At a glance
- Environmental, Social and Corporate Governance (ESG) investing has grown rapidly over the past few years, driven both by investors’ desire to do good and increasingly lucrative returns.
- The focus of ESG investing has been primarily on the ‘E’ (environment), particularly prioritising the threat of climate change. However, recently, investors have begun shifting their attention towards other environmental threats, including the loss of biodiversity.
- ESG investing presents a big financial opportunity for the UK and has the capacity to help our planet. However, certain challenges still restrict sustainable investing from fulfilling its true potential: namely, greenwashing and a lack of standardised ESG disclosure practices.
ESG: purpose or profit?
Forms of sustainable investing have grown rapidly in recent years driven both by the search for better long-term financial returns, and a pursuit of better alignment with investors’ values.
Through the combination of traditional investment approaches with Environmental, Social and Corporate Governance (ESG) criteria, conscious investors screen potential sustainable
investment opportunities.
Companies and institutional investors alike are under increasing scrutiny to deliver more than simply good returns. They must also demonstrate good engagement with ESG-related issues. While all three criteria (Environmental, Social, Governance) of ESG investing have gained popularity over the past few years, investors’ focus falls primarily on the ‘E’ of ESG (environmental). This is arguably because of the increased global awareness around the threat posed by climate change. However, it is important to note that investors don’t simply invest sustainably to ‘do good’. There is a growing recognition that companies demonstrating strong ESG profiles are more likely to deliver long-term sustainable value to their stakeholders.
This begs the question: is ESG investing actually helping our world, or is it just a good risk management strategy? The answer is both. A survey done by Aquila Capital showed that 73% out of 64 interviewed institutional investors in the UK consider economic viability to be a key driver of investment in renewable infrastructure, while only 40% cited the desire for socially and environmentally responsible investment. Thus, the main motivation for renewable energy investment is returns. While this may not sound too positive for environmentalists, the renewable energy industry is arguably at a point where it no longer needs people to want to ‘do good’. Instead, investors can do what makes sense financially, and do good anyway. As Oldrik Verloop (co-head of hydro investments at Aquila Capital) puts it: ‘[t]his is not charitable work, this makes sense from an investment perspective’. Of course, it is not only about good returns. Some investors are looking to do good, especially those among younger generations. Others are thinking about the financial difficulties that climate change could cause if it is not dealt with, seeing as the state of the environment can directly affect a company’s competitive positioning and have an impact on assets. Regardless of the reason, awareness and engagement with climate issues as well as renewable energy is increasing rapidly in the UK among both companies and investors. This trend is seen globally, too.
Jes Staley, CEO of Barclays, says that the international demand for financing sustainable projects presents a huge opportunity for the UK. According to him:
Climate today is like technology was in 1995. If you think about it…all the Amazons, the Googles, didn’t really exist in 1995 and now it dominates 40% of the economy. I think it’s a fair argument that dealing with climate and dealing with the environment is in the same position now.
And to some extent, we can see the growth in demand around renewable energy happening already. Over the past decade, renewable energy consumption has grown at an average annual rate of 13.7%, making it the only category of energy that grew globally at double digits, and these numbers are rapidly increasing. Investors around the world are realising the rising demand for sustainable investments. According to S&P Global, global sales of green bonds, used to finance everything from sustainable agriculture to clean transportation projects, have more than quadrupled in five years. Furthermore, sales this year have already exceeded last year’s record $135 billion.
Climate change does not care about the reasons that led to the surge in ESG investing. What matters is that the growth in ESG investing can ultimately contribute towards a reduction in CO2 emissions with a more sustainable future. This is because ESG is changing business models, pressuring companies to act in order to slow down climate change, while encouraging investors to invest in the increasingly profitable renewable market. Both will ultimately contribute to the slowing down of climate change. There is a growing trend of investing in the ‘E’ in ESG globally. The United Nations recently introduced the Asset Owners Net Zero Alliance, a group of asset managers overseeing a collective $2.4 trillion that have pledged to align their portfolios to meet net-zero greenhouse gas emissions by 2050. In the UK, a few institutions have led the way. For example, the Church of England’s pension fund divested around £600m away from companies that weren’t making progress towards the Paris Climate Agreement goals. Meanwhile, Brunel Pension Partnership has threatened to sack fund managers who don’t get in line with ESG issues. According to Richard Mattison (member of the EU Sustainable Finance Group), ‘80% of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change’.
