Investors switch focus to environmental, social and governance factors

“Green” is a generic term for environmental, social and governance (ESG) finance and investments, but the last two aspects are often overlooked in the rush to address climate change. But the community is now looking at numerous ways to deal with both the S and G factors too.

While non-financial reporting requirements are still a way off for most organisations, those that deal with large corporates or need capital are going to have to quickly address all ESG issues in order to be successful.

About 70 per cent of the world’s wealth, more than $100 trillion, is managed by organisations that have signed up to the UN’s Principles of Responsible Investment. Of the almost 4,000 signatories, nearly a third have signed up since the start of 2020, so it has now reached a critical mass.

"If you want to sell your business or raise capital, ignoring ESG may result in these UN PRI signatories ignoring you. So while mandatory non-financial reporting may not be immediately applicable to smaller entities, if you want access to funds and to work with larger organisations, you will be driven to embrace ESG issues," says Liam McKenna, partner at Mazars.

The pandemic has played a part in the swift move towards acknowledging the S and G, as it showed the inequalities between nations, and investors are asking whether their pensions should be invested in funds that take into account not just environmental issues but also social ones.

“They are investing for 30-40 years and they want to feel good about those investments and to know that they aren’t doing any harm,” says Richard Kelly, head of client business at LGIM. They are seeing a big focus on ethnic and diversity issues, for example Black Lives Matter, which started in the US but is now across Europe and the UK, and these are concerns that really matter to investors.

“Unsustainable global societal inequality poses a serious risk to the future stability of the world and needs to be given as much attention as we give the climate emergency. Frameworks for ESG all incorporate equality, for example the 17 UN Sustainability Development Goals include individual goals for gender equality and reducing inequality, which specifically mentions inequality based on gender, sexuality and disability,” says McKenna.

Social targets

While the UN SDG is the most recognised, other common frameworks also reference the social targets to protect the vulnerable in society.

“Our own Mazars ESG Health Check incorporates the requirements of the UN Global Compact Ten Principles, the UN SDGs, the IFC Performance Standards, the UN Guiding Principles on Business and Human Rights and the International Labour Organisation’s core labour standards,” he adds.

A current ESG challenge globally is finding a common language – particularly when it comes to the S and the G.

There are so many new acronyms, reporting requirements, frameworks and methodologies – and the jigsaw does not yet fit neatly together, according to Mary Whitelaw, director of corporate affairs, strategy and sustainability at AIB.

“This makes comparability difficult not just for investors but for all stakeholders. Global convergence will be a big enabler, and in AIB we have committed to align our reporting to Stakeholder Capitalism Metrics – a set of environmental, social and governance (ESG) metrics and disclosures released by the World Economic Forum and its International Business Council in September 2020. We are the first Irish company to commit to doing this,” she says.

The reason behind the investment community focusing primarily on environmental factors up until now is that they are easier to calculate and address, via environmentally focused and renewable energy investments, says Ian Halstead, associate director L&P Investment Services.

“Social and governance factors are harder to address. On social factors, investors tend to look at areas of social justice, such as compliance with international labour standards and the UN Convention on Human Rights. On governance, investors typically look to vote at company agms in accordance with their views and avoid companies with a history of bribery and corruption,” he says.

Labour standards

A fund should have specific S and G goals within the fund documentation, such as adherence to international labour standards for social, and company agm voting processes for particular issues around governance, he adds.

“Depending on the fund’s objectives, investors can target more specific social and governance areas, including policies on corporate behaviour, remuneration practices and gender board diversity,” he says.

Social issues close to home are also attracting a lot of attention.

“We are seeing huge interest in our planned social housing fund, which aims to provide 1,000 homes for social housing in its first three years and addresses a critical social need facing Ireland. On a more global level, we are seeing huge interest in our carbon credit investment, which partners with an Irish charity to address both environmental and social needs in the developing world. This has benefited 130,000 people in sub-Saharan Africa, as well as generating huge environmental benefits,” he says.

While the motivations of individual investors are difficult to know, it is clear that investments in entities that do not address ESG concerns comes with additional risk.

“Risk that they won’t have the same access to capital, risk they will pay higher insurance premiums, risk that large customers will demand changes or stop contracting with them and risk that they will be unprepared for the inevitable compliance change. It is clear that the world will be fed, powered and resourced differently in the future. You don’t need to be motivated by altruism to invest in organisations that are embracing ESG issues. It makes business sense,” McKenna concludes.