Chapter 1: Introduction

Question 1

ESG investing

Answer 1

Approach to managing assets where investors explicitly acknowledge the relevance of environmental, social and governance (ESG) factors in their investment decisions, as well as their own role as owners and creditors, with the long-term return of an investment portfolio in mind.

Question 2

ENVIRONMENTAL FACTORS

Answer 2

Factors pertaining to the natural world. These include the use of, and interaction with, renewable and non-renewable resources like water, minerals, ecosystems and biodiversity.

• Climate change
• Resource depletion
• Waste
• Pollution
• Deforestation

Question 3

SOCIAL FACTORS

Answer 3

Lives of Humans. Human Resources, Local Communities, Clients.

• Human rights
• Modern slavery
• Child labour
• Working conditions • Employee relations

Question 4

Governance Factors

Answer 4

Factors that involve issues inherent to the business model or common practice in an industry, as well as the interest of broader stakeholder groups.

• Bribery and corruption
• Executive pay
• Board diversity and structure
• Political lobbying and donations • Tax strategy

Question 5

corporate social responsibility (CSR)

Answer 5

broad business concept that describes a company’s commitment to conducting its business in an ethical way.

Big in 20th Century. Led to 3BL.

Question 6

Triple-bottom line

Answer 6

Three Ps:
People
Planet
Profit

Question 7

Effective management of the company’s sustainability can:

Answer 7

• Affirm the company’s license to operate in the eyes of governments and civil society;
• Increase efficiency;
• Attend to increasing regulatory requirements;
• Reduce the probability of fines;
• Improve employee satisfaction and productivity; and
• Drive innovation and introduce new product lines.

** ESG investing recognises these benefits and aims to consider them in the context of security/asset selection and portfolio construction.

Question 8

Approaches to ESG Investing

Answer 8

• Responsible investment;
• socially responsible investment (SRI);
• sustainable investment;
• best-in-class investment;
• ethical/values-driven investment;
• thematic investment;
• impact investment;
• green investment;
• social investment;
• shareholder engagement.

Question 9

Responsible Investment

Answer 9

Factors ESG into investment decisions and active ownership.

Considers how ESG affects the risk-adjusted return of an asset and the stability of an economy, as well as how investment in and engagement with assets and investees can impact society and the environment.

Question 10

Socially Responsible Investment (SRI).

Answer 10

Applies Social and Environmental criteria in evaluating companies.

Investors implementing SRI generally score companies using a chosen set of criteria, usually in conjunction with sector-specific weightings.

A hurdle is established for qualification within the investment universe, based either on the full universe or sector-by-sector.

This information serves as a first screen to create a list of ESG- qualified companies.

SRI ranking can be used in combination with best-in-class investment, thematic funds, high-conviction funds or quantitative investment strategies.

Question 11

Best-in-class investment

Answer 11

Selecting only the companies that overcome a defined ranking hurdle, established using ESG criteria within each sector or industry.

1. companies are scored on a variety of factors that are weighted according to the sector.
2. The portfolio is then assembled from the list of qualified companies.

3. Due to its all-sector approach, best-in-class investment is commonly used in investment strategies that try
to maintain certain characteristics of an index. 

In these cases, security selection seeks to maintain regional and sectorial diversification and a similar profile to the parent market cap index, while targeting companies with higher ESG rating.

The tracking error for MSCI World SRI, which is designed to represent the performance of companies with high ESG rating and employs a best-in-class selection approach to target the top 25% companies in each sector, is only 1.79% .

Question 12

Sustainable Investment

Answer 12

Sustainable investment refers to the selection of assets that contribute in some way to a sustainable economy, i.e. an asset that minimises natural and social resource depletion. Broad term.

Further used to describe companies with positive impact or companies that will benefit from sustainable macro-trends.

ALSO: Can Screen out activities considered contrary to long-term environmental and social sustainability, such as coal mining or exploring for oil in the Arctic regions.

Question 13

Thematic Investment

Answer 13

Refers to selecting companies that fall under a sustainability-related theme, such as clean-tech, sustainable agriculture, healthcare or climate change mitigation.

Ex: Smart city fund

Not all thematic funds are considered to be ‘responsible investments’. Depends on companies.

Question 14

Green Investment

Answer 14

refers to allocating capital to assets that mitigate:
▶ climate change;
▶ biodiversity loss;
▶ resource inefficiency; and
▶ other environmental challenges.

