ESG Rising!
ESG trends are gaining popularity, and Covid-19 seems to be accelerating this shift. And with quite a momentum boost, it looks like ESG is all set to be the new normal.
The ongoing pandemic is accelerating a lot of shifts in the world — digitisation and WFH trends are some of them. Another theme that’s been gaining popularity in recent times is ESG — Environmental, Social and Governance. While talks of sustainable investing and ESG-related products have been doing rounds over the past few years, this pandemic will accelerate the same in the medium-to-long term, though there may be a slight disruption in the short-term. A lot of people will think of environmental factors when they hear the term ESG, but it encompasses a whole lot more. Social issues include a company’s talent management, diversity, its relationship with customers and the community. Governance norms cover shareholder rights, board structure, audits, leadership and executive pay.
There is a sense among people to actively contribute to the betterment of planet Earth and the society. We’ve realised the need for collaboration and sticking together (figuratively of course, got to maintain social distancing) in times of chaos, and also the importance of contributing to a more sustainable and equitable society. Recent events have increased focus on ESG, especially the ‘S’ part. With rising awareness and widespread acknowledgement of the detrimental effects of climate change, rampant gender and racial discrimination among other social issues, people will start looking more deeply into their purchases and investments. In addition to the increasing levels of social and green consciousness, there is the real fact that clean tech will be the future. There’s only so much fossil fuels that we can tap into, and given the recent oil price scare, a lot of companies are trying to diversify their product suite and banks are looking to reduce their exposure to the fossil fuel industry. Thus an understanding of ESG becomes quite important. We can analyse the ESG environment from multiple vantage points by looking at the various stakeholders in the situation.
Companies and Financial Institutions
Companies and financial institutions can navigate the ESG path via a two-pronged approach: increasing ESG compatibility and offering ESG-related products
Increasing ESG compatibility
One of the important focus areas is ESG reporting. Companies and financial institutions must provide data on where they stand with respect to different ESG criteria and what they plan on doing in order to improve their position. By doing so, companies stand to benefit from an image boost, as such reporting reaffirms their commitment to ESG. It would consequently enhance their appeal to the increasingly ESG-conscious customer base, especially among the millennials.
Establishing firm targets and reporting their progress is something a lot of firms are already doing. Reducing GHG emissions, sourcing 100% renewable electricity, becoming a net zero firm, improving diversity in managerial posts, enhancing employee work satisfaction are some goals companies can work towards. Measurable and ambitious targets will serve as a guide map to achieving green and sustainable goals. Fossil fuel industries meanwhile will have to focus on minimal collateral damage to the environment while sourcing and manufacturing their products and ensure healthy work environments for their employees.
Multiple financial institutions have announced restrictions on financing energy sensitive sectors like fracking, oil sands and projects in ecologically endangered locations. Goldman Sachs recently announced that it shall not take a US or European firm public if it has an all-white and all-male board.
Once firms establish targets and restrictions, they must report on it diligently. There are numerous standards and frameworks for ESG reporting. The Taskforce on Climate-related Financial Disclosures (TCFD) and UN Principles for Responsible Investing (UNPRI) are two major frameworks that financial institutions can adopt. Industry agnostic frameworks include Global Reporting Initiative (GRI) and reporting along Sustainable Development Goals (SDGs). While many institutions do devote sections within their annual reports to ESG-related content, there is a growing number of firms putting out separate annual ESG reports, thus cementing their commitment to ESG.
Offering ESG compatible products
There is immense opportunity to tap into the ESG-related products space for companies of multiple industries. Demand for such products is steadily increasing, and companies can secure an early-mover advantage via innovative products and efficient services.
Electric vehicles, renewable energy installations, sustainable fashion, plastic alternatives, organically sourced food are some of the avenues that are quickly gaining ground today. Giving back some of the proceeds to needy communities, charities and environmental organisations are some additional opportunities that firms may look into. Banks and financial institutions can retool their product offerings to incorporate ESG-based asset and wealth management services, ESG mutual funds, sustainability-linked loans, sustainable financing, green advisory, carbon credit trading and green trading. According to market tracker Pensions and Investments, ESG mutual funds globally had net inflows of $2.7bn in the first quarter of this year despite the broader equity mutual fund market witnessing new outflows of $5.7bn, clearly depicting the resilience of ESG products.
