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CFA ESG Investing > Chapter 1 - Introduction to ESG Investing > Flashcards

Chapter 1 - Introduction to ESG Investing Flashcards

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1
Q

Describe the adverse effects of short-termism in the UK equity market

(3 Points)

A

Short-termism may promote:
* bubbles
* financial instability
* general economic underperformance

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2
Q

Name Forms of ESG Investing

(9 Points)

A

Different approaches to ESG investing include:
* responsible investment
* socially responsible investment
* sustainable investment
* best-in-class investment
* ethical/values-driven investment
* thematic investment
* green investment
* social investment
* shareholder engagement

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3
Q

Shareholder Rights Directive (SRD)

(2 Points)

A

By the European Union (EU) in September 2020:
A directive requiring investors to be active owners and act with a more long-term focus.

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4
Q

Examples of Environmental ESG Issues

(5 Points)

A
  • Climate Change
  • Resource Depletion
  • Waste
  • Pollution
  • Deforestation
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5
Q

Examples of Social ESG Issues

(6 Points)

A
  • Human Rights
  • Modern Slavery
  • Child Labor
  • Working Conditions
  • Employee Relations
  • Community Impact
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6
Q

Examples of Governance ESG Issues

(9 Points)

A
  • Bribery
  • Corruption
  • Executive Pay
  • Board Diversity
  • Board Structure
  • Trade Association
  • Lobbying
  • Donations
  • Tax Strategy
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7
Q

ESG Investing

A

An approach to managing assets where investors explicitly acknowledge the relevance of environmental, social, and governance factors in their investment decisions, with the long-term return of an investment portfolio in mind.

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8
Q

Long-Termism

A

A focus on long-term value creation and investment practices that prioritize long-term outcomes over short-term gains.

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9
Q

Short-Termism

A

Investment practices that prioritize short-term momentum, price movements, and quarterly financials over long-term value creation.

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10
Q

Responsible Investment

(3 Points)

A

Is a strategy and practice to incorporate ESG factors into investment decisions and active ownership.

It is sometimes used as an umbrella term for all ESG investment approaches.

At a minimum, responsible investment consists of mitigating risky ESG practices in order to protect value. To this end, it considers both how ESG might influence the risk-adjusted return of an asset and the stability of an economy and how investment in and engagement with assets and investees can impact society and the environment.

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11
Q

Socially Responsible Investment (SRI)

(4 Points)

A

SRI evaluates companies based on social and environmental criteria. Investors score companies using specific criteria and weightings.

A qualification hurdle is set for the investment universe.

This creates a list of SRI-qualified companies.

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

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12
Q

Sustainable Investment

(4 Points)

A

Sustainable investment involves selecting assets that contribute to a sustainable economy, minimizing resource depletion.

It considers ESG issues and may include best-in-class and ESG integration.

It also includes companies with positive impact and those benefiting from sustainable trends.

Sustainable investment can also refer to strategies that exclude environmentally and socially unsustainable activities, like coal mining or Arctic oil exploration.

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13
Q

Best-in-Class Investment

A

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

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14
Q

Ethical/Faith-Based Investment

A

An approach to ESG investing that aligns investments with specific ethical or faith-based criteria, such as avoiding investments in industries like tobacco or weapons (Negative Screening).

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15
Q

Thematic Investment

(2 Points)

A

Thematic investment focuses on specific ESG-related themes like clean energy, sustainable agriculture, affordable housing, affordable healthcare and nutrition.

However, not all thematic funds are responsible or best-in-class investments. The fund’s theme and the ESG characteristics of the invested companies determine its classification.

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16
Q

Green Investment

(3 Points)

A

Green investment involves allocating capital to assets that address climate change, biodiversity loss, resource inefficiency, and other environmental challenges.

This includes low-carbon power generation, energy efficiency, pollution control, recycling, waste management, and other technologies that solve environmental problems.

Green investment falls under thematic and impact investing. Green bonds, which raise funds for climate and environmental projects, are commonly used in this type of investment.

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17
Q

Social Investment

(2 Points)

A

Social investment involves allocating capital to assets that address social challenges, such as products for the poorest two-thirds of the population (Bottom of the Pyramid - BOP).