ESG investing and biodiversity
Based on the considerations above, it is clear that the ‘E’ in ESG has grown exponentially over the last years. It is also clear that investors have focused mainly on the renewable energy market. This makes sense, seeing as the renewable energy market is becoming increasingly profitable, and can contribute to the reversal of climate change, which has been one of the main reasons for the boost in ESG investing. However, while the climate crisis is one of the planet’s gravest problems, it is not the only environmental threat that needs tackling. Ashim Pain, co-head of ESG research at HSBC says: ‘biodiversity is this major risk that we face but which people have ignored… all the attention has been on climate change’. Awareness of our interconnectedness with other species grew in 2020 as it became clear that unsustainable development increases the risk of pandemics (such as COVID-19). As put by John Vidal (environmental editor of the Guardian), ‘as habitat and biodiversity loss increase globally, the novel coronavirus outbreak may be just the beginning of mass pandemics’.
Investors and regulators are increasingly turning their attention to biodiversity. Companies and investors are also becoming more and more concerned about the significant financial risks stemming from biodiversity loss, with more than half of the world’s total gross domestic product dependent on natural resources, from food to medicine. ‘Biodiversity loss and climate change both present critical financial and economic risks’, said Jenn-Hui Tan, global head of stewardship and sustainable investing at Fidelity International.
One of the reasons for the lack of focus on biodiversity loss is a lack of data and measurement standards. While metrics such as ‘CO2 equivalent’ are a fairly reliable way to quantify greenhouse gas emissions, there is no similar measurement for biodiversity. Furthermore, according to a recent assessment by the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services, countries have been unable to identify the main drivers behind biodiversity loss, or to implement adequate legislation. While collecting data around biodiversity loss is still a challenge, regulators are stepping up pressure on companies to disclose their impact on biodiversity. Europe is leading the way on this by enacting new requirements for ESG disclosure through its sustainable finance disclosure regulations (SFDR) which is likely to lead to increased biodiversity reporting requirements on companies. The SFDR will determine what business activities integrate biodiversity. Of course, seeing as the UK has recently left the EU, the SFDR is not as relevant domestically. However, after Brexit, the UK has announced its intention of becoming a ‘global green finance leader’ by enacting its own legislation based on the Task Force on Climate-related Financial Disclosures (TCFD), which is going to be (supposedly) stricter than the EU’s SFDR. Based on these considerations, we can assume that the UK intends to follow the advancements seen in the EU’s SFDR and maybe even add more positive changes.
Recently, we have been seeing a growth in ESG investing relating to biodiversity. For example, last September, two dozen financial institutions signed the Finance for Biodiversity Pledge and committed to protect and restore ecosystem services through their finance activities and investments. Furthermore, according to Bloomberg, investors at firms, including Fidelity International and AXA Investment, claim that in 2021 they will be focusing on the threat of biodiversity loss. Again, regardless of whether the rise in attention towards the issue of biodiversity loss is being led by a want to do good, fear of the future, or financial interests; the increased focus of ESG investing into biodiversity will ultimately create a more sustainable world, contributing to a greener future.
Challenges
The rise in ESG investing presents a huge investment opportunity that also helps the health of our planet. At the same time, it also presents a huge marketing opportunity. The rising popularity of ESG investing has been accompanied by a rebranding of funds which in some cases represents only a small amount of ‘dressing’ around the edges. Larry Fink (CEO of Blackrock) says that it only takes the mere inclusion of the phrase ‘ESG incorporation’ for a company to attach the ESG label to a fund. This is also known as ‘greenwashing’ (i.e., when a company makes claims about the sustainability of their products or services that are misleading).
As assessed above, the ‘E’ in ESG currently revolves around the renewable energy market, which is something that contributes to slowing down climate change. However, Swasti Gupta (professor of finance at Loyola University) argues that climate change is too big of a problem, and the ‘E’ in ESG should be separated from the ‘S’ and ‘G’. She argues:
Environmental, social and governance concerns were grouped together because social good connects all ESG issues. However, it is time to delineate how environmental concerns are defining fiduciary duties. Given the effects of climate change already in evidence, society and business can ill-afford confusion around defining and prioritizing climate risk.
