The ESG Market Flashcards
World commission on Environment and Development
WCED
the Brundtland Commission -
issued our common future
introduced the concept of sustainable development and described how it could be achieved
laid the foundation’s for the Rio de Janeiro Earth Summit (Rio summit/ UN Conference on Environment and development UNCED) - led to creation of UN Commission on Sustainable development in 1992
an international group of environmental experts, politicians and civil servants
proposing long-term solutions for bring about sustainable development
Rio Summit
- spelled out the role of business and industry in the sustainable development agenda
Rio declaration states that
businesses have a responsibility to ensure that activities within their own operations do not cause harm to the environment as businesses gain their legitimacy through meeting the needs of society.
Early phase of ESG investing
Social responsible investment SRI -
negative screening
1st ethical mutual funds - pioneer fund launched in 1928
begin with Vietnam War with the establishment of the Pax world Fund (IMPAX Asset Management)
Divestment movement （撤资）in protest at South Africa’s system or apartheid
The sullivan principles -
used by investors to engage and divest, required that a condition for investment for the invest company was to ensure that all employees regardless or race, are treated equally and in an integrated environment as a condition for investment.
this form of SRI - referred to as value-based or exclusionary, primarily considered ethical behavior.
Modern responsible investment
key developments between early and modern SRI - growth in shareholder activism
SRI utimately combines ESG factors into the traditional investing framework focused on ly on profit and risk-adjusted returns.
2002 Sarbanes - Oxley Act
regulation with an increasing emphasis on the importance of good corporate governance and in specific regulation
in 1/2004, UN global compact and International Finance Corporation (IFC) integrate ESG into capital markets
- report entitled Who Cares Wins, which effectively coined the term ‘ESG’.
- makes good business sense and leads to more sustainable markets and better outcomes for societies
UN Environment Program Finance Initiative (UNEP FI)
- fresh fields report
showed that ESG issuers are relevant for financial valuation and fiduciary duty
the two reports formed the backbone for the launch of the Principles for responsible investment (PRI) 2006
and launch of the sustainable stock exchange initiative (SSEI) 2007
The Stern Review on the Economics of Climate Change – the Stern report
climate change is the greatest and widest-ranging market failure ever seen, presenting a unique challenge for economics and that early action far outweighs the costs of not acting.
Without action, the overall costs of climate change would be equivalent to losing at least 5% of global GDP each year, now and forever.
ESG investing in numbers
negative screening is the largest strategy in Europe
ESG integration commands most assets in the USA, Canada, AU and NZ.
Corporate engagement and shareholder action constitute the predominant strategy in Japan.
asset classes in global ESG investing 2018
51% public equity 36% FI 7% other (cash on depository vehicles, commodities and infrastructure) 3% PE Hedge fund 3% real estate
main stakeholders
- asset owners
- pension funds
- insurance
- sovereign wealth funds, endowment funds and foundations
- individual (retail) investors and wealth management - asset managers
- fund promoters
- investment consultants and retail investment advisers
- investment platforms
- fund labellers - financial services
inv. banks, inv. research and advisory firms, stock exchanges, financial and ESG rating agencies - Policymakers and regulators
6 invetees
7 government
8 Civil society and academia
Asset owners set the tone for the inv. value chain.
Their understanding how ESG factors influence financial returns and how their capital impacts the real economy can significantly drive the amount and quality of ESG investing from the investment value chain
the effectiveness of asset owners in steering the investment value chain towards an increased integration of ESG depends on :
- the number of asset owners implementing responsible investment
- the total AUM of these asset
- the quality of implementation across the different asset classes
Challenges asset osnwer face
hesitancy on the part of consultants and retail financial advisors to integrate ESG investing into their offerings and/or assess the ESG characteristics of funds - leading to fewer options for the asset owners to choose from in the market.
- smaller asset owners who have limited resources to conduct their own ESG assessment of mangers and their funds.
