Introduction to ESG Flashcards
What is ESG Investing?
- Approach to manage assets
- Considering and pricing environmental, social and governance (ESG) factors in investment decisions
- Along with own role as owner and creditors
- Long-term return of investment portfolio in mind
Environmental Factors
• Factors pertaining to the natural world
• The use of and interaction with renewable and non-renewable resources
• Such as water, minerals, ecosystems, and biodiversity
• Examples:
o Climate change
o Resource depletion
o Waste
Corporate social responsibility (CSR)
• Broad concept describing company’s approach to ethical business
• 20th century: philanthropic – now around behaviour can play role in business model
• Strategy changes led to triple bottom line (three P’s)
o People
o Planet
o Profit
Responsible investment
• Strategy to incorporate ESG factors into investments and active ownership
• Considers how ESG impacts:
o Risk adjusted returns
o Stability of an economy
o Engagement with assets impact society and environment
Socially responsible investment (SRI)
• Approaches that apply social and environmental criteria in evaluating companies
• Score companies:
o Chosen set of criteria
o Sector specific weightings
• Hurdle set for qualification based on full universe or sector
• First screen for ESG companies, used with:
o Best-in-class investment
o Thematic funds
o High-conviction funds
o Quantitative strategies
Best-in-class investment
• Score companies and overcome hurdle:
o Chosen set of criteria
o Sector specific weightings
• All-sector approach means good for maintaining a characteristic in an index
• (?) 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
Sustainable investment
• Select assets that contribute to sustainable economy
• Can be used for consideration of
o ESG issues
o Best-in-class issues
o ESG integration – securities risk and return profile
• Used to describe those that benefit macro-trends
• Can also screen out certain activities such as coal mining
Thematic investment
• Selecting companies related to sustainability related theme
• Clean-tech, sustainable agriculture, healthcare, climate change
• Fund picks companies in various sectors related to theme
• Not all thematic funds are responsible investments as must
o Be related to theme (and)
o Have ESG characteristics
• A smart city fund invests in
o EVs
o Public transport
o Renewable energy
o Green buildings
Green investment
• Capital for assets that mitigate environmental challenges o Climate change o Biodiversity • Examples include o Low-carbon generation o Pollution control o Recycling and waste management o Process innovations • Considered sub-category of thematic or impact • Example: green bonds
Social investment
• Capital for assets that address social challenges
• Can be BOP
o BOP: Bottom of the Pyramid
o Refers to the poorest two-thirds (4 billion people)
o Alleviate poverty while providing growth for businesses serving these communities
• Examples
o Micro-finance
o Basic telecommunications
o Energy access
• Example: social impact bonds – public sector contract – better social outcomes – passes saving to investor
Impact investment
• Specific intent of generation social and environmental impact alongside financial return
• Usually direct investments:
o Private debt
o Private equity
o Real estate
• Range of returns – below-market to market - The Global Impact Investing Network (GIIN) estimates the size of the global impact investing market to be US$502 billion (£393bn); its 2019 annual survey indicated that 66% of investors in impact investing pursue competitive, market-rate returns.
• Invests in companies that
o Offer basic services
o Provide availability of low carbon energy
• Measurement and tracking usually at heart of investment
Ethical/value-driven and faith-based investment
• Usually negative screening avoiding morally objectionable investments ‘sin stocks’ by
o Religion
o International declarations
o Conventions
• Typically include: tobacco, alcohol, pornography, weapons, breaches in Universal declaration of Human Rights
• Catholic ‘sin stocks’
o Facilitate abortion, contraceptives, weapons
• Shariah
o Firms that profit from alcohol, pornography, or gambling
o Carry heavy debt loans and pay interest
o Own investments that pay interest
o Invest in pork-related businesses
Why Integrate ESG?
