Chapter 2 Flashcards
the ESG market
what are the historical evolutions of ESG Investing
Early Ethical Investing (16th-18th Century), Emergence of Modern ESG (1970s-1980s), Institutionalization (1990s-2000s), Climate Change and ESG (2006 Onwards).
historical evolutions of ESG Investing - Early Ethical Investing (16th-18th Century)
The origins of ESG investing are rooted in ethical practices influenced by religious and moral beliefs. Religious groups like the Quakers and Methodists guided their followers on ethical investment practices, laying the groundwork for what would become socially responsible investing (SRI).
historical evolutions of ESG Investing - Emergence of Modern ESG (1970s-1980s
The Vietnam War and apartheid in South Africa fueled the rise of SRI. The Sullivan Principles, which guided investors to engage with and divest from companies involved in unethical practices, were instrumental during this period.
historical evolutions of ESG Investing - Institutionalization (1990s-2000s)
The formalization of ESG as a concept
occurred in the early 2000s. Key developments include the UN’s Global Compact, the “Who Cares Wins” report in 2004, and the establishment of the Principles for Responsible Investment (PRI) in 2006. These initiatives highlighted the importance of integrating ESG factors into capital markets to foster sustainable and ethical investment practices.
historical evolutions of ESG Investing - Climate Change and ESG (2006 Onwards)
The publication of the Stern Review in 2006 was a turning point, emphasizing that the economic costs of climate change far outweighed the costs of mitigation. This report, along
with subsequent global financial crises, reinforced the importance of ESG factors in financial markets and investment decisions.
what are the expanding scope of ESG Investing
Global ESG Assets: ESG investing has grown significantly, with assets under management (AUM) reaching $35.3 trillion across five major markets (Europe, the United States, Japan, Canada, and Australia/New Zealand)
by 2020. This represents a 15% increase over two years.
Geographical Distribution: Europe and the United States account for the largest shares of ESG assets globally, with 48% in the U.S. and 34% in Europe. However, other regions,
including Canada and Japan, are also
experiencing rapid growth in ESG
investments.
Investment Strategies: ESG strategies vary widely, including negative screening, positive/best-in-class screening, ESG integration, thematic
investing, and impact investing. The most prominent strategy globally is ESG integration, managing $25.1 trillion in assets.
Asset Classes: ESG considerations are applied across a diverse range of asset classes, including equities, fixed income, real estate, private equity, and infrastructure. Public equities remain the dominant asset class, accounting for 51% of ESG assets, followed by fixed income at 36%.
what are the Key Strategies in ESG Investing
ESG Integration: The process of
systematically incorporating ESG factors into financial analysis and investment decisions. This approach considers how ESG issues can impact the financial performance of investments and is the leading strategy with $25.1 trillion in AUM globally.
Negative/Exclusionary Screening: This strategy involves excluding companies or sectors that do not meet specific ESG criteria,
such as tobacco, weapons, or fossil fuels. It remains a popular approach, particularly in Europe.
Thematic Investing: Focuses on specific ESG themes, such as renewable energy, clean technology, or gender diversity. This strategy is gaining traction, especially in the U.S., where sustainability thematic investing has seen significant growth.
Impact Investing: Seeks to generate measurable social or environmental impact alongside a financial return. This strategy often involves investing in projects or companies that address global challenges, such as climate change or poverty alleviation.
what are the key drivers of ESG intergration
Investor Demand: There is a growing demand for ESG investments, particularly from millennials and younger generations who are inheriting wealth and seeking to align their investments with their values. Studies show that millennials are twice as likely as older generations to invest in companies or funds with ESG considerations.
Intergenerational Wealth Transfer: The largest transfer of wealth in history is underway, with an estimated $30 trillion set to pass from baby boomers to millennials. This shift is expected to significantly influence the growth of ESG investing, as younger investors prioritize sustainability and social responsibility.
Regulation and Policy: Regulatory frameworks around the world are increasingly mandating ESG disclosure and integration. The EU’s Sustainable Finance Disclosure Regulation (SFDR) and the U.S. SEC’s proposed climate risk disclosure requirements are key examples of how regulation is driving ESG integration.
Public Awareness: Public awareness of issues like climate change, social inequality, and corporate governance has grown significantly, pressuring companies to adopt more sustainable and ethical practices. This shift is influencing corporate behavior and driving the demand for ESG investments.
Data Sourcing and Processing Improvements: Advances in data technology and analytics have made it easier for investors to assess ESG risks and opportunities. The availability of high-quality ESG data is crucial for making informed investment decisions and has
contributed to the growth of ESG
investing.
what are the challenges in Integrating ESG Principles
inconsistent Data Quality: One of the
biggest challenges in ESG investing is the lack of consistent, high-quality data. Different reporting standards and methodologies can lead to discrepancies in ESG ratings and
assessments, making it difficult for investors to compare and evaluate investments.
Greenwashing: The practice of
greenwashing, where companies exaggerate or falsely claim to be environmentally friendly, poses a significant risk. Investors must be vigilant in distinguishing between
genuine ESG efforts and marketing tactics designed to attract ESG-focused capital.
Short-Termism vs. Long-Termism: Many investors and companies are still focused on short-term financial performance, which can conflict with the long-term nature of ESG benefits. Balancing short-term returns with long-term sustainability goals remains a challenge.