Pension funds 59% of 100 largest asset owners
mgmt of pension savings and pay-outs to individuals
3 internal players:
1. executives, mgmt the fund’s day-to-day fundctioning
2. trustee, hold the ultimate fiduciary responsibility
act separately from the employer and hold the assets in the trust for the beneficiaries of the scheme
3. beneficiaries who pay into the fund or are pensioners benefitting from the assets
Long-termism and ESG
short-termism
- tend to ignore ESG factors
Shareholder Rights Directive (SRD) issued by EU in 9/2020, requiring investors to be active owners and to act with a more long-term focus
Insurance
are by nature sensitive to certain aspects of ESG due to factors impacting insurance products such as:
- frequency and strength of extreme weather events (p&c)
- demographic changes (life insurance)
Property and casualty
life
re-insurance - provides insurance to an insurer, sharing a portion of an insurer’s risk against payment of some premium
Sovereign wealth
wealth managed through a state-owned investment fund
- a sovereign wealth fund (SWF)
often mandated in line with mid-to-long-term objective of their state
- economic stabilization
- securing wealth for future generation
- strategic development of the state’s territory
- other objectives
foundations (legal form or organization LFO) and public charities
difference -
private foundation originate their capital through one funder (a family or a business
public charities originate their capital though publicly collected funds
retail investors are slower in adopting ESG
millennials are quite interested in ESG investing
1990 MSCI KLF 400 Social Index
- FIRST ESG Index
1999 DJ Sustainability index
- first global ESG Index
2001
FTSE 4good indexes
2004
Widerhill clean energy index
-first alternative energy
2013
Barclays MSCI ESG FI index
-first global series of ESG fixed income indexes
2016
ESG + Factors indexes, FTSE MSCI, SOLACTIVE
challenges faced by asset managers in integrating ESG:
- Lack of clear signals from asset owners that they are interested in ESG
- a very narrow interpretation of investment objectives on which consultants and advisers based their advice to owners
- resource challenges, especially for investors who see ESG investing as separate from the core investment process
fund promoter:
- investment consultants and retail financial advisers
- investment platforms
- fund labellers
PRI 2017 review concluded most consultants fail to consider ESG issues in investment practice
Further challenges emerge because consultants and financial advisers often base their advice on a narrow interpretation of investment objectives.
they can :
- aid trustees in understanding ether fiduciary obligations
- formulate a strategy inclusive of ESG
- draft inv. principles and policies in line with the strategy and fiduciary obligations
Inv. platforms can integrate the extend and depth which funds integrate ESG to:
- increase awareness of ESG funds to both retail and institutional investors
- enable easier identification of and information on these funds
fund labellers
provide bmk and quality guarantees for both practitioners and clients.
financial services
inv. banks custodial banks inv. research and advisory firms stock exchanges and financial and ESG rating agencies
financial regulators’ objectives are to:
- maintain orderly financial markets
- safeguard inv. in financial instruments, savings/pensions and inv. vehicles and
- bring about an orderly expansion of activities of the financial sector
policymakers are responding to the growing urgency of sustainability topics:
- the stability of the financial system (climate change, emerging issues such as biodiversity and resource scarcity)
- the risks to an individual investor’s portfolio
regulations involve 3 themes:
- corporate disclosure
encourage/require investee companies to disclose information on material ESG risks - Stewardship (closely linked to shareholder engagement)
governs the interactions b/w investors and investee companies and seeks to protect shareholders and beneficiaries as well as the health and stability of the market. - asset owners
focus on pension funds
increasing number of governments will recognize the importance of moving to stronger requirements, moving away from:
- comply or explain to comply and explain
- voluntary to mandatory
- policy to implementation and reporting
EU taxonomy regulation published on june 2020
address green bonds and low-carbon benchmarks
established a framework that states conditions for an economic activity to be considered environmentally sustainable, including:
- contribution substantially to at least one of the environmental objectives
- doing no significant harm to any of the other environmental objectives
- complying within minimum social and governance safeguards
6 objectives of Taxonomy regulation
- climate change mitigation
- climate change adaptation
- the sustainable use and protection of water and marine resources
- the transition to a circular economy
- pollution prevention and control
- the protection and restoration of biodiversity and ecosystem
EU sustainable finance disclosure regulation SFDR
DEC 2019
created requirements to promote consideration of environmental and social risks that may affect investment.
aim to enhance transparency of sustainably invested products to prevent green washing
- identifies principal adverse indicators that have a negative impact on the environmental and social issues stemming from inv. decisions.
Task force on climate-related financial disclosures TCFD
released climate-related financial disclosure recommendations to help firms disclose info to support capital allocation.
- governance
- strategy
- risk mgmt
- metrics and targets
Investees
companies
projects
agencies and
jurisdictions
challenges limiting the development of ESG investing:
- availability of expertise and skilled individuals
- quality of data, research and analysis
- limited tools to assist with portfolio construction and management
higher risk of greenwashing to the industry
negative impact on the industry’s credibility
US DOL clarification of fiduciary duty welcomes by ESG investing industry because:
allowed plans to invest in generating societal benefits in addition to financial return, as long as they were deemed appropriate for the plan’s investment objectives, return and risk.
