As sustainability and climate concerns dominate public debate, investors are taking note

Environmental, social and governance factors have moved towards the top of the agenda.

By Sean MacHale Bank of Ireland Global Markets

2019 was the year where issues such as sustainability and climate concern dominated public debate, with Greta Thunberg emerging as a leading international commentator. It was also the year where Environmental, Social and Governance (ESG) factors moved towards the top of both the business and public policy agendas.

In 2020 not only does this trend look set to continue as responses to climate change increasingly take hold, we believe that ESG is set to dominate public discourse and impact all business regardless of sector, industry or size.

I believe we will see several trends emerge, as ESG moves from what was once a niche investment area to mainstream business.

Investment and asset management

ESG-oriented investing has experienced a meteoric rise, with global sustainable investment now topping $30 trillion.

In 2020 Private Equity is set to join the ESG drive, with two of the world’s largest firms, KKR and TPG, having signed up to the principles laid out by the World Bank’s International Finance Corporation.

This will see both firms reporting on the positive environmental, social and governance impacts of their investments, as well as their potentially negative effects.

Integration and performance

Investors are re-evaluating the traditional investment model and are looking at ways to minimise risk across climate, data security and regulatory breaches.

Bank of America research found that ESG could have helped avoid 90% of bankruptcies in the S&P 500 between 2005 and 2015, where companies had poor Environmental and Social scores for the 5 years before bankruptcy.

Their research also found traditional financial metrics, such as earnings quality, leverage and profitability, don’t come close to ESG as signals of future earnings.

Demographics and Demand – Generation Y

Investor profiles are changing, with millennials and women, in particular, caring deeply about ESG issues. Research estimates that in the US alone ESG funds will see growth of between $15 trillion to $20 trillion, roughly doubling the size of the US equity market.

In 2020 ESG scores will play a bigger role in determining whether fund managers or exchange-traded funds buy a stock and how much a company pays on its loans.

Consumers
ESG is driving consumer preference. Customers are not just paying lip service; they are now paying to “go green”.

NYU Stern’s Center for Sustainable Business carried out extensive research into U.S. consumers’ actual purchasing of consumer packaged goods (CPG).

Products that carried a sustainability claim accounted for 16.6% of the market in 2018, up from 14.3% in 2013, and delivered nearly $114 billion in sales.

Most striking, is the fact that products marketed as sustainable grew 5.6 times faster than those that were not.

Unilever reported that a third of consumers are now buying brands based on their social and environmental impact. One such brand, Sunlight dishwasher detergent, uses much less water than other brands leading to sales of Sunlight and Unilever’s other water-saving products to outpace category growth by more than 20% in some water-scarce markets.

McKinsey research found that 70% of consumers surveyed across multiple industries, including automotive, building, electronics, and packaging, said they would pay an additional 5% for a green product if it met the same performance standards as a non-green alternative.

Data and Definitions 

Despite advances, assessing ESG risks remains far from straightforward. There are variations in ESG methodologies, frameworks and reporting which can be inconsistent.

The lack of standardisation creates difficulties in measuring and comparing non-financial performance and remains a major hurdle.

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It is not surprising that ESG data to date has been better suited to highlighting the worst-performing companies, through ‘negative screening’ where firms or entire sectors are excluded from investment portfolios, often on ethical or health grounds. 

Thankfully, a big first step in addressing the definition deficit is the EU Technical Expert Group on Sustainable Finance which provides a substantial foundation of classification across 7 industry codes and 76 economic activities.

Technology is enabling a transformational shift in ESG, where Artificial Intelligence and Machine learning can now analyse and amalgamate multiple data sources including emissions sources, firm footprint, health and safety, supply chain impact and diversity targets through the use of surveys, data collection, media publications and online mediums.

This, in turn, will accelerate the identification of positive opportunities for sustainable investment.

Regulation

When the Kyoto Protocol was signed in 1997 there were only 70 laws or policies addressing climate change. By 2018 this number had reached over 1,500. Investors and consumers alike are demanding Environmental, Social and Governance regulation and carbon controls to be agreed and implemented with greater pace and detail.

The EU has been leading the way with its package of legislative proposals across disclosures, the creation of new low carbon benchmarks, amendments to MIFID and the Insurance distribution directive in relation to ESG.

However, this is only the beginning of what will become a detailed framework of rules coupled with National Government responses in line with the Paris agreement in 2015.

By the end of 2020, investment firms will have to publish their policies on the integration of sustainability risks in their investment decision-making process. Pension Trustees in the UK are now required to hold their investment consultants and investment managers to account on ESG, SIPs must include trustees’ policies on arrangements with asset managers, and detail trustees’ stewardship approach with a deadline of 1 Oct 2020.

It is safe to assume that the pace will increase with disclosures to become increasingly mandatory and detailed not only covering climate change but rather the full scope of ESG. This change will not only be regulatory driven but more importantly will be the result of investor demand. 2019 was a good year for ESG, and 2020 will be better. ESG will become the business imperative across global commerce.

Sean MacHale is head of institutional strategy, connectivity and growth at Bank of Ireland Global Markets