These can include:
▶ low-carbon power generation and vehicles;
▶ smart grids;
▶ energy efficiency;
▶ pollution control;
▶ recycling;
▶ waste management and waste of energy;
▶ process innovation; and
▶ other technologies and processes that contribute to solving particular environmental problems.

Green investment can thus be considered a broad sub-category of thematic investing and/or impact investing.

Green bonds ARE COMMON

Question 15

Green Bonds

Answer 15

Fixed-income instrument that is specifically earmarked to raise money for climate and environmental projects.

Question 16

Social Investment

Answer 16

Social investment focuses on Social Challenges.

Can address BOP.

▶ micro-finance and micro-insurance;
▶ access to basic telecommunication;
▶ access to improved nutrition and healthcare; and
▶ access to (clean) energy.

Social investing can also include social impact bonds.

Question 17

Social Impact Bonds

Answer 17

Mechanism to contract with the public sector which pays for better social outcomes in certain services and passes on part of the savings achieved to investors.

Question 18

Impact investment

Answer 18

Generating positive, measurable social and environmental impact alongside a financial return.

These are usually associated with direct investments, such as in private debt, private equity and real estate.

▶ offer access to basic services, including housing, healthcare and education;
▶ promote availability of low-carbon energy;
▶ support minority-owned businesses; and
▶ conserve natural resources.

Question 19

Ethical/value-driven

Answer 19

▶ tobacco;
▶ alcohol;
▶ pornography;
▶ weapons;
▶ nuclear power;
▶ Human Rights

Question 20

WHY ESG?

MATERIALITY.

Answer 20

Financial materiality:

ESG investing can reduce risk and enhance returns, as it

considers additional risks

and injects

new and forward-looking insights into the investment process.

ESG integration may lead to:

A. reduced cost and increased efficiency (as much as 60%,)
B. reduced risk of fines;
C. reduced externalities; and
D. improved adaptability to sustainable megatrends

Question 21

EFFICIENCY

Answer 21

CDP (Climate Disclosure Project) estimated that companies experience an average internal rate of return of 27% to 80% on their low-carbon investments.

A strong ESG proposition can help companies attract and retain quality employees, and enhance employee motivation and productivity

Question 22

Sustainably Mega Trends

Answer 22

▶ social challenges (such as increasing income inequality, poverty, and human and labour rights abuses); and
▶ environmental issues (such as climate change, biodiversity loss and resource scarcity).

Urbanisation
Demographic changes and wealth inequality
Climate change and resource scarcity

These factors have interacted with:
▶ the aftermath of the financial crisis;
▶ ageing populations;
▶ the rise of emerging countries; and
▶ rapid tech change

In the AG space:
▶ alter growing conditions and seasons;
▶ increase pests and disease; and
▶ decrease crop yields.

In Supply Chain:
unpriced natural capital assets, such as biodiversity, groundwater, clean air and climate.

Water depletion

Question 23

Financial performance (MARK CARNEY)

Answer 23

1: Companies that score well on ESG metrics could better anticipate future climate-related risks and opportunities. This makes them more strategically resilient.
2. Second, strong ESG scores could signal that a firm is more naturally disposed to longer-term strategic thinking and planning. Long-Term Value Creation.
3. Strong ESG firms may enjoy valuation premiums consistent with shifting investor preferences.

Question 24

Economics

Answer 24

Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system, has already identified climate change as a potential systemic risk.

Bubbles and Spikes.

Stockholm Resilience Centre has identified nine ‘planetary boundaries’ within which humanity can continue to survive. 4 have been crossed. climate change, loss of biosphere integrity, land-system change and altered biogeochemical cycles (phosphorus and nitrogen)

Climate change and biosphere integrity are ‘core boundaries’.

Question 25

Why?

Impact/Ethics vs. Client Demand vs. Regulation

Answer 25

Impact Ethics:

▶Positive Impact: Tackling the world’s social and environmental problems through capital.

▶ Avoid negative impact: At times for religious reasons, usually do not invest (negative screening) from controversial sectors (such as arms, gambling, alcohol, tobacco and pornography).

Client Demand:

▶ Growing awareness that ESG factors influence:
» company value;
» returns; and
» reputation; and
increasing focus on the environmental and social impacts of the companies they are invested in.

Regulation:

Regardless of their views or beliefs, some investors are being required to increasingly consider ESG matters.