• Reduce risk and enhance returns – forward-looking insights into the investment process
• Leads to
o Reduced cost and increased efficiency
o Reduced risk of fines
o Reduced externalities
o Improved adaptability to sustainability megatrends
Sustainability megatrends
i. Emerging and urban
- Economic activity in emerging markets – industrial and urban revolutions simultaneously
- 97 % of Fortune Global 500 in developed – will be half by 2025
- Half of GDP between 2010 and 2025 – 440 cities in emerging markets
- Impact: supply chains, workforces, local communities
ii. Technological disruption
- Accelerated adoption of technology leading to accelerated innovation
- Social media becoming new social fabric
- AI – perform tasks that would usually require human intelligence
- Health industry – track patients’ data and medication
- One-third of jobs can be replaced by smart machines
iii. Demographic changes and wealth inequality
- 2030 – world’s population is set to increase by 1 bn
- Increased elderly population – China labour force peaked in 2012
- Rethink economy potential – need for caring for elderly
- Increased population – 35 % more food by 2030, increased energy use
- Concentration of wealth increasing social strains
iv. Climate change and resource scarcity
• Average temperature increase more than 2 C – irreversible environmental damage
• Reduced water availability in Africa
• Agricultural sector:
o Alter growing conditions and seasons
o Increased pest and disease
o Decrease crop yields
• Challenging to predict future disruption – unpriced and could be internalised such as commodity price
• Pacific Gas and Electric Company (PG&E), a listed American utility, was driven to bankruptcy proceedings due to wildfire liabilities. The company’s equipment led to more than 1,500 fires between 2014 and 2017.
Putting ESG into practice
Three ways
o Incorporating ESG factors into investment decisions
o Corporate engagement
o Policy engagement
i. Investment decisions
• Support from investment consultants – factor in ESG policy, implementation and outcomes into selection process
• Use investment mandates and monitoring processes
• Embed ESG to strategic asset allocation (SAA) – SAA is the process an investor uses to allocate capital across asset classes based on return, income and risk appetite
• In security selection
o Apply filter or threshold
o Integrating ESG with financial or risk analysis
o Using ESG criteria for thematic approach
ii. Shareholder engagement
- In AGM by formally expressing view via voting
- With investment firm, individually or collective discussion
iii. Policy engagement
• Work with regulators to design system that is o More stable o Levels playing field o Brings ESG to financial decision making • Investors can o Respond to policy consultations o Collective initiatives o Recommend to policy makers
United Nations Global Compact (UNGC)
• Launched in 2000 as collaboration between companies and UN
• 8,000 corporate signatories – largest corporate sustainability initiative
• Adhere to 10 principles from:
o Universal Declaration of Human Rights
o International Labour Organisation Declaration on Fundamental Principles and Rights at Work
• Provided investors with set of principles to assess and engage companies
• Directly aided to companies increasing sustainability
United Nations Environmental Programme Finance Initiative (UNEP FI)
• Launched in 1992 as a partnership between UNEP and finance sector
• 300 members – banks, insurers and investors
• Goal: integration of sustainability into financial market practice
• Frameworks established or co-created:
o Principles for Responsible Investment (PRI)
o Principles for Sustainable Insurance (PSI)
o Principles for Responsible Banking (PRB)
Principles for Responsible Investment (PRI)
• Established in 2006 by UNEP FI and UNGC
• ½ of institutional investors apply (USD 83 tn)
• Goal: understand implications of ESG to investment and ownership decisions
• Support in four main areas:
o Tools and reports for best practices, supporting implementation across asset classes and providing insights into ESG issues
o Collaborative engagement platform
o Reviews, analyses and responds to investment related consultation
o PRI Academy – develops and distributes academic studies for responsible investments
• Six voluntary principles
o Incorporate ESG issues into investment analysis
o Active owners and incorporate ESG into ownership policies
o Seek appropriate disclosure on ESG issues
o Promote acceptance of principles in investment industry
o Work together to enhance effectiveness of principles
o Report activities and progress of implementation
• Establishes partnerships with other organisations – Sustainable Stock Exchange – members not required to report annually – PRI assesses investor practices
• Minimum requirements:
o Investment policy covers >50 % of AUM
o Internal or external staff for implementing responsible investment policy
o Senior-level commitment and accountability mechanisms
• In 2019, PRI asset owner signatories numbered 432 and managed aggregate assets of over US$20tn (£16tn); total number of signatories was 2,372 with assets circa US$86tn (£67tn).
