Chapter 1: Introduction to ESG Flashcards
Define ESG Investing?
Investors explicitly acknowledge:
- Environmental
- Social
- Governance
factors into their investment decisions
-
Asset management approach that acknowledges importance of ESG in
- INVESTMENT DECISIONS
- own ROLE AS OWNERS
- own ROLE AS CREDITORS
Impact of ESG?
- Risk
- Volatility
- Long-term return
- Individual securities and market
Define Corporate Social Responsibility?
Broad concept that companies want to act in an ethical way.
What is Triple P accounting or Triple Bottom Line?
- People
- Planet
- Profit
Coined by John Elkington
also ‘Triple Bottom Line’
Expanding from profit –> includes social & environmental impacts to company
What is Responsible investment?
- Strategy and practice
- Integrate ESG into investment decisions
- Stewardship
- Considers how ESG factors impacts the risk-adjusted return of an asses and the stability of the economy
- ESG are taken into account to mitigate risk and focus on financial return
What are the main responsible investment strategies?
- Best-in-Class investing
- Socially responsible investing
- Sustainable investing
- Thematic investing
- Green investing
- Social investment
- Impact investment
- Ethical and Faith based investing
What is Best-in class Investment? (criteria, selection, diversification, tracking error, screening)
- Selecting a company that passes a pre-defined ranking hurdle and ESG criteria within sector and industry.
- Used in investment strategies that try to keep characteristics of an index and maintain regional or sectoral diversification.
- Low tracking error
What is Socially responsible investment? (criteria, selection, diversification, tracking error, screening)
- Applies social and environment factors in evaluating companies
- Investors score companies using criteria, usually in conjunction with sector-specific weighting
- Set hurdle for investable universe which serves as a screening for qualitied companies
What is Sustainable Investment? (criteria, selection, diversification, tracking error, screening)
- investment strategy that wants to contribute to sustainable economy and minimize resource depletion
- Could include best in class
- Could also mean investing in companies that have a positive impact.
- Screening
What is Thematic Investment? (criteria, selection, diversification, tracking error, screening)
- Selecting companies that fall under sustainable-theme, such as Cleantech
- Not all thematic investments are considered responsible investment
- Because companies may not comply with other ESG characteristics
What is Green Investment? (criteria, selection, diversification, tracking error, screening)
- Broad subcategory of thematic investment
What is Social Investment? (criteria, selection, diversification, tracking error, screening)
- Adresses bottom-of-the-period.
- Is a market-based instrument of economic development and poverty eliviation and
- includes invesmtments in micro-finance.
What is Impact Investment? (criteria, selection, diversification, tracking error, screening)
- Investment made with specific ESG impact and financial return (unlike philantrophy)
- Different return expectations.
What are the THREE factors impacting EFFICACY of SHAREHOLDER ENGAGEMENT?
Reflects active ownership by investors, seeking to influence companies decision impact ESG.
Efficacy depends on
- SCALE OF OWNERSHIP (individual or collective initiative)
- QUALITY OF ENGAGEMENT DIALOGUE & method used
- Whether company has been informed that DIVESTMENT IS a POSSIBLE sanction
SQUiD
How can ESG investing become FINANCIALLY MATERIAL?
- Reduced COST and increased EFFICIENCY
- Reduced RISK OF FINES and state interventions
- Reduced EXTERNALITIES
- Improved adaptability to MEGATRENDS
CERFEM
What are externalities?
- Production or consumption of a product or service’s private price equilibrium can’t reflect true costs of product of service for society as a whole
- When externalities are negative, private costs are lower than societal costs, leading to market failures.
How can CLIMATE CHANGE SOCIAL COSTS be INTERNALIZED by governments and markets? What instruments exist?
- MARKET-BASED instruments e.g. charges, taxes or tradeable permits
- REGULATORY instruments e.g. standards
- VOLUNTARY instruments
MRV
MaRV
What are megatrends?
- Urbanization and Emerging economies
- Technological disruption
- Demographic change
- Wealth inequality
- Climate change and resource scarcity
What do we know about ESG and financial performance?