Many agree with Gupta, with rising concerns that corporations may not be acting quickly enough to address the issue of climate risk. According to Richard Mattison (CEO of Trucost), many investors and regulators fear that the market doesn’t grasp the full scope of the costs and consequences of climate risk. Venture capitalist, Wal Lierop, further states that: ‘while this support for the environment is encouraging, it is delusional to believe that we can win the war on carbon without more fundamental ESG changes’.
Another challenge that may hinder ESG investors from making a positive impact on our environment is a lack of effective and standardised ESG disclosure practices. The lack of consensus also includes regulators and policymakers who lack a common framework to communicate the standards and practices of environmental protection. According to S&P Global, the continuing absence of a universally accepted global framework means that there is a lack of standardisation in the green bond market. All of this poses a challenge to investors and companies attempting to get involved with ESG investing.
Whether or not ESG investing will have a good and lasting impact on the environment will become clearer in time. The considerations above seem to suggest that ESG will indeed have a positive impact on the environment. However, a broadening-out from a climate change focus is needed if we want to truly see ESG helping to take our civilisation into a sustainable future.
Endnotes
- Armstrong A, ‘Ethics and ESG’ Australasian Accounting, Business and Finance
Journal (2020) 6 https://ro.uow.edu.au/aabfj/vol14/iss3/2/ - Austin D, ‘RI long read: Can ESG grasp what ecology says?’ Responsible Investor
(2021) - Baldwin R, ‘Top ESG Goal: Achieving purpose and profit’ pwc (2021)
- Boffo R, OECD, ‘ESG investing: Environmental Pillar Scoring and Reporting’ OECD
Paris (2020) - Cooper G, ‘The ESG data files, part nine: Biodiversity – the new frontier’
Environmental Finance (2020) - Georgieva A, ‘Responsible Investing Zeroes in on Biodiversity in Momentous 2021’
Qontigo (2021) https://qontigo.com/responsible-investing-zeroes-in-on-biodiversity/ - Gupta S, ‘Climate Action Is Too Big for ESG Mandates’ Stanford social innovation
review (2020)
https://ssir.org/articles/entry/climate_action_is_too_big_for_esg_mandates - Gurdus L, ‘Climate change will be a ‘really big’ focus for ESG investors in 2021,
market analyst says’ CNBC (2020) - Henisz W, ‘Five ways that ESG creates value’ Mckinsey Quarterly (2019)
- Kishan S, ‘Biodiversity, Supply Chain Rank Among Biggest ESG Themes in 2021’
Bloomberg (2021) - Lierop W, ‘Most ESG Investing Makes A Charade Of Fighting Climate Change’
Alteryx (2020)
- Mattinson R, Accounting for Climate: the next frontier in ESG’ S&P Global (2019)
- Nauman B, ‘ESG investors wake up to biodiversity risk’ The Financial Times (2020)
https://www.ft.com/content/100f0c5b-83c5-4e9a-8ad0-89af2ea4a758 - Octopus Group, ‘Why ESG investing is more relevant than ever before’ Climate
Action (2020) - Rapier, R ‘Renewable Growth Rate Continues at a Blistering Pace’ Forbes (2020)
- Rintoul F,’ESG: doing some good in the world’ funds europe (2015)
https://www.funds-europe.com/february-2015/esg-doing-some-good-in-the-world - Vidal J, ‘’Tip of the iceberg’: is our destruction of nature responsible for Covid-19?’
The Guardian (2020) - ‘Assessing ESG factors in the energy sector’ DLA Piper (2020)
- ‘Can ESG awakening end the biodiversity crisis?’ ESG Clarity (2020)
https://esgclarity.com/can-esg-awakening-end-the-biodiversity-crisis/ - ‘From where we were to where we stand’ Natixis (2021)
- ‘Spotting the best trusts in the ESG jungle’ interactive investor (2021)
https://www.ii.co.uk/analysis-commentary/spotting-best-trusts-esg-jungle-ii515195 - ‘Understanding the “E” in ESG’ S&P Global (2019)
<https://www.spglobal.com/en/research-insights/articles/understanding-the-e-in-esg>
This article was first published by UKELA e-law May/June 2021 Issue 124