ESG Responsible Investments and Sustainable Finance, from Niche to Mainstream?

ESG / SRI Investments is gaining momentum during the last years. The ESG / SRI market grows at a stable pace the last years - in terms of assets under management, number of ESG relevant funds, number of Asset Owners and Asset Managers that integrate ESG factors into their investment strategies as well as the number of UN PRI Members. Moreover the mainstream global and European market leaders of the global investment industry started gradually to commit to ESG products, since they see the growing market trend in this relative new investment segment. 

ESG vs Mainstream Investing

Why should investors integrate ESG Metrics into their investment strategy and why could an ESG investment approach offer a potentially better Return on Investment (ROI)?

  • ESG market in terms of assets under management, new funds, new market players is growing during the last years and there is an ongoing positive trend
  • ESG funds perform generally well and, in some cases, outperform in comparison to mainstream funds
  • The policy at EU level (Sustainable Finance Legislative Package) but also at the national level (initiatives in France, Netherlands, Luxemburg, Germany etc.) support Sustainable Finance and ESG Investments as a topic, encouraging a sustainable way of investing. The national Financial Supervisory Authorities in various EU member states started already survey investors, insurance firms and asset managers on ESG investing.
  • ESG metrics provide the possibility to identify gaps in corporate governance, potential regulatory (also litigation), reputation, environmental, social, operational, market, sectoral and other risks, as well as vulnerabilities in companies that financial KPIs do not show
  • ESG criteria provide the chance to evaluate and analyse the non-financial KPIs and how sophisticated the company’s strategy is
  • ESG is more suitable for mid-term and long-term strategy

After the positive signal of the Paris Agreement on Climate Change by a vast majority of states and despite the negative signals on the topic by the Trump Administration, the policy side, especially in the EU, is willing to support and boost the topic of sustainable finance and responsible investments by proposing new regulation. The EU can be proud that it is ahead of the USA regarding the topic and far ahead of Asia. But how will the new EU Sustainable Finance Initiative, and the relevant proposed legislative sustainable finance package proposed by the European Commission, impact the investment industry? Is the new proposed EU regulatory framework enough to boost the ESG investment market or do we need more than that? 

In May 2018 the Commission presented a package of measures as a follow-up to its action plan on financing sustainable growth. The package includes three proposals aimed at:

  • A unified EU classification system (taxonomy) of ESG relevant investors, asset managers and funds establishing an EU-wide classification system of sustainable economic activities and setting the basis for the establishment of common standards. 
  • Investors and asset managers’ duties and disclosures. The proposed regulation will introduce consistency and clarity on how institutional investors integrate environmental, social and governance (ESG) factors in their risk processes, how their investments relate to ESG factors and targets, and explain how they comply with these. 
  • Introducing carbon footprint for investors and asset managers creating a new category of benchmarks which will help investors compare the carbon footprint of their investments.
  • Inform and advise better clients (esp. individuals) about ESG factors regarding investment process and decision. The aim is to amend Delegated Acts under the Markets in Financial Instruments Directive (MiFID II) and the Insurance Distribution Directive.

The European Parliament and Council will review the proposals before the final texts are agreed upon, which is expected in early 2019. Member states then have two-years to implement the proposed legislation.

The Gap in ESG

In this growing market, ESG is not yet regulated and there are no commonly recognized international standards about which funds and products can be considered as 'ESG relevant', which asset management firms can be considered 'ESG asset managers', and which persons at the asset management firms can be considered to have the expertise to be called 'ESG portfolio and fund managers'. It is thus relatively easy at the moment to name a fund ESG. Therefore, at the moment, there is a gap and a risk in the ESG industry, that should be mitigated and solved as soon as possible.

The membership of an investor or asset manager at the United Nations Principles for Responsible Investment Initiative (UN PRI) is the minimum but cannot be considered anymore as enough condition an Investor or Asset Manager to be called ESG relevant. There is a need for regulation and adoption of common international standards. The proposed EU legal framework on sustainable finance is contributing to that direction but it will take time, it will be valid only in EU, and it does not solve the problem of necessary standardisation of the industry. It must also be discussed and clarified which of the existing and applied ESG investment strategies (exclusion, inclusion, best in class, norms-based screening, ESG integration, sustainability-themed investing, corporate engagement/shareholder activism, impact investing) are accepted and recognised as equally ESG relevant. Not all are equally complex, not all apply the same criteria and processes, and not all lead to the same results. For example, a fund that integrates only the governance factor in its investment strategy or just excludes (exclusion investment strategy) a few sectors (e.g. defence, gaming industries) from its investment universe is not at the same level as a fund that strictly integrates all three ESG factors in its investment strategy. At the moment, though, both are considered equally ESG funds.

The policy initiatives at EU level (recent proposed packaged on sustainable finance) or national level in various EU member states support Sustainable Finance & ESG Investments. The good performance of quite a few ESG funds the last years, as well as the economic changes and trends in the real economy in various sectors regarding the three elements of ESG (Environment, Social, Governance) confirm positive signals and provide good cases, which could potentially contribute to a shift to a more ESG Investment Philosophy:
The transition to the use of more clean energy and less fossil fuels, the gradual growth of sharing mobility and electric mobility (electric cards, electric bikes), the adoption of the concept of smart cities by more and more cities, the digitalization of the state, the cities and the corporate world, the shareholders positive activism is adopted more and more, and also the gradual understanding by the corporations, investors and banks that a transparent and well-functioning corporate governance scheme is important for the minimization of the risks, performance and growth. The same is valid for the gender diversity allowing the company to be a good workplace for its employees and all its stakeholders. The firm is considered part of the society and should think not only of the shareholder value but of the stakeholder value.

The ESG Investment market is still a niche with a positive trend to become potentially and gradually a more mainstream segment - under the conditions of appropriate regulation and adoption of well-defined common international standards on which funds can be considered as ESG relevant, in order to avoid the potential risk of a new ESG this time market “bubble”.


References:

by Yannis Salavopoulos, Managing Director, Global Sustain GmbH, Group Head. Int. Affairs, ESG/SRI Market Intelligence Experts, Guest Lecturer, SRH Berlin Int. Management University.

Global Sustain Group / Global Sustain GmbH is organising for 3rdconsecutive year in cooperation with Forum for Responsible Investment (FNG – the leading Association for ESG Investments in Germany, Austria, Switzerland & Lichtenstein), Investment Bank Berlin (IBB) and International Bankers Forum (IBF) the 3rd ESG Responsible Investments, Green Finance & Brands Forum 2018 in Berlin on 26.9.2018 with the motto this year “ESG, from Niche to Mainstream?”.