ESG Ch. 1 INTRO Flashcards
ESG investing is an approach to managing assets where investors explicitly acknowledge the relevance of ..
(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.
Name Enviromental Factors
These are the factors pertaining to the natural world. These include the use of, and interaction with, renewable and non-renewable resources (e.g. water, minerals, ecosystems and biodiversity). ie Climate change, water, pollution
What are Social Factor
These are the factors that affect the lives of humans. The category includes the management of human resources, local communities and clients. ie human rights, slavery, work conditions
What are Gov. Factors
These are the factors that involve issues inherent to the business model or common practice in an industry, as well as the interest of broader stakeholder groups. ie corruption, pay, baoard diversity
What is CSR
The concept of ESG investing is closely related to the concept of investees’ corporate sustainability. Related
to this, corporate social responsibility (CSR) is a broad business concept that describes a company’s
commitment to conducting its business in an ethical way
CSR led to the theory of
triple-bottom line
accounting - three Ps (People, Planet, Profit)
Effective management of the company’s sustainability can:
▶ reaffirm 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.
Responsible investment is a strategy and practice
to incorporate environmental, social and governance (ESG)
factors into investment decisions and active ownership. It considers both how ESG might influence the riskadjusted
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.
Socially responsible investment (SRI) refers to
approaches that apply social and environmental criteria in evaluating companies.
SRI generally score companies using a chosen set of criteria, usually in conjunction with sector-specific weightings - can be used in combination with best-in-class investment, thematic funds, high-conviction funds or quantitative investment strategies.
Best-in-class investment involves selecting only
the companies that overcome a defined ranking hurdle, established using ESG criteria within each sector or industry. 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
Sustainable investment refers to the selection
assets that contribute in some way to a sustainable economy, i.e. an asset that minimises natural and social resource depletion - could also mean a strategy that screens out activities
Thematic investment refers to selecting companies
fall under a sustainability-related theme, such as
clean-tech, sustainable agriculture, healthcare or climate change mitigation - not all thematic are considered RI (dependant on ESG characterisitics)
Green investment refers to allocating capital to assets that mitigate
▶ climate change;
▶ biodiversity loss;
▶ resource inefficiency; and
▶ other environmental challenges.
Social investment refers to allocating capital to
assets that address social challenges. These can be products that address the bottom of the pyramid (BOP - thiers of social wealth) - could include immpact bonds
Impact investing refers to investments made with the specific intent
of generating positive, measurable social and environmental impact alongside a financial return (coulld be below, at or above market returns) could be in EM or DM
Ethical/value-driven and faith-based investment
refers to investing in line with certain
principles, usually using negative screening to avoid investing in companies whose products and services are deemed morally objectionable by the investor
Shareholder engagement reflects
active ownership by investors in which the investor seeks to influence a corporation’s decisions on matters of ESG, either through dialogue with corporate officers or votes at ashareholder assembly
Shareholder engagement efficacy usually depends on
▶ the scale of ownership (of the individual investor or the collective initiative);
▶ the quality of the engagement dialogue and method used; and
▶ whether divestment is known to be a possible sanction.
One of the main reasons for ESG integration is recognising that ESG investing
is Finacialy material - it 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 therefore lead to
A. reduced cost and increased efficiency;
B. reduced risk of fines;
C. reduced externalities; and
D. improved adaptability to sustainability megatrends.
A. Efficiency and productivity
Research conducted by McKinsey found that resource efficiency can affect operating profits by
as much as 60%, and that more broadly, resource efficiency of companies across various sectors is
significantly correlated with the companies’ financial performance.
Another study showed that companies experience an average internal rate of return of 27% to 80% on their low-carbon investments.
attract and retain quality employees, and enhance
employee motivation and productivity overall. Employee satisfaction is positively correlated with
shareholder returns. ( 2.3 to 3.8%pa over peers over 25yrs)
Look at case studies
DOW Chamical/GE/Walmart/Nike
B. Reduced risk of fines and state intervention
typically, one-third of corporate profits are at risk
from state intervention (not only fines).
