2020 and Beyond: ESG Integration
A Seismic Shift Begins
2020 and Beyond: ESG Integration
A Seismic Shift Begin
January 2020
By Danae Kyriakopoulou
Sustainable investment is becoming mainstream around the world. According to the 2018 Global Sustainable Investment Review, total sustainable assets across five key markets – Japan, US, Europe, Canada and Australia/ New Zealand – grew 34% in the two years to early 2018 to stand at US$30.7 trillion.
Three Emerging Trends in ESG
The advantages of sustainable investment go beyond ESG benefits. Several academic studies have shown a strong correlation between ESG scoring models and financial performance. Listed companies that incorporate ESG principles into their governance have also been shown to have lower reputational risk and a reduced likelihood that they will lose their licenses to operate.
13. Climate Change Transforming the Investment Industry
With carbon emissions on the rise since 2015, it is looking unlikely that the world will be able to hold the increase in the global average temperature to well below 2°C above pre-industrial levels, as set out in the Paris Agreement.
Heatwaves, flooding and drought will be considerably more severe at 2°C than at 1.5°C.
According to the BNY Mellon Investment Management ‘Future 2024’ report, 57% of the chief investment officers, portfolio managers and strategists surveyed viewed climate change as both a risk and opportunity, reflecting widespread uncertainty about how global warming might affect asset returns.
Institutional investors are increasingly integrating climate considerations into investment decisions to increase low carbon investments and screen out companies with high emissions and fossil fuel reserves. Forward-looking analysis of potential sources of risk and return can inform the strategic asset allocation decision-making process by calculating how exposed the institution’s investments are to changes in global temperatures.
14. Impact Investing Redefining the Role of Capital
According to Frances Barney, Head of Global Risk Solutions at BNY Mellon, in addition to regulatory requirements for greater disclosure, there is now tremendous energy behind the push for sustainability from institutional and individual investors alike. Through shareholder activism and sustainable investments, millennial investors in particular are scrutinizing their investments to understand what they own and how it impacts society.
Investors are demanding transparency on ESG issues and looking for additional investment options that may lead to positive ESG outcomes.
Some investors are pursuing impact investing as a way to drive innovation in alternative technologies that may reduce the environmental impact of more traditional solutions.
As millennials accumulate wealth, financial services firms should shift strategies and create values-based investment options and products.
15. Material ESG Factors Driving Positive Financial Returns
Some institutional investors have embraced the idea of “materiality” to determine which ESG concerns are relevant to particular investments.
For many years, investors have been concerned that ESG investing requires compromises on investment return objectives. In fact, there is some evidence to suggest that a focus on ESG investing does not require a reduction in investment return expectations. According to a recent study, which used the materiality framework of the Sustainability Accounting Standards Board, companies that address material ESG issues and ignore immaterial ones outperform those that address both material and immaterial issues by 4% and outperform companies that address neither by nearly 9%.
With global regulations gaining momentum, investors should adopt sound practices to determine materiality and evaluate managers. Institutional investors need to change their investment and capital allocation processes in the ways required for this kind of investing to take off.
Similarly, a number of studies have shown a positive relationship between integrating material ESG factors and financial performance, supporting the notion that managing ESG risk factors can be beneficial for long-term financial returns, risk reduction and identifying alpha across a range of asset classes.
Asset owners can no longer afford to view ESG integration as a value-oriented “nice-to-have” impact strategy. Regulatory shifts responding to government commitments to sustainability will materially impact market structures and valuations. There is a clear business case for the investment community to adjust portfolios to mitigate risks and identify the opportunities from the transition to a sustainable growth path.
ESG At a Glance
Australia
The Australian Sustainable Finance Initiative was launched in March 2019 to redefine the financial system with recommendations on climate change.
An Australian Council of Superannuation Investors May 2019 policy paper called on regulators, government and investors to strengthen investment stewardship and mandate ESG integration into investment decision-making.
The A$48 billion Cbus super fund drew up a plan in September 2019 to reduce the carbon emissions of its property portfolio to zero by 2030.
Canada
Following Prime Minister Justin Trudeau’s re-election in 2019, it is expected that the administration will fulfill its commitment to reducing greenhouse gas emissions to 30% below 2005 levels by 2030 and make progress in clean tech. If successful, these efforts would support the favorable trajectory for ESG, where responsible investment AUM grew by 42% over a two-year period¹.
China
ICBC, the world’s largest bank by assets, issued a US$2.2 billion green bond in April 2019.
Ping An became the first Chinese asset owner to sign up to the UN Principles for Responsible Investment (UNPRI) in August 2019.
The China Securities Regulatory Commission will make ESG information disclosure mandatory for all listed companies by 2020.
Japan
76 local firms committed to the Taskforce on Climate-Related Financial Disclosure in April 2019.
The Government Pension Investment Fund currently allocates JPY 3.5 trillion across five ESG benchmarks, requires all asset managers to integrate ESG into their investment analysis, and plans to increase its range of sustainable indices beyond Japan.
Malaysia
Large asset owners, including the Employees’ Provident Fund and Khazanah are signatories to UNPRI.
Netherlands
Known as a socially progressive nation, the Netherlands is well suited to adopting ESG investing. In 2018, more than 70 Dutch pension funds with combined assets of nearly €1.2 trillion signed a covenant with NGOs, trade unions and the Dutch government, pledging worldwide cooperation on sustainable investment in alignment with the United Nation’s Guiding Principles for Businesses and Human Rights and OECD guidelines.
In one recent industry study, half of Dutch pension fund members accrue pension funds with rights that pursue an integrated sustainability policy.
South Korea
The National Pension Service announced in April 2019 that it would publish an annual report on its ESG practices.
In June 2019, the government issued its first green bonds, raising US$500 million. Korea Electric Power Corporation also issued a US$500 million green bond focused on renewable energy.
United States
A 2019 survey conducted by the CFA Society of New York showed that asset owners are committed to continued learning about ESG, with 42% planning to educate their supervisory boards on its importance and on sustainability issues; 39% said they were planning to integrate ESG more formally into their investment processes by updating existing policies or adopting new ones.