- Overwhelming evidence indicates positive correlation between ESG and financial performance
- Positive correlation between ESG performance and stock price
- But no clear correlation between ESG and fund level performance
- Good ESG standards lower cost of capital
- Positive correlation operational performance
What can be considered modern ESG fiduciary duty?
○ Incorporate ESG factors in investment decision making
○ Incorporate sustainability preferences of beneficiaries or clients, regardless if these preferences are financially material
○ Be active owners, encourage high ESG standards in invested companies/assets
○ Support stability and resilience financial system
- Disclose investment approach and how preferences are incorporated
What are UNIVERSAL OWNERS, and why do they need to address ESG?
- Large institutional owners with highly diversified holdings across sectors and asset classes that represent the global market and investible universe
- Their investment returns depend on global economy
- Need to include ESG factors to account for megatrends
What are the Six Principles for Responsible Investment ?
- INCORPORATE ESG issues in investment analysis and decision making process
- ACTIVE owners and incorporate ESG in ownership policies and practices
- SEEK ESG DISCLOSURE in invested entities
- PROMOTE PRINCIPLES in investment industry
- WORK TOGETHER in implementing principles
- REPORTon implementation activities
IASPWR
IAS POWER
What are the minimum requirements for the PRI?
- Investment policies covering firm’s responsible investment policy covering >50% assets
- Internal or external staff responsible for implementing investment policy
- Senior level commitment and accountability mechanisms
What are the FOUR key areas for the UN GLOBAL COMPACT
- Environment
- Labor
- Human rights
- Anti-corruption
HEAL
What are the FOUR key areas of the
Task Force on Climate-related Financial disclosures (TCFD)?
- GOVERNANCE - around organizations climate-related risks and opportunities
- STRATEGY - the actual potential impact of risks and opportunities on organizations strategy, business and financial planning
- RISK MANAGEMENT
- METRICS and TARGETS
GaS RM
What is ESG investing?
- Taking ESG factors into account in investment decisions
- Acknowledging own role in having negative and positive ESG impact
- Ensuring holistic sustainability of long-term returns, functioning of society, environment and economy
Why do ESG investors engage with policy makers?
Consideration of ESG-related matters can contribute to proper functioning of financial markets
Describe SOCIAL FACTOR
Related to the lives of humans, including management of:
- Human resources
- Local communities
- Clients
LoCH
Bottom of the pyramid
Market-based model of economic development to alleviate poverty while providing growth & profits for businesses
Examples include:
- Micro-finance
- Micro-insurance
- Access to telecommunication
- Access to improved nutrition and healthcare
- Access to clean energy
What rate do Fortune 100’s best companies outperform in stock market?
2.3% - 3.8% per year over 25 yrs
ESG Methods by Institutional Investors? (3)
1) INCORPORATE ESG FACTORS into investment decision making
2) Through CORPORATE engagement
3) Through POLICY engagement
–
INCORPORATE
CORPORATE
POLICY
I Ce Pe
Sustainable Finance Disclosure Regulation (SFDR)
- Supports institutional & retail clients to compare, select, and monitor the sustainability characteristics of investment funds by standardizing sustainability disclosures
UNPRI commitments (6, voluntary)
1) We will incorporate ESG issues into investment analysis & decision-making process
2) We will be active owners & incorporate ESG issues into ownership policies and practices
3) We will seek appropriate disclosure on ESG issues by entities 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 princples
6) We will report on our activities and progress towards implementing the principles
Value Reporting Foundation (VRF)
Created in merger from International Integrated Reporting Council (IIRC) and Sustainability Accounting Standards Board (SASB)
- Aim is to offer resources designed to help businesses and investors develop a shared understanding of enterprise value drivers and standards
Corporate Reporting Dialogue (CRO)
Joint effort to drive better alignment of sustainability reporting frameworks
- promotes further integration of non-financial & financial info
Joint project led by: CDP, CDSB, GRI, IIRC, SASB