Big Pharma lowest at 25-30%, Banks and Auto the highest at 50-60%
C. Reduced negative externalities
situations where the production or consumption of goods and services creates costs or benefits to others that are not reflected in the prices charged for them (ie pollution) - private cost are lower than societal costs and is the main reason gov’t intervene
Three ways negative externalities can be managed
▶ market-based instruments, e.g. charges, taxes and tradable permits;
▶ regulatory instruments, e.g. vehicle emission and safety standards, traffic restrictions; or
▶ voluntary instruments, e.g. agreements with the car industry to reduce CO2 emissions from new passenger cars.
D. Sustainability megatrends
recognising the economic implications of:
▶ 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).
These factors have interacted with: ▶ the aftermath of the financial crisis; ▶ ageing populations; ▶ the rise of emerging countries; and ▶ rapid technological changes.
the 4 Mega Trends
Emerging and urban - nearly half of the world’s large companies are expected to be headquartered in emerging markets by 2025. With Majority of GDP coming from EM
Technological disruption - Accelerated adoption invites accelerated innovation - estimates that one-third of jobs will soon be replaced by smart machines
and robots and Google estimates robots will attain the level of the intelligence of human by 2029
Demographic changes and wealth inequality - Today, about 60% of the world’s population lives in countries with fertility rates below the replacement rate. A smaller
workforce will place a greater onus on productivity for driving growth and may cause economists to rethink the
economy’s potential (support aging population, demand on resources and food)
Climate change and resource scarcity - The
interconnectivity between trends in climate change and resource scarcity is amplifying the impact: climate
change could reduce agricultural productivity by up to a third across large parts of Africa - Globally, demand for water will increase by 40% and for energy by 50%. In short, the world’s current economic
model is pushing beyond the limits of the planet’s ability to cope.
SHORT-TERM RISK OUTLOOK
Ecosystem destruction, heatwaves, geo political, cyber attacks all expected to increase
There is a growing recognition in the financial industry and in academia that ESG factors
influence financial performance.
Meta analysis - there was a positive correlation
between ESG performance and corporate financial performance, including stock prices
Fiduciary duty
(PRI) on the topic have clarified that financially material ESG factors must be incorporated into investment decision-making.
argue that failing to consider long-term investment value drivers – which include ESG issues – in investment practice is a failure of fiduciary duty
Economics
recognition that negative megatrends will, over time,
create drag on economic prosperity as basic inputs (such as water, energy and land) become increasingly
scarce and expensive, and the prevalence of health and income inequalities increase instability both within
countries and between
Impact and ethics
positive impact see investment as a means of tackling the world’s social and environmental problems through effective deployment of capital
avoiding negative impact, at times for religious reasons, usually do not invest (negative screening
Client demand
calling for greater transparency about how and where their money is invested.
This is driven by:
▶ 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.
Asset owners are instrumental representing on average around 34% of GDP in OECD countries
Regulation
Regulatory change has also been driven by a realisation among national and international regulators that the financial sector can play an important role in
meeting global challenges, such as climate change, modern slavery and tax avoidance.
Acceleration of policy since 08
Three ways of putting PUTTING ESG INTO PRACTICE
A. incorporating ESG factors into investment decision-making;
B. through corporate engagement; and
C. through policy engagement.
Investment decisions
Asset owners can include ESG factors in their request for proposal and consider them in their appointment
Asset owners and some asset managers can embed ESG into strategic asset allocation (SAA)
Asset managers and asset owners who invest directly can incorporate ESG issues within their security selection
process. (filter threshold, include ESG in risk analysis, use ESG criteria to identify investment op)
Shareholder engagement
Investors can encourage investees to improve their ESG practices. This can happen via a company’s annual
general meeting (AGM) - Engagement can
also happen outside of this process
Policy engagement as insto investor
Policy engagement by institutional investors
is therefore a natural extension of an investor’s responsibilities and fiduciary duties to the interests of beneficiaries.
Investors can work with regulators
▶ is more sound and stable;
▶ levels the playing field; and
▶ brings ESG more effectively into financial decision-making.
