Why sustainable investing is here to stay
The rise of ESG is not just a trend, but an essential shift in practices for responding to climate crisis. By Timur Tillyaev
Human-caused climate change is real
This summer the USA is experiencing a drought experts believe could be the worst for over 1200 years. The extreme heatwave afflicting America would be “virtually impossible” without climate change, scientists have concluded.
Europe is suffering from its own record breaking heatwaves, while devastating floods in Germany have cost the lives of over 200 people, with more than 150 more still missing at the time of writing. Again, the severity of this tragic disaster, Germany’s worst floods in the post-war era, is being linked to climate change. Thousands have been left without homes and electricity. The total financial impact, including uninsured losses, is predicted to reach $6bn.
For years, many in the West saw climate change as a problem of the future, or one that only affected faraway places in the Global South. No longer. The consequences of climate crisis are being felt everywhere and right now.
Investors are taking action
Unsurprisingly, climate consciousness is becoming an influential phenomenon in the investor community. Sustainable investment is becoming mainstream and a growing number of investors are pushing for more radical change.
There are now 575 investors with more than $54 trillion assets under management signed up to The Climate Action 100+ initiative, which aims to influence the world’s largest greenhouse gas emitters to act on climate change.
The Investor Agenda unites another 1,200 institutional investors, managing over $35 trillion in assets, driving to scale up measures needed to reach the Paris Agreement goals. These are just two of a number of initiatives pushing for sustainability.
Investment in sustainable funds reached record highs in 2020 at over $51 billion, more than double the previous record set in 2019. And it looks as though sustainable investing will only grow in 2021. The FT reported in June that investors had already piled $54bn into sustainable bond funds in the first five months of 2021.
The rise of ESG
This drive for environmentally responsible investment gave rise to ESG — environmental social and governance. Put broadly, ESG policies are the measures taken by corporates to improve their sustainability. Investors, with the help of ESG ratings agencies and their own methodologies, analyse a company’s ESG policies to work out if the company is a risky investment.
Social policies include things like comprehensive health and safety plans, efforts to improve diversity and effective community engagement and development projects. To score well on governance companies can create oversight boards to ensure compliance and establish clear codes of conduct to prevent corruption, fraud and other illegal practices. The boards are also expected to be on top of climate-related trends in the financial markets and have tools to mitigate their company’s climate-related risks.
Environmental policies are by far the most important strand for investors as climate-related risks are becoming more and more prominent in the investors risk assessments. Companies are now increasingly expected to disclose their carbon footprints, set bold greenhouse gas reduction targets and report on how climate-related risks, such as potential loss of revenue from extreme weather events, can undermine future prosperity.
On the more day-to-day operations side, companies are reducing air travel, electrifying their vehicle fleets and increasing recycling to reduce their carbon footprints. Many large companies producing or dependent on fossil fuels are looking to divest and upscale their use of renewable energy wherever possible.
ESG is here to stay
For some in the business community, ESG represents “nothing but a passing investment fad”. Accusations of greenwashing are also common. These concerns are valid. The main issue facing ESG is a lack of clear standardised reporting. ESG ratings are provided by several different ratings agencies, but each follows its own methodology. Meanwhile, a lack of universal standards and transparency across industries makes it difficult to get a clear picture of compliance.
An investigation in April by the US Securities and Exchange agency found that a number of the 600 exchange-traded funds that claim to invest sustainably in line with global ESG frameworks were not meeting their obligations.
Despite these problems, there can be no doubt that ESG is here to stay. It represents not a short-term fashion, but a landslide shift in perception which recognises the climate crisis as the most important challenge of our time.
Over the past three years, public concerns about climate change and the environment have risen exponentially worldwide.
Climate activists such as Greta Thunberg and Extinction Rebellion cut through to the mainstream where so many of their predecessors failed. Both the Pentagon and the UN now view climate change as an existential threat to our planet.
China, planet earth’s heaviest polluter, shocked the world in September last year when it announced a pledge to become carbon neutral by 2060. With the 26th UN Climate Change Conference of the Parties (COP26) taking place in Glasgow in November 2021, there will only be an acceleration of ambitious pledges and policy commitments.
Central banks are increasing efforts to stress test banks and insurers to assess their exposures to climate-related financial risks. And asset managers continue to turn the screws on companies slow to take real action against climate change.
In this context sustainable investment and ESG are not luxuries or fashions, but necessities.
The world appears to have finally understood that business as usual is no longer an option.
Follow Timur Tillyaev at: