The interest in environmental, social and governance issues as investment criteria continues to grow rapidly, driven by global economic factors and consumer purchasing preferences.
By Juan Pablo Arenas Garcia
The term Environmental, Social and Governance (ESG) is quite new, having started as a niche practice almost two decades ago. It was first introduced in 2005 by the UN in a study called “Who Cares Wins”, and this provided a blueprint for companies to integrate ESG practices within their day to day operations. It is considered a sustainable approach, and even though it has its roots in SRI (Socially Responsible Investing), it has since expanded to take into account the financial impact of these practices as well as their social implications.
Since that important study, major sustainable milestones have been achieved. In 2011, the Sustainable Accounting Standards Board (SASB) was founded to create benchmarks for sustainability measurements and accounting, to better communicate information between companies and investors. Companies started to integrate ESG practices into their operations. Financial institutions and investors started to focus more on ESG-compliant companies while excluding businesses that don’t focus on creating a positive impact in the world. Within the most common ESG compliant investment strategies, investors are screening out companies in certain industries, such as tobacco, alcohol, oil, gambling, or weapons. Enterprises with a poor ESG score (based on various ESG data providers) or with a high controversies score are excluded. Companies with a certain level of CO2 emissions are also screened out, with investors preferring to place their capital in companies demonstrably generating a positive impact or at least reducing negative practices.
Now, thanks to the increase in the general concern regarding climate change and social justice issues, ESG investing has been gaining a lot of popularity throughout the world. Adeline Diab, Head of ESG and Thematic Investing EMEA & APAC at Bloomberg Intelligence, said “The pandemic and the global race to net zero carbon emissions have put ESG criteria into orbit – from niche to mainstream to mandatory. ESG is fundamentally reshaping the financial industry, becoming part of financial reporting. This is in part due to mounting scrutiny from regulators, markets being more sensitive to ESG-related news, and asset owners appointing managers on the basis of ESG across asset classes.”
This is a trend that has more weight in Europe, mainly due to the UCITS funds with the help of the SFDR articles, but is now becoming a global movement. According to Navex Global, 88% of public companies and 67% of private ones had ESG initiatives in place in 2020. That is also influenced by growing awareness of consumers, 76% of whom say they will stop buying or utilizing services from companies that treat badly the environment, their employees, or the community to which they operate (PWC 2021). Not only consumers are gaining awareness: governments and banks are now issuing green bonds to support specific climate-related or environmental projects.
According to Morningstar Direct, the assets under management (AUM) of global public ESG funds that claim to have a sustainability objective or use binding ESG criteria when selecting investments were $1.65 trillion by the end of 2020. But, thanks to new products, re-brandings (funds that didn’t use an ESG approach and change the methodology to an ESG focused one) and a gain of popularity, the AUM of sustainable funds jumped to $2.74 trillion by December 2021. In the U.S. alone, the AUM of these funds went from $236 billion in 2020 to $357 billion by the end of 2021, an increase of more than 50% in just one year, in part because of $70 billion invested in 192 new ESG funds.
How are ESG investments expected to grow and what will they represent in the near future? According to Bloomberg Intelligence, the total AUM of ESG funds will be approximately $50 trillion by 2025 out of a $140.5 trillion universe, almost a third of all assets under management. The AUM of ESG ETFs are also expected to surpass the $1 trillion mark by 2025, with a lot of ETFs managers changing their methodologies and indices to those with an ESG focus. Right now, the whole financial ecosystem is making a change from investing mostly in companies implementing ESG strategies. At the same time, the next generations of consumers are preferring to buy only from companies contributing to positive change, which in turn causes investors to create and invest in more and more ESG strategies. All this is transforming ESG investing into a mainstream practice and increasingly a mandatory one.
Still, there is a long way to go to reach that point. Standing in the way is the continuing confusion and complexity of ESG standards and benchmarks. Sorting out this wilderness of options is a challenge both for companies and investors. But the emerging trend is clear: there’s little doubt that the focus on ESG factors is becoming part of a new normal. The only questions remaining are which measures and standards, and which ESG investment vehicles will ultimately prove dominant. As in other emerging industries, there will inevitably be a shake-out and a coalescence around dominant players, funds, and indices.
If your company is in need of guidance on ESG issues and interested in optimizing its ESG ratings and impact, Global Imprint is here to help. Just reach out to us with your interests and concerns and we’ll get right back in touch.