Question 26

Three Ways to PUT ESG INTO PRACTICE

Answer 26

A. incorporating ESG factors into investment decision-making;

B. incorporating ESG factors through corporate engagement; and

C. incorporating ESG factors through policy engagement.

Question 27

Strategic asset allocation (SAA)

Answer 27

SAA is the process in which an investor chooses to allocate capital across asset classes, sectors and regions based on their need for return and income, and risk appetite.

By::: Applying a filter or threshold, which rules potential investments in or out of the investment universe;

» integrating ESG issues within their financial and risk analysis; or
» using ESG criteria to identify investment opportunities through a thematic approach (e.g. water fund, impact investing, etc.).

Question 28

KEY INITIATIVES

Answer 28

United Nations Global Compact

United Nations Environment Programme Finance Initiative (UNEP FI)

which leads:

▶ Principles for Responsible Investment (PRI), established in 2006 by UNEP FI and the UN Global Compact now applied by half the world’s institutional investors (US$83tn).

▶ Principles for Sustainable Insurance (PSI), established in 2012 by UNEP FI and today applied by one-quarter of the world’s insurers (25% of world premium).

▶ Principles for Responsible Banking (PRB) launched with more than 130 banks collectively holding US$47tn (£37tn) in assets.

Question 29

Principles for Responsible Investment (PRI) four main areas.

Answer 29

1. Provides tools and reports on best practices for asset owners, asset managers, consultants and data suppliers.
2. It hosts a collaborative engagement platform.
3. Reviews, analyses and responds to responsible investment-related policies and consultations. Also provides a policy map to investors and facilitates communication between investors and their regulators on the topic of responsible investment.
4. PRI Academy develops, aggregates and disseminates academic studies on responsible investment-related themes.

Question 30

PRI SIX PRINCIPLES

Answer 30

1. We will incorporate ESG issues into investment analysis and decision-making processes.
2. We will be active owners and incorporate ESG issues into our ownership policies and practices.
3. We will seek appropriate disclosure on ESG issues by the entities in which we invest.
4. We will promote acceptance and implementation of the principles within the investment industry.
5. We will work together to enhance our effectiveness in implementing the principles.
6. We will each report on our activities and progress towards implementing the principles.

Question 31

PRI Minimum Requirements

PRI Academy develops, aggregates and disseminates academic studies on responsible investment-related themes.

Answer 31

1. Investment policy that covers the firm’s responsible investment approach, covering >50% of assets under management (AUM).
2. Internal or external staff is responsible for implementing responsible investment policy.
3. Senior-level commitment and accountability mechanisms for responsible investment implementation.

Growth of the ESG market and the increased use of the term ‘ESG’ has been highly correlated to the growth in PRI membership. Growth = 30% annual.

Question 32

United Nations Framework Convention on Climate Change (UNFCCC)

Answer 32

The United Nations Framework Convention on Climate Change (UNFCCC), launched at the Rio de Janeiro Earth Summit in 1992, aims to stabilise greenhouse gas (GHG) emissions to limit man-made climate change.

UNFCCC hosts annual Conferences of the Parties (COP) meetings

COP3 meeting in Kyoto in 1997, which created the Kyoto Protocol. This commits industrialised countries to limit and reduce their GHG emissions in accordance with agreed individual targets.

COP21 meeting in Paris in 2015, which led to the Paris Agreement. This commits developed and emerging economies to strengthen the response to the threat of climate change by keeping a global temperature rise this century well below 2°C (3.6°F) above pre-industrial levels.

Question 33

UN Sustainable Goals

Answer 33

The Sustainable Development Goals (SDGs), agreed by all UN members in 2015 in replacement of the UN Millennial Goals, are the UN’s blueprint to address the key global challenges, including those related to poverty, inequality, climate change, environmental degradation, peace and justice. The 17 goals are all interconnected and particularly aimed at governments. The Paris Agreement, though negotiated in parallel to the SDGs, became one of its goals.

Have become a powerful framework to these two actors, with some investors already reporting against their impact on the SDGs and driving capital to contribute to their achievement.

Question 34

International Corporate Governance Network (ICGN)

Answer 34

Established in 1995 to promote effective standards of corporate governance and investor stewardship to advance efficient markets.

Of note, the ICGN developed two key guidance documents for investors: one on stewardship and another one on investment mandates.

