Chapter 2: ESG Market Flashcards
Describe the history of sustainability?
- Bruntland Report published in 1987 introduced concept of sustainable development
- Rio 1992
- Sullivan Principles on Apartheid
Rank the ESG investment strategies from largest to smallest
1) Negative / Exclusionary screening
2) ESG integration
3) Corporate engagement and shareholder action
4) Norms-based screening (Ethical)
5) Best-in-class
6) Sustainability-themed
7) Impact
What is the most common ESG strategies around the world?
- Negative screening: Europe
- ESG integration: US, CA, AU and NZ
- Corporate engagement and shareholder action: Japan
What are asset owners?
○ Legal owner of asset
○ Make asset allocation decision based on own objectives + analysis
○ Can outsource asset management via investment mandate
- Pension funds, Insurance, Individual investors and banks
What are asset managers
- Not legal owner of the asset
- Fiduciary duty to client
- Make investment decisions pursuant to investment management agreement
What determines the EFFECTIVENESS of ASSET OWNER’s ability to steer investment towards ESG?
- NUMBER OF ASSET OWNERS implementing responsible investment
- TOTAL AUM
- QUALITY OF IMPLEMENTATION across scales
Who are the KEY STAKEHOLDERS for PENSION funds?
- EXECUTIVES : who manage the fund
- TRUSTEES: who hold ultimate fiduciary responsibility, similar to board of a company
- BENEFICIARIES/ members
BET
What can pension funds do to integrate long-termism?
- Integrate long-termism in their investment belief statement
- Set up investment mandate that places greater value on long-termism
- Demand long-term metrics from asset managers and underlying investees (assets)
What can asset managers do to work with ESG?
- Select securities and offer a portfolio of those to asset owners
- They influence ESG characteristics of the portfolio through selection, as well as engagement with investee companies
- Offer also new products indices and passive funds that integrate ESG
What are the principal tasks of policymakers?
- Maintain orderly financial markets
- Safeguard investments
- Orderly Expansion -> green bonds
What can policy makers do to promote ESG?
- Corporate disclosure
- Stewardship - Interactions between investors and investees, protect shareholders, stability of the market
- Asset owners - require pension funds to integrate ESG
What are the main challenges for ESG integration prior to integration?
- Perception that implementing ESG may have negative impact on financial performance
- Belief that fiduciary duty prevents ESG integration
- Bad advice from investment consultations and financial advisors; or hesitancy to recommend ESG investments
What are the main challenges for ESG integration once decision has been made?
- Lack of understanding to build an investment mandate that promotes ESG -> Model Mandate Initiative
- Perception that more resources are needed
- Gap between marketing, commitment and delivery of funds regarding ESG performance
–
- Lack of clear signals from asset owners that they are interested in ESG
- Narrow interpretation of invt objectives on which consultants and advisors base their advise to owners
- resources challenges (esp for investors who see ESG investing as separate from core investment process.. ie viewed as mktg or compliance task)
What are the main challenges for ESG integration in terms of technical resources?
- Data availability - Disclosure is challenging
- Modelling - Challenging to integrate ESG into traditional financial models, breakthrough changes, no historical patterns
- Valuation techniques - To adjust corporate valuations with e.g. ESG-based discount rate future cash flow, or valuation ratios (price-to-earnings or book value)
What is portfolio tilting and when is it used?
- Tilting means “overweighting” or “underweighting” sectors or companies in a portfolio
- Required in screening, divestment and thematic investment
What are key ESG market trends?
- From “comply or explain” (with investors challenges ESG) TO “comply and explain”
- From voluntary to mandatory
- From policy to implementation and reporting
Why is ESG investing a concern for investors that are cautious of tracking error?
Perception that exclusion resulting from ESG integration will distort weights of sectors and countries in the portfolio in comparison to benchmarking leading to tracking error
What are the impacts of short-termism and what is the name of an important report on the subject?
- Makes managers less interested in projects that have long-term benefits
- Risk to overlook ESG factors that have long-term impact
- Report by John Kay for UK gov supported myopic nature of short-termism
- Less R&D
EU Taxonomy
Impacts green bonds and low-carbon benchmarks
Issues with ‘Comply or Explain’?
Leads investors to challenging the assertion that ESG is a requirement
Issues with short-termism
- Disproportionate focus on quarterly returns
- ‘Patient’ capital less likely to develop
- Less investments into long-term assets, like ‘infrastructure’
How is fiduciary duty managed with respect to ESG investing?
Addressed in Freshfields Report
- Fiduciary duty applies to both FINANCIAL and NON-FINANCIAL objectives, including ethical preferences, when acting in pension beneficiaries interests
What is the ‘Who Cares Wins’ report about?
By UN Global Compact
- Report introduced the term ‘ESG’
- Encourages financial institutions to integrate ESG into capital markets
Why are investment mandates an important element of ESG investing?
They set the contracts that define requirements of an asset manager with regards to ESG
Which reports originated the PRI? (Principles for Responsible Investment)
Freshfields Report
+
Who Cares Wins
What are the sensitivities to ESG risk from the perspective of insurance companies?
Non-life (P&C):
- Climate Change
- Extreme Weather
Life
- Demographic changes
Who are the key stakeholders for Responsible Investing?
- Asset managers
- Asset owners
- Fund promoters
- Financial services
- Policy-makers and regulators
- Investees
- Government
- Civil society
- Academia
What are the roles and guidelines of asset managers?
- Act as agent on behalf of clients (asset owners)
- Not legal owners of assets under management
- Not the counterparty to transactions or derivatives
- Can manage assets via separate accounts and/or funds
- Make investment decisions pursuant to guidelines stated in investment management agreement (IMA) or fund constituent documents
- Required to act as a fiduciary to clients
How many ESG indices are there?
- Over 1000
about 1% of 3.7m total? need to validate
Which regions have highest implementation of ESG / RI
USA and Europe
Why should investors engage with policymakers
Consideration of ESG matters can contribute to proper functioning of financial markets
What was the Bruntland Report about?
Created by UN General Assembly in 1987
- Also called ‘Our Common Future’
- Introduced the concept of Sustainable Development