Examples of social investment include micro-finance, micro-insurance, access to basic telecommunication, improved nutrition and healthcare, and access to clean energy.

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18
Q

Shareholder Engagement

(2 Points)

A

The active ownership of investors in influencing the behavior and decision-making of companies in which they invest, particularly regarding ESG issues.

This can be done either through dialogue with corporate officers or votes at a shareholder assembly (in the case of equity).

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19
Q

Corporate Social Responsibility (CSR)

(3 Points)

A

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

Until recently, many companies implemented CSR by contributing to society through philanthropy (donations).

Modern understanding of CSR recognizes that a principles-based behavior approach (operating in ways that, at a minimum, meet fundamental responsibilities in the areas of human rights, labour, environment and anti-corruption) can play a strategic role in a firm’s business model.

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20
Q

Triple Bottom Line (TBL) Accounting

(4 Points)

A

An accounting framework that considers three dimensions of performance:
* economic (profit)
* social (people)
* environmental (planet)

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21
Q

Benefits of Incorporating ESG

(3 Points)

A

The advantages of considering ESG factors in decision making, including improved risk management, enhanced returns, and alignment with stakeholder values.

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22
Q

Challenges of Incorporating ESG

(5 Points)

A

The difficulties and obstacles associated with integrating ESG factors:
* perception that ESG has a negative impact on investment performance
* fiduciary duty prevents investors from integrating ESG
* investment consultants and retail financial advisers not supportive of ESG products
* significant resources needed
* limited data availability

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23
Q

Financial Materiality of ESG Integration

A

The concept that ESG factors can have a material impact on the financial performance and value of an investment.

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24
Q

Double Materiality

(3 Points)

A

Double materiality is a concept that considers the financial impacts of a company’s activities on the environment and society, as well as the financial impacts of external environmental and social factors on the company itself.
It emphasizes the interconnectedness between ESG factors and financial performance.

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25
Q

Dynamic Materiality

(4 Points)

A

The understanding that the materiality of ESG factors can evolve over time due to:
* changing market conditions
* regulations
* societal expectations

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26
Q

ESG Megatrends

(4 Points)

A

Long-term trends related to environmental, social, and governance issues that can significantly impact companies and their practices.

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27
Q

Stockholm Resilience Centre’s Nine Planetary Boundaries

(10 Points)

A

The Stockholm Resilience Centre’s Nine Planetary Boundaries are a set of ecological thresholds that, if crossed, could result in irreversible and abrupt environmental changes.
They include:
* climate change
* biosphere integrity
* land-system change
* freshwater change
* biogeochemical flows
* ocean acidification
* novel entities
* atmospheric aerosol loading
* stratospheric ozone depletion

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28
Q

World Economic Forum’s Global Risks Report

(3 Points)

A

The World Economic Forum’s Global Risks Report is an annual publication that highlights the most significant risks facing the global economy and society.

It assesses risks in various categories, such as economic, environmental, geopolitical, societal and technological, based on their likelihood and impact.

Environmental risks are high on the radar. Among all global risks, climate now tops the agenda.

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29
Q

What is one of the Challenges in ESG Investment?

(2 Points)

A

Identification of ESG issues that are genuinely material to a specific sector and company.

Determining which ESG factors are financially relevant and have a significant impact on long-term performance can be complex.

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30
Q

What is the Freshfields Report?

(3 Points)

A

Comissioned by UNEP FI in 2005.