United Nations Framework Convention on Climate Change (UNFCC)
• Launched 1992
• Goal: Stabilise greenhouse gas (GHG) emissions to limit man-made climate change
• Hosts Conference of the Parties (COP) meetings – advance member states voluntary agreements to limit climate change
• Two COPs of most importance:
o COP3: 1997: Kyoto Protocol
Industrialised counties to limit and reduce GHG emissions
In accordance with individual targets
o COP21: 2015: Paris Agreement
Developing and emerging economies
Keep global temperature rise below 2 C on pre-industrial levels
Led to various investor-led initiatives to understand alignment
United Nations Sustainable Development Goals (SDGs)
• Launched 2015 • Agreed by all UN members as replacement of UN Millennial Goals • Aim: at governments around inequality, poverty, climate change, environmental degradation • Become framework for investors and business – around reporting • The 17 SDGs o No poverty o Zero hunger o Good health and well-being o Quality education o Gender equality o Clean water and sanitation o Affordable and clean energy o Decent work and economic growth o Industry, innovation and infrastructure o Reduced inequalities o Sustainable cities and communities o Responsible consumption and production o Climate action o Life below water o Life on land o Peace, justice and strong institutions o Partnerships for the goals
International Corporate Governance Network (ICGN)
• Launched in 1995 • Aim: promote effective standards off corporate governance and investor stewardship to advance efficient markets • Two guidance documents: o Stewardship o Investment mandates
Global Sustainable Investment Alliance (GSIA)
- Aim: International collaboration of sustainable investment organisations, acts as a forum for advancing ESG
- Members: Europe, USA, Canada, Japan, Australia and New Zealand
- Uses regional and national reports
Task Force on Climate-related Financial disclosures (TCFD)
• Aim: Operationalise the 2 C Paris Agreement target in the business world
• Urges companies to disclose:
o Governance: around climate-related risks and opportunities
o Strategy: impacts of climate-related of risks and opportunities on organisations businesses, strategy and financial planning
o Risk management: process used to identify, assess and manage climate risks
o Metrics and targets: used to assess and manage climate related risks and opportunities
• Recommends:
o Provide as part of mainstream filings
o Put climate change as board issues
o Transparency and realistic scenario planning
Global Impact Investing Network (GIIN)
• Aim: reducing barriers to impact investment by building critical infrastructure and developing education and activities to accelerate development of impact investment
• Mode of operation:
o Facilitates knowledge exchange
o Highlights innovative investment approaches
o Builds the evidence base for impact investing
o Produces tools and resources
• Databases of note:
o IRIS+
o ImpactBase
Global Reporting Initiative (GRI)
• Publishes GRI standards – provide guidance on disclosure • Used by UNGC • Includes: o Coverage of sustainability activity o Further prose to aid contextualisation
Integrated Reporting Framework (IRF)
- Put forward by International Integrated Reporting Council (IIRC)
- Aim: encourage companies to integrate sustainability in strategy and risk assessment by putting in annual report
- Easier for investors to review – more likely part of investment decisions
Climate Disclosure Project (CDP)
- NGO with 10,000 companies, cities, states and regions reporting risks and opportunities of climate change, water security and deforestation
- Aim: supports companies, financial institutions and cities to disclose and manage environmental footprint
Climate Disclosure Standards Board (CDSB)
- Consortium of NGOs (business and environmental)
* Aim: conditions for climate change and natural capital information reported into mainstream reporting
Corporate Reporting Dialogue (CRD)
• Joint project: o CDP o CDSB o GRI o IIRC o SASB • Aim: alignment of sustainability reporting frameworks • Better Alignment Project: o Align corporate reporting landscape o Easier for effective and coherent disclosures
Sustainability Accounting Standards Board (SASB)
- Standards that are focused on key material sustainability issues
- 70+ industry categories
- Materiality maps: what is material for reporting and standardised benchmarking
