When anyone utters ESG…..Environment, Social, Governance echos!
These are trending buzz words in the recent markets, with just about every firm or financial institution flaunting their ESG practices.
The US ESG investment market alone grew in double-digit numbers from 2018 to 2020, contributing $17.1 trillion of the $35.3 trillion total across five major investment markets.
Interesting right!
But the sad part is that these claims of sustainability are not utilised to their best and are still shallow, deliberately misleading at worst, and governing bodies are starting to intervene.
The good news is that nowadays, firms have been considering ESG policies seriously.
In this blog article, let’s have a look at forecasted regulations on ESG investing and how such policies can benefit investors’ portfolios.
What Is ESG and why is it important to understand it from an investor’s standpoint?
A lot of stress on this buzz word huh!
ESG is simply,
Environment: The subject revolves around resource usage, pollution, and climate change. For example, the parameter focuses on how companies abide by the greenhouse gas emissions rules and waste reduction rules across the supply chain.
Social: This subject matter revolves around how companies interact with and impact the communities in which they operate. It includes everything from the health and safety of their employees and their suppliers’ employees to involvement in conflict regions.
Governance: By this, we mean corporate governance – how are companies investing in diversity, ethics, etc. through their internal decision making. For example, equal pay, diversity of board members, and auditing for corruption would all be necessary for strong corporate