The authors argued that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”

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31
Q

3 ways investors reflect ESG Considerations in their Investment Process

(3 Points)

A
  1. Incorporating ESG factors into investment decision-making
  2. Corporate engagement
  3. Policy engagement
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32
Q

Ways of Corporate Engagement

(3 Points)

A
  • Investors can engage with companies through annual general meetings (AGMs)
  • Engagement can happen individually or through collective initiatives
  • Discussions with company boards or management about ESG issues
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33
Q

Policy Engagement

(2 Points)

A
  • Investors can work with regulators, standard setters, and other parties to shape the financial system
  • Responding to policy consultations, participating in collective initiatives, and making recommendations to policymakers
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34
Q

United Nations Global Compact (UNGC)

(3 Points)

A

Collaboration between leading companies and the UN in 2000:
* Adheres to 10 principles derived from global standards, focusing on human rights, labor, environment, and anti-corruption
* Largest corporate sustainability initiative in the world with over 8,000 corporate signatories

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35
Q

United Nations Environment Programme Finance Initiative (UNEP FI)

(4 Points)

A
  • Partnership between UNEP and the global financial sector
  • Aims to mobilize private sector finance for sustainable development
  • Works with over 300 members, including banks, insurers, and investors
  • Established frameworks like Principles for Responsible Investment and Principles for Sustainable Insurance
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36
Q

Principles for Responsible Investment (PRI)

(3 Points)

A

Established in 2006 by UNEP FI and the UN Global Compact.

Network of investors working to understand implications of ESG investment - Growth of the S & G correlates to PRI membership.

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37
Q

Principles for Sustainable Insurance (PSI)

(4 Points)

A
  • Established in 2012 by the United Nations Environment Programme Finance Initiative (UNEP FI)
  • Framework for insurers to integrate sustainability into their business practices
  • Focuses on managing environmental, social, and governance (ESG) risks and opportunities
  • More than one-quarter of the world’s insurers have adopted the PSI principles to date
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38
Q

Principles for Responsible Banking (PRB)

(4 Points)

A
  • Launched in 2019 by the United Nations Environment Programme Finance Initiative (UNEP FI)
  • Framework for banks to align their business strategies with sustainable development goals
  • Focuses on impact, transformation, and accountability in banking operations
  • More than 200 banks globally have committed to the PRB, representing over $47 trillion in assets
39
Q

6 Principles of the PRI (Principles for Responsible Investment)

(6 Points)

A
  1. Incorporate ESG issues into investment analysis and decision-making.
  2. Be active owners and incorporate ESG issues into ownership policies and practices.
  3. Seek appropriate disclosure on ESG issues by the entities in which they invest.
  4. Promote acceptance and implementation of the principles within the investment industry.
  5. Work together to enhance effectiveness in implementing the principles.
  6. Report on their activities and progress in implementing the principles.
40
Q

United Nations Framework Convention on Climate Change (UNFCCC)

(3 Points)

A

Launched at the Rio de Janeiro Earth Summit in 1992.

Aims to stabilize GHG emissions to limit man-made climate change.

The UNFCCC hosts annual Conference of the Parties (COP) meetings, which seek to advance member states’ voluntary agreements on limiting climate change.

41
Q

UN Sustainable Development Goals (SDGs)

(4 Points)

A
  • Set of 17 global goals adopted by the United Nations in 2015
  • Designed to address social, economic, and environmental challenges worldwide
  • Goals include ending poverty, promoting gender equality, ensuring clean energy access, and more
  • Provide a framework for international cooperation and guide national development policies
42
Q

UN Sustainable Development Goals (SDGs)

(17 SDGs)

A
  1. No Poverty
  2. Zero Hunger
  3. Good Health and Well-being
  4. Quality Education
  5. Gender Equality
  6. Clean Water and Sanitation
  7. Affordable and Clean Energy
  8. Decent Work and Economic Growth
  9. Industry, Innovation, and Infrastructure
  10. Reduced Inequalities
  11. Sustainable Cities and Communities
  12. Responsible Consumption and Production
  13. Climate Action
  14. Life Below Water
  15. Life on Land
  16. Peace, Justice, and Strong Institutions
  17. Partnerships for the Goals
43
Q

Glasgow Financial Alliance for Net Zero (GFANZ)

A

GFANZ brings together existing and new net-zero finance initiatives across banking, insurance, and asset management in one sector-wide coalition.

44
Q

Global Reporting Initiative (GRI)

(3 Points)

A

The GRI Standards provide guidance on disclosure across environmental, social, and economic factors for all stakeholders, including investors.

The GRI framework is the standard for the United Nations Global Compact (UNGC).

The framework covers the most categories of sustainability activity and encourages anecdotes and further prose to help contextualization.