Complexity of ESG Metrics: ESG factors are often complex and interrelated, making it challenging to develop standardized metrics for measuring ESG performance. This
complexity requires specialized knowledge and tools to effectively analyze ESG risks and opportunities.
Resource Limitations: Smaller asset owners and managers may lack the resources and expertise to conduct thorough ESG analysis, leading to challenges in fully integrating ESG factors into their investment processes.
what are the Role of Key Stakeholders in ESG
Integration?
Asset Owners: Include pension funds,
insurance companies, sovereign wealth funds, foundations, and individual investors. These stakeholders are critical in shaping the investment value chain and driving the adoption of ESG principles. Their investment
mandates and engagement strategies significantly influence the market’s direction.
Asset Managers: Responsible for selecting securities and creating portfolios that align with ESG principles. Asset managers play a
central role in the investment value chain, responding to asset owners’ interest in ESG issues and developing new ESG products and strategies.
Fund Promoters: Investment consultants, retail financial advisers, and fund labelers are key intermediaries that guide institutions and individuals in making ESG conscious investment decisions. Their recommendations and labels help investors identify and choose funds that align with their ESG preferences.
Policymakers and Regulators: These stakeholders create the regulatory environment that supports or hinders ESG integration. Regulations like the EU Taxonomy and the U.S. SEC’s proposed climate disclosure rules are examples of how policymakers are shaping the ESG
landscape.
Investees: Companies and projects in which investments are made are at the core of ESG integration. Their commitment to ESG principles and transparency in reporting are crucial for the overall success of ESG investing. Civil Society and Academia: NGOs and academic institutions play an influential role by advocating for ESG practices, conducting research, and educating stakeholders about the importance of sustainable investing.
ESG Investing by the Numbers
Global AUM: ESG assets under management have grown to $35.3 trillion in 2020, reflecting a 15% increase over two years. This growth underscores the mainstreaming of ESG investing across major markets.
Regional Distribution: The U.S. leads with 48% of global ESG assets, followed by Europe with 34%. Canada has the highest proportion of sustainable investments relative to total managed assets, at 62%.
Retail vs. Institutional Investors: While institutional investors continue to dominate the market, retail investors are increasingly engaging in ESG investing. By 2018, retail investors accounted for 25% of total ESG assets, a significant increase from previous years.
Asset Class Allocation: The majority of ESG investments are in public equities (51%) and fixed income (36%). Real estate, private equity, and other alternative assets are also growing in prominence as ESG considerations expand across different asset classes
Real-World Case Studies in ESG Integration
ABP Pension Fund (Netherlands): In 2021, ABP, one of the world’s largest pension funds, announced plans to divest EUR15 billion from fossil fuel producers by 2023. This decision was driven by the need to address climate risks and align the fund’s investments with the goals of the Paris Agreement.
HSBC Bank UK Pension Scheme: HSBC transitioned its defined contribution pension scheme to a passive smart-beta fund with ESG factors and climate tilts. This move was aimed at enhancing risk-adjusted returns while addressing climate risks.
Government Pension Investment Fund (Japan): GPIF, the world’s largest pension fund, invested in multiple ESG- themed indexes as part of its strategy to improve long-term returns by reducing negative externalities on the environment and society.
UK Environment Agency Pension Fund: In 2014, the UK Environment Agency Pension Fund launched a sustainable global listed equities portfolio with a focus on long-termism and ESG integration. This case illustrates how pension funds
can align their investment strategies with long-term sustainability goals.
what is the the Role of Asset Managers in ESG Integration
ESG Across Asset Classes: While ESG integration initially focused on listed equities, it has since expanded to include fixed income, real estate, private equity, and infrastructure. Asset managers are increasingly applying ESG principles across a broader range of asset classes.
Green Bonds: The issuance of green bonds has become a key strategy for integrating ESG into fixed-income portfolios. Green bonds are specifically earmarked for climate and environmental projects, attracting investors focused on sustainability.
ESG Indexes: The proliferation of ESG indexes has provided investors with new tools for benchmarking and passive investing. As of 2021, over 1,000 ESG indexes were available, reflecting the growing demand for ESG investment products.
Technology and Data Integration: Leading asset managers are investing heavily in technology to develop proprietary ESG scoring systems and dashboards. These tools enable more sophisticated analysis and monitoring of ESG performance, enhancing the integration of ESG factors into investment decisions
The Impact of Policymakers and Regulators on ESG
Global Regulatory Trends: Policymakers around the world are increasingly recognizing the importance of ESG factors in maintaining financial stability and promoting sustainable development. Regulations such as the EU Taxonomy and the TCFD recommendations are shaping the future of ESG investing.
EU Taxonomy Regulation: Introduced in 2020, the EU Taxonomy provides a
framework for determining whether an economic activity is environmentally sustainable. It sets criteria for investments that contribute to climate change mitigation, adaptation, and other environmental objectives.
Task Force on Climate-Related Financial Disclosures (TCFD): Established in 2017, the TCFD provides recommendations for climate-related financial disclosures. These recommendations have become mandatory in several jurisdictions, including New Zealand, Japan, and the UK, influencing corporate reporting practices worldwide.
U.S. SEC Proposal (2022): The SEC’s proposed rule on climate risk disclosure marks a significant shift in the U.S. regulatory landscape. The rule requires companies to disclose their governance of climate-related risks, emissions, and transition plans, reflecting the increasing importance of ESG factors in corporate governance.
