A few weeks ago, FTSE Russell, a notable subsidiary of the London Stock Exchange Group, said 200 companies are in danger of being thrown out of their stock indices after failing to meet some meticulous environmental standards. The companies represent almost 15 per cent of the stocks in the FTSE4Good series, an index measuring the performance of businesses with strong environmental, social and governance (ESG) practices. The companies were given 12 months to better meet the tighter standards before they face removal. "These tougher requirements reflect a groundswell of investor demands for companies to develop credible climate transition strategies and emission reduction targets,” Arne Staal, chief executive of FTSE Russell told the financial times in mid-June. "We are setting the bar higher and ratcheting up the requirements. This topic is of existential importance to all of us.”
ESG investing metrics have been reshaping the global investment sphere for the past few years, and like many other world-changing topics, Covid has accelerated processes that could have otherwise taken decades. The global disaster was also referred to by many investors as a "sustainability” crisis that has renewed, and even deepened the focus on climate change, social adversities, and corporate governance.
Who cares, wins
In 2004, Kofi Annan, then residing as UN Secretary, asked major financial institutions to partner with the UN and the International Finance Corporation to identify methods to integrate environmental, social, and governance concerns into capital markets and global investment institutions. Following that request, the World Bank conducted The Who Cares Wins conference in 2005, which first brought together institutional investors, asset managers, buy-side and sell-side research analysts, global consultants and government bodies and regulators to examine the role of environmental, social and governance indicators, first coining the phrase ESG. Across roles and platforms there was an overwhelming degree of agreement that ESG factors play an important role in the context of longer-term investment, and multiple studies that year determined the impact could be detrimental from both societal and business perspectives.
These studies changed the investment sphere, expanding on the moral and ethical concerns and taking into account the financial impacts as well as societal implications of how a company operates, and evaluating factors such as health and safety policies, water management, supply chains, and corporate culture started to be more commonplace.
The founding of the UN’s Principles for Responsible Investment (PRI) in 2006 solidified the movement toward ESG, and is an independent advocate and exemplar, providing a "blueprint for responsible investment” for more than 3900 signatories worldwide.
These 3 simple words, environment, social, and governance, may sound straightforward, but they incorporate multiple implications.
The environmental component, currently leading public opinions about performance, encompasses a company’s impact on the planet in both positive and negative ways.
Environmental aspects may include usage of renewable energy, including wind and solar, climate change policies, plans, and disclosures, GHG emissions goals and transparency on meeting them, and more. As with other environmentally-related metrics around the world, the word "goal” is extremely prevalent, and while it presents a nice-to-have approach, concrete numbers and metrics are becoming increasingly essential in demonstrating real impact.
The social component consists of people-related elements, like company culture and issues that impact employees, customers, consumers, suppliers, the local community, and society at large, and may include: employee treatment, pay, benefits, engagement and staff turnover, diversity and inclusion in hiring, and more.
According to "Amplifying the S in ESG”, a white paper by the ESG Working Group, a pro bono partnership, over the past decade, investors’ understanding of both environmental and governance indicators has improved, and integrating those indicators into risk analysis and screening has become a materiality. However, social performance considerations have often been dismissed, because of the misperception that they present a lower risk to revenue streams or are less likely to be subject to regulatory action or punitive measures.
The quantification of the implications of social factors is considered the hardest among the ESG and therefore the link to investor returns has been under-explored. Many companies adopt a public position that their only obligation is to comply and that social issues are the responsibility of governments, rather than private actors or investors.
This perspective needs to change, and now more than ever, after the vast effects that Covid has and is still having on the global business sphere, and on communities everywhere, and especially in Africa. As the private sector increasingly becomes a meaningful player in realizing infrastructure gaps across the continent, it is crucial that companies take full responsibility for their social roles in these often vulnerable societies.
The corporate governance component relates to the strength of the board of directors and company oversight, as well as how shareholder-friendly versus management-centric the company is. It may include diversity of the board of directors and management team, whether the company’s chairman and CEO roles are separate, transparency of communication with shareholders, and much more.
To access the details and assess ESG factors, sustainability reports are made by more and more companies, prepared using respected sustainability standards, such as those established by the Global Reporting Initiative (GRI), and the PRI.
Sustainable investments at the top of global indices
Covid-19 has put various ESG issues in a new perspective. Responsible investment trends were in their way and already taking shape, but the global pandemic fanned the flames in a substantial way. According to Morningstar, an American financial services firm, in the first half of 2020, net inflows into ESG funds in the US reached $21 billion, nearly equalling the total amount for the entirety of 2019, which was in itself four times the previous record.
Covid has been serving as the first real proof-point for sustainability-focus investing, and interesting numbers are pouring in, underlining the fact that ESG investing can boost returns, and have extreme resilience in the face of crisis. According to Blackrock, one of the biggest American multinational investment management corporations, 88 per cent of sustainable funds in their analysis outperformed their non-sustainable counterparts in the beginning of 2020, when the world was literally collapsing. Morningstar indices showed 51 of their 57 sustainable indices outperformed broad market counterparts.
The number of PRI signatories is the best evidence for the increasingly growing interest in ESG, as it almost doubled since the pandemic began. The governance body’s current 3900 signatories represent over US$100 trillion in AUM.
In the coming years, ESG will be so immersed into the investing sphere that there will no longer be a discernable distinction between sustainable and traditional investing. Investors and CEOs all over the world are quickly realizing that the best thing they can do for both their business and the planet is think in a sustainable manner. What could be a better silver lining for a global pandemic?
The writer is an entrepreneur and investor, leading sustainability-driven companies in Africa and the Middle East