45
Q

Value Reporting Foundation (VRF)

(4 Points)

A

Formed in 2021 through merger of International Integrated Reporting Council (IIRC) and the Sustainability Accounting Standards Board (SASB):
* Aims to enhance corporate reporting by integrating financial and sustainability information
* Develops and maintains the Integrated Reporting Framework and the SASB Standards
* Supports organizations in reporting and disclosing their value-creation activities, including environmental, social, and governance (ESG) factors

46
Q

ESG Disclosure Framework (EDF)

(4 Points)

A
  • Framework developed by the International Business Council (IBC)
  • Created in collaboration with leading companies and stakeholders
  • Provides a standardized approach to ESG reporting and disclosure for companies
  • Aims to enhance transparency, comparability, and consistency in ESG reporting across organizations and industries
47
Q

International Sustainability Standards Board (ISSB)

(4 Points)

A
  • Proposed sustainability standard-setting board under the International Financial Reporting Standards (IFRS) Foundation
  • Aimed at developing global sustainability reporting standards
  • Intended to provide consistency, comparability, and reliability in corporate sustainability reporting
  • Seeks to address the growing demand for standardized and reliable information on environmental, social, and governance (ESG) performance
48
Q

Corporate Sustainability Reporting Directive (CSRD)

(3 Points)

A

The Corporate Sustainability Reporting Directive (CSRD) requires companies to report on the impact of corporate activities on the environment and society, and requires the audit (assurance) of reported information.
Its due to go live in 2023, and will replace the Non-Financial Reporting Directive (NFRD) by covering nearly 5 times more companies to report.

49
Q

Task Force on Climate-Related Financial Disclosures (TCFD)

(3 Points)

A
  • TCFD is a market-driven initiative developed to establish and recommend a general framework for identifying, assessing, and reporting climate-related financial disclosure.
  • TCFD is voluntary
  • Focuses on four key areas: governance, strategy, risk management, and metrics and targets
50
Q

Carbon Disclosure Project (CDP)

(3 Points)

A

CDP is a non-governmental organization (NGO) that 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.

51
Q

Climate Disclosure Standards Board (CDSB)

(2 Points)

A

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.

52
Q

Asia Investor Group on Climate Change (AIGCC)

(2 Points)

A

AIGCC is an initiative to create awareness among Asia’s asset owners and financial institutions about the risks and opportunities associated with climate change and low-carbon investing.

AIGCC provides capacity for investors to share best practices and to collaborate on investment activity, credit analysis, risk management, engagement, and policy.

53
Q

Global Impact Investing Network (GIIN)

A

The GIIN focuses on reducing barriers to impact investment by building critical infrastructure and developing activities, education, and research that help accelerate the development of a coherent impact investing industry.

54
Q

Global Sustainable Investment Alliance (GSIA)

(3 Points)

A

Many countries have a national forum for responsible investment.

The GSIA is an international collaboration of these membership-based sustainable investment organizations.

It is a forum itself for advancing ESG investing across all regions and asset classes.

55
Q

International Corporate Governance Network (ICGN)

(3 Points)

A

Investor-led organization established in 1995.

To promote effective standards of corporate governance and investor stewardship to advance efficient markets.

ICGN established a Model Mandate Initiative.

56
Q

How does Fiduciary Duty relate to ESG Investing?

(2 Points)

A

Fiduciary duty, traditionally seen as a barrier to considering ESG factors in investments, has a modern interpretation that recognizes the failure to consider long-term investment value drivers, including ESG issues, as a failure of fiduciary duty.
This means that considering ESG factors is now considered part of fulfilling fiduciary duty.

57
Q

Bottom of the Pyramid (BOP)

(3 Points)

A

A market-based model of economic development that seeks to simultaneously alleviate poverty while providing growth and profits for businesses serving these communities.

Social investments (not green investments) allocate capital to assets that address the BOP — that is, the poorest two-thirds of the economic human pyramid.

Micro-finance is an example of such social investment.