Green and sustainable firms can leverage their ‘ESG-ness’ for marketing and branding purposes as well, resulting in other firms wanting to follow suit.
Customers and Investors
Customers have a responsibility in this regard, and must make themselves aware of what they’re purchasing and how items are sourced. Getting to know the offering company’s policies a bit, supporting companies showing a good diversity track record and ESG compliance, pivoting to green products are some of the things which will help in shifting the demand and thus further incentivising companies to offer ESG compliant products.
According to a Responsible Investor survey, 64% of the respondents feel that Covid-19 is their tipping point for ESG investments. Investors can focus on making their portfolios ESG compliant as ESG and sustainable investing seeks to become the new normal.
ESG Data Providers
One of the biggest challenges when it comes to analysing ESG compatibility of companies and investments is the availability of data. It is not an easy task to quantify and assess the ESG compatibility of a firm as data isn’t readily available and standardised metrics aren’t mainstream yet. Thus the spotlight falls on ESG data and index providers like MSCI, Sustainalytics, Bloomberg ESG, TruValue Labs, GRESB and Owl Analytics. These are entities who analyse and gather data about thousands of companies, assimilate them and measure ESG compatibility via multiple metrics. GHG emissions, biodiversity impacts, customer welfare, HR, employee treatment, business ethics, transparency of payments, competitive behaviour etc. are some of the items that these firms usually cover. A number of them also benchmark different companies based on these metrics, offer ESG investing strategies and help in portfolio monitoring. These players leverage AI to develop actionable insights, aiding banks and investors on their ESG journey. With the market for ESG data set to potentially reach $1bn by 2021 with an annual growth of 20%, ESG data providers play an important role in showcasing ESG behaviour of market participants.
Governments and Policy Makers
Of course, the bedrock of any good ecosystem is a policy framework that balances flexibility and prudence. The policy environment should become robust in order to ensure an equitable and sustainable planet. Multiple countries are directing their focus towards ESG. Governments must implement efficient country-wide regulations on data protection, environmental protection, sustainability and corporate governance frameworks and support feasible bloc-wide and international agreements and treaties. Incentivization of ESG compliance and plans to shift away from unsustainable practices must be some focus areas.
In November 2019, the Monetary Authority of Singapore laid out plans to invest $2bn to develop the country as a green finance hub. The country’s 2020 budget also prioritizes the spread of ESG principles and practices across various economic sectors.
The EU Emissions Trading System (ETS), which operates in all EU countries, Iceland, Liechtenstein and Norway limits emissions from over 11,000 heavy energy-using installations and airlines operating between these countries. It also covers ~45% of the EU’s GHG emissions. The ETS follows a ‘cap and trade’ system.
Let’s take a detour and look at what we do when we want to stop inflow of a product into the country. Broadly, we have two options — tariffs and quotas. The idea is to either spike up tariffs, thus disincentivizing exporters from sending in further goods or we directly impose an upper limit on the number of goods they can send in. A similar framework can be adopted with respect to ESG principles as well. Take the pressing issue of rising GHG and CO2 levels in the atmosphere. We want companies to reduce emitting carbon. We can either tax companies based on their carbon emissions or impose a quota on the amount of carbon they can emit. Carbon credits are an example of the latter.
A carbon credit is a permit or certificate that allows the owner to emit one ton of CO2 (or an equivalent amount of another GHG). And this isn’t a static allotment, but is tradable. A company P can sell its excess carbon credits on the market. If company Q needs to provision for a greater amount of emissions, it can purchase carbon credits on the market. Overall, it creates an entirely new green market while maintaining an overall amount of carbon emissions overall. This is the EU ETS’ ‘cap and trade’ model. The system has shown how putting a price on carbon and trading in it can work.
Thus firms, customers and the government all play vital roles in the further evolution of ESG norms in society. It is slowly but surely becoming the new normal in a multitude of sectors, and quick steps must be initiated to capitalize on the momentum boost from Covid-19 and develop strong ESG frameworks and policies.
