Who cares wins: Why the integration of ESG factors is crucial for business

In January 2004 the UN secretary general got the conversation on integrating environment, social and governance philosophies into capital markets by inviting more than 50 CEOs from major global financial institutions. The very next year the term ESG was coined in a landmark report titled Who Cares Wins. The report made a strong case for embedding ESG factors in capital markets. Not many knew how to do it then, but with time the movement is gathering momentum.

According to the US Social Investment Forum, ESG integration by institutional investors increased by 60 per cent between 2012 and 2014. The Global Sustainable Investment Alliance suggests that assets worth $23 trillion were managed under responsible investment strategies globally in 2016, up 25 percent from 2014. The Forum for Sustainable and Responsible Investment’s 2018 report on sustainable, responsible and impact investing trends, says that, as of 2017, more than one out of every four dollars under professional management in the United States was invested according to SRI strategies. With interest in ESG is on the rise, JP Morgan has developed a quantitative tool, ESGQ, to help investors pick stocks in a responsible way and outperform the broader index.

Corporate disclosures on ESG parameters is a reasonably recent phenomenon. The Global Reporting Initiative (GRI) came out with indicators to report on in 2000. More than 7000 companies use the indicators to do non-financial reporting today and that includes more than 80 percent of the S&P 500 companies. Over time, the number of disclosure frameworks has proliferated. The Sustainability Accounting Standards Board (SASB), International Integrated Reporting Council (IIRC), Dow Jones Sustainability Index (DJSI) and Carbon Disclosure Project (CDP) are some of the organisations that have created disclosure frameworks for corporations.

The profusion of frameworks has been followed by a nearly 50 percent increase in sustainable investment funds in 2018 over 2017. While 37 new funds were launched in 2018, 63 existing funds added ESG criteria. Green bonds are seeing a sharp uptick too. In 2017, the green bond market reached $221 billion and the Climate Bonds Initiative (CBI), an NGO which promotes and tracks the expansion of the green bonds market, is confident that a target of $1 trillion market of bonds invested in climate solutions is achievable by 2020.

Institutional investors were initially reluctant to embrace the concept, arguing that their duty was limited to the maximisation of shareholder value, irrespective of environmental or social impact, or broader governance issues such as corruption. But this has changed with many studies showing that good corporate sustainability performance is associated with good financial results. The Journal of Sustainable Finance and Investment in 2015 meta-analysed 2,200 studies and stated that 90 per cent of the studies found a neutral or positive relationship between corporate sustainability performance and financial results. One important benefit of using ESG information is that investors are able to anticipate risks associated with climate change including the potential risk of stranded assets and can shape their investment strategies accordingly.

The ability to cogently use ESG information and effectively incorporate it into stock value projections or project valuation is still developing. Many financial organisations now have dedicated ESG analysts and that is a step in the right direction. The real good news is that the ESG conversations are no longer limited to non-profits, activists and civil society, but are now of concern to an increasingly larger number of people from the financial community.