58
Q

Corporate Sustainability

A

Corporate sustainability is an approach aiming to create long-term stakeholder value through the implementation of a business strategy that focuses on the ethical, social, environmental, cultural, and economic dimensions of doing business.

59
Q

Stockholm Resilience Centre

(3 Points)

A

The Stockholm Resilience Centre identified nine “planetary boundaries” within which humanity can continue to develop and thrive for generations to come.

It found that four of them—climate change, loss of biosphere integrity, land-system change, and altered biogeochemical cycles (phosphorus and nitrogen)—have been crossed.

Two of these—climate change and biosphere integrity—are deemed “core boundaries,” for which significant alteration would “drive the Earth System into a new state.”

60
Q

Asset Owners for Insurers and Pension Funds

A

Entities that manage investments on behalf of participants, beneficiaries, or the organization itself (i.e. pension funds and insurers)

61
Q

Professor William Nordhaus

(2 Points)

A

Recently awarded the Nobel Prize for his work on the externality of climate change.

Developed a model to measure the impact of environmental degradation on economic growth and thus created a price for carbon pollution.

62
Q

Externalities

(2 Points)

A

Situations where production/consumption of goods/services creates cost/benefits for others for which they are not charged for.

E.g. harm from pollution during production.

63
Q

Negative Externality

A

Situations where the production or consumption of a product or services private price equilibrium cannot reflect the true cost of that product or service versus society as a whole.

64
Q

Internalization

(2 Points)

A

Internalization refers to all measures (public or private) to ensure that externalities become reflected in the prices of commercial goods and services (i.e., pollution tax).

65
Q

ESG Tilting

(2 Points)

A

Screening, divestment, and thematic investment strategies involve “tilting” the portfolio toward desired ESG characteristics by over- or underweighting sectors or companies that perform either well or poorly in those areas.

Institutional investors may feel that this conflicts with their obligation to invest prudently, because it involves straying from established market benchmarks.

66
Q

University of Cambridge Institute for Sustainability Leadership

A

Developed a toolkit to establishing long-term, sustainable mandates.

67
Q

Issues covered by the UN Global Compact

(4 Points)

A
  1. Human Rights
  2. Labor
  3. Environment
  4. Anti Corruption
68
Q

4 main Areas where PRI provides Support

(4 Points)

A
  1. The PRI provides a broad range of tools and reports on best practices for asset owners, asset managers, consultants, and data suppliers, supporting the implementation of the principles across all asset classes and providing insights into ESG issues.
  2. It hosts a collaborative engagement platform, by which it leads engagements and also enables like-minded institutions to coordinate and take forward engagement with individual companies and sectors.
  3. The PRI reviews, analyzes, and responds to responsible investment-related policies and consultations. It also provides a policy map to investors and facilitates communication between investors and their regulators on the topic of responsible investment.
  4. The PRI Academy develops, aggregates, and disseminates academic studies on responsible investment-related themes
69
Q

3 Requirements for PRI Signatories

(3 Points)

A
  1. Investment policy that covers the firm’s responsible investment approach, covering >50% of assets under management (AUM)
  2. Internal or external staff responsibility for implementing responsible investment policy
  3. Senior-level commitment and accountability mechanisms for responsible investment implementation
70
Q

COP3 - Kyoto Protocol

A

This commits industrialized countries to limit and reduce their GHG emissions in accordance with agreed individual targets.

71
Q

COP21 - Paris Agreement

A

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.

72
Q

“Race to Zero”

(2 Points)

A

Race to Zero is the UN-backed global campaign rallying non-state actors—including companies, cities, regions, and financial and educational institutions—to take rigorous and immediate action to halve global GHG emissions by 2030.

All members are committed to the same overarching goal: reducing GHG emissions across all scopes swiftly and fairly in line with the Paris Agreement, with transparent action plans and robust near-term targets.

73
Q

International Integrated Reporting Council (IIRC)

A

Encourages companies to produce in the greater reports which unite financial and DSG considerations into a single document.

74
Q

Sustainability Accounting Standards Board (SASB)

(2 Points)

A

The SASB Standards were focused on key material sustainability issues, which affect 70-plus industry categories and were developed along with the SASB materiality maps.