Investors can:
▶ respond to policy consultations;
▶ participate in collective initiatives; and
▶ make recommendations to policy makers.
What are the three United Nations (UN) initiatives
United Nations Global Compact
United Nations Environment Programme Finance Initiative
United Nations Framework Convention on Climate Change
(UNFCCC)
UN Sustainable Development Goals (SDGs)
United Nations Global Compact (UNGC) was launched in 2000
as a collaboration between leading companies and the UN.
These signatories agree to adhere to the ten principles, derived from broader global
standards such as the Universal Declaration of Human Rights and the International Labour Organization’s
Declaration on Fundamental Principles and Rights at Work.
United Nations Environment Programme Finance Initiative (UNEP FI) is a partnership between UNEP and
the global financial sector to mobilise private sector finance for sustainable development.
UNEP FI started in 1992 with a few banking institutions and today it works with over 300 members
United Nations Environment Programme Finance Initiative (UNEP FI) created three priciple bodies
▶ Principles for Responsible Investment (PRI), established in 2006
Principles for Sustainable Insurance (PSI), established in 2012
Principles for Responsible Banking (PRB) launched with more than 130 banks in 2019
The PRI provide support in four main areas:
The PRI provides a broad range of tools and reports on best practices
It hosts a collaborative engagement platform
The PRI reviews, analyses and responds to responsible investment-related policies and consultations
The PRI Academy develops, aggregates and disseminates academic studies on responsible investment-related
themes.
What are the PRI’s 6 princi
- We will incorporate ESG issues into decision-making processes.
- We will be active owners and incorporate ESG issues into our ownership .
- We will seek appropriate disclosure
- We will promote acceptance and implementation
- We will work together to enhance our effectiveness
- We will each report on our activities
The three requirements for membership to PRI
- Investment policy that covers the firm’s responsible investment approach, covering >50% of assets under
management (AUM). - Internal or external staff is responsible for implementing responsible investment policy.
- Senior-level commitment and accountability mechanisms for responsible investment implementation.
The The United Nations
Framework Convention on Climate Change (UNFCCC), launchedUnited Nations
Framework Convention on Climate Change (UNFCCC), launched…
Rio de Janeiro Earth Summit in 1992,
aims to stabilise greenhouse gas (GHG) emissions to limit man-made climate change.
annual Conferences of the Parties (COP) meetings, which seek to advance members states’
voluntary agreements on limiting climate change. two of importance are
- The 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. - The 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.
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 International Corporate Governance Network (ICGN)
investor-led organisation established in 1995 to
promote effective standards of corporate governance and investor stewardship to advance efficient markets
The Global Sustainable Investment Alliance
(GSIA) is an
international collaboration of these membership-based (country level) sustainable investment organisations
Core members of the GSIA includes representatives from the regional responsible investment
Europe, the USA, Canada, Japan, Australia and New Zealand.
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 - Governance, Risk management, strategy and metric targeting
Global Impact Investing Network (GIIN) focuses on reducing barriers to impact investment by building
critical infrastructure and developing activities, education and research that help accelerate adoption it…
▶ facilitates knowledge exchange;
▶ highlights innovative investment approaches;
▶ builds the evidence base for impact investing; and
▶ produces tools and resources.
Name the 6 reporting initiatives
Global Reporting Initiative (GRI) - provide guidance on disclosure across ESG
Integrated Reporting Framework (IRF) - put forward by the International Integrated Reporting Council
(IIRC), encourages companies to integrate sustainability within their strategy and risk assessment by integrating it into the traditional annual report.
CDP (former Carbon Disclosure Project) - non gov org to disclose and manage their environmental impact.
Climate Disclosure Standards Board (CDSB) - mission to create the enabling conditions for material climate change and natural capital information to be integrated into mainstream reporting.
Corporate Reporting Dialogue (CRD) - joint project with CDBS, GRI, IIRC, SASB to drive better alignment of sustainability
reporting frameworks
Sustainability Accounting Standards Board (SASB) - issues standards that are focused on the key material
sustainability issues
