’S ON THE HORIZON? 

As a result of Covid-19, companies have come under increased scrutiny with respect to their progress towards putting sustainability targets and contingency plans in place related to sustainability risks. Many of the organisations that will emerge from this crisis successfully are those who drove a modal shift towards sustainable investing and establishing strong ESG practices. Not only will this help in accelerating the global recovery from the pandemic, but it can foster a more resilient society and economy for the future.

J.P. Morgan polled investors from 50 global institutions, representing a total of $12.9 trillion in assets under management (AUM) on how they expected COVID-19 would impact the future of ESG investing. 71% of respondents said it was highly likely that the occurrence that a risk such as Covid-19 would heighten awareness and actions globally to tackle high impact /probability risks such as those related to climate change and biodiversity losses.

Using the broadest classification for the ESG market, assets following global sustainable investment approaches could reach around $45 trillion AUM by the end of 2020. Corporations and investors that aspire long-term success are likely to increase, rather than slow down, their sustainability efforts.

The pandemic has acted as a warning to the much greater challenge arising from climate change. In his famous speech, Mark Carney, then Governor of the Bank of England, argued that the catastrophic impact of climate change will be felt beyond traditional horizons and will impose a cost on future generations that the current one has no incentive to fix. Thus, public investments can serve a catalytic function in this context.

In a speech published by the European Central Bank (ECB), Isabel Schnabel states that the coronavirus crisis offers a must-seize opportunity and the costs of letting it go to waste would be exceptionally large. There are considerably lower shares of both growing and shrinking firms than in other advanced economies, holding back productivity growth as well as technology creation and diffusion.

The European Green Deal is the cornerstone of the EU’s response to the Covid-19 pandemic, given the massive amounts required for a sustainable and green recovery. ESG products have demonstrated their resilience during the market decline caused by the pandemic and will play a pivotal role in accelerating the transition to a sustainable economy.

CONCLUSION

As more and more investors and companies embrace good ESG performance as a strategic asset, a window of opportunity is opening to recover better. Even if policymakers fail their people, there is no doubt that the market-led forces that propel the sustainability movement will continue to gain momentum. Technological change, environmental imperatives and long-term social norm changes will propel ESG investing and corporate sustainability forward. Intelligent ESG investing is bound to become the new normal. The lessons to be learned are loud and clear: prevention is better than cure, and decision-making informed by science is the way to build resilience and ensure future survival.

Corlytics can assist in highlighting initiatives by the regulators in integrating ESG factors into your business decisions and making sustainable investing a practicable option. Please contact us to find out more about us and to arrange a demo of our products.