Question 35

Global Sustainable Investment Alliance (GSIA)

Answer 35

Many countries have a national forum for responsible investment. The Global Sustainable Investment Alliance (GSIA) is an international collaboration of these membership-based sustainable investment organisations.

Question 36

Task Force on Climate-related Financial disclosures (TCFD)

Answer 36

The Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD) takes the Paris Agreement’s 2°C (3.6°F) target and tries to operationalise it for the business world.

Discloses against the following:
governance:

strategy, financial planning, risk management, metrics and targets.

Question 37

Reporting initiatives

Global Reporting Initiative (GRI)

Answer 37

The Global Reporting Initiative (GRI) publishes the GRI Standards, which provide guidance on disclosure across environmental, social and economic factors for all stakeholders, including investors, whereas the other major frameworks are primarily investor focused. Several thousand organisations worldwide use the GRI framework, which is among the most well-known and is the standard for the United Nations Global Compact.

Question 38

Reporting initiatives

Integrated Reporting Framework (IRF)

Answer 38

The Integrated Reporting Framework (IRF), put forward by the International Integrated Reporting Council (IIRC), encourages companies to integrate sustainability within their strategy

Question 39

CDP (former Carbon Disclosure Project)

Answer 39

CDP is a non-governmental organisation (NGO) which supports companies, financial institutions and cities to disclose and manage their environmental impact. It runs a global environmental disclosure system in which nearly 10,000 companies, cities, states and regions report on their risks and opportunities on climate change, water security and deforestation.

Question 40

Climate Disclosure Standards Board (CDSB)

Answer 40

Climate Disclosure Standards Board (CDSB) is an international consortium of business and environmental NGOs with the mission to create the enabling conditions for material climate change and natural capital information to be integrated into mainstream reporting.

Question 41

Corporate Reporting Dialogue (CRD)

Answer 41

Corporate Reporting Dialogue (CRD) is a joint project led by the CDP, the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB). Its objective is to drive better alignment of sustainability reporting frameworks, as well as with frameworks that promote further integration of non-financial and financial information.

Its Better Alignment Project is focused on driving better alignment in the corporate reporting landscape, to make it easier for companies to prepare effective and coherent disclosures that meet the information needs of capital markets and society.

Question 42

Sustainability Accounting Standards Board (SASB)

Answer 42

The Sustainability Accounting Standards Board (SASB) issues standards that are focused on the key material sustainability issues which affect 70-plus industry categories. These, along with the SASB materiality maps, are particularly helpful for investors determining what is material for reporting, and aids more standardised benchmarking.

Question 43

Portfolio Construction

Answer 43

All forms of responsible investment, except for engagement, are ultimately related to portfolio construction.

Question 44

One of the main reasons for ESG integration is recognising that responsible investment can reduce risk and enhance returns.

Answer 44

Financial materiality can be due to:

a. reduced cost and increased efficiency;
b. reduced risk of fines;
c. reduced externalities; and
d. improved adaptability to sustainability megatrends.

Question 45

Global Risks Report?

Answer 45

Evidence of the risks that ESG megatrends carry is illustrated by the World Economic Forum’s Global Risks Report, which for many years now has highlighted the growing likelihood and impact of extreme weather events and the failure to address climate change.

Question 46

Fiduciary Duty?

Answer 46

Think Long Term

Question 47

Universal Owners

Answer 47

Large institutional investors, known as universal owners, have holdings that are highly diversified across all sectors, asset classes and regions. Their investment returns are thus dependent on
the overall economy. A reason for implementing ESG stems from the recognition that negative megatrends will, over time, create drag on economic prosperity and may increase instability both within countries and between the ‘global north and south

Question 48

Demand

Answer 48

Client Demand is super important for driving ESG.

Question 49

Institutional investors typically reflect ESG considerations by incorporating ESG factors into…

Answer 49

…investment decision-making, through corporate engagement, and through policy engagement.

Including …

a. within their investment mandates;
b. within their strategic asset allocation process;
c. by applying a filter based on ratings;
d. by integrating ESG issue(s) into financial models; or
e. by using ESG factors to identify investment opportunities.

Question 50

The Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD)…

Answer 50

…takes the Paris Agreement’s 2°C (3.6°F) target and tries to operationalise it for the business world.

It should also drive a substantial advance in disclosures by seeking transparency about realistic scenario planning, particularly around the physical impacts of climate change, including for investors.