The SASB products were particularly helpful for investors determining what is material for reporting, and they aid more standardized benchmarking.

75
Q

Integrated Reporting Framework (IRF)

(3 Points)

A

Developed by the IIRC.

Encourages companies to integrate sustainability into their strategic and risk assessments by integrating it into the traditional annual reporting.

The aim of the integrated report was to make it easier for investors to review such information as part of normal research processes and thus increase the likelihood that sustainability information is material to investment decisions.

76
Q

“Comply or Explain”

(2 Points)

A

Is a regulatory mechanism that says that one either has to comply with a recommendation or — if one plans not to — name reasons for one’s deviation (explain).

Leads to investors challenging the assertion that ESG integration is a requirement.

77
Q

Benefits of ESG Integration

(4 Points)

A
  • reduced cost and increased efficiency
  • reduced risk of fines and state intervention
  • reduced negative externalities
  • improved adaptability to sustainability megatrends
78
Q

ESG Investing Challenges

(4 Points)

A

Challenges are:
* interpretation of fiduciary responsibility
* lack of understanding
* impression of resource intensity
* gap between market commitment and delivery

79
Q

Why are ESG Considerations non-financial?

A

They are difficult to value precisely and difficult to time.

80
Q

How is ESG typically reflected in Investment Approaches?

(3 Points)

A

By:
* integrating ESG into investment decisions
* engaging with companies on ESG issues
* engaging with public policy debates

81
Q

Why would Investors engage with Policymakers on ESG?

A

The consideration of ESG can contribute to the proper functioning of financial markets.

82
Q

What does Shareholder Engagement Efficiency depend on?

(3 Points)

A
  • scale of ownership
  • the quality of the engagement dialogue and method used
  • whether disinvestment is a possible sanction
83
Q

Stakeholder Engagement

A

Reflects active ownership by investors that seek to influence corporate decisions on ESG matters through a dialogue with corporate offices or voting at shareholder assemble.

84
Q

Impact Investing

A

Refers to investments made with the specific intent of generating positive, measurable social and environmental impact alongside a financial return (which differentiates it from philanthropy).

85
Q

Strategic Asset Allocation (SAA)

(2 Points)

A

Strategic asset allocation is an investment strategy premised on long-term asset allocation.

This strategy rebalances its portfolio only when the asset mix represents significant deviation from the original or targeted allocation mix.

86
Q

Environmental Factors to Report under ESG

(4 Points)

A
  1. Biodiversity
  2. Climate Change
  3. Pollution and Resources
  4. Water Security
87
Q

Social Factors to Report under ESG

(6 Points)

A
  1. Labor Standards
  2. Human Rights
  3. Community
  4. Health and Safety
  5. Pollution and Resources
  6. Customer Responsibility
88
Q

Governance Factors to Report under ESG

(4 Points)

A
  1. Anti-Corruption
  2. Corporate Governance
  3. Risk Management
  4. Tax Transparency
89
Q

Fiduciary Duty

(3 Points)

A

Fiduciary duty is a legal obligation requiring a person or entity (fiduciary) to act in the best interest of another party (beneficiary).

It involves prioritizing the beneficiary’s interests, exercising care, loyalty, and honesty.

Breach of fiduciary duty can lead to legal consequences for the fiduciary.

90
Q

2 Core Boundaries of Stockholm Resilience Centre’s Planetary Boundaries

(2 Points)

A
  • Climate Change
  • Biosphere Integrity
91
Q

Minimum Requirements for PRI Membership

(3 Points)

A
  1. Investment policy that covers the firm’s responsible investment approach, covering >50% of assets under management (AUM)
  2. Internal or external staff responsibility for implementing responsible investment policy
  3. Senior-level commitment and accountability mechanisms for responsible investment implementation
92
Q

Meta-Studies on ESG performance revealed that:

A

There was a positive correlation between ESG performance and corporate financial performance, including stock prices.

93
Q

Name the 4 areas that United Nations Global Compact (UNGC) covers

(4 Points)

A
  • Human Rights
  • Labor
  • Environment
  • Anti-Corruption

CFA ESG Investing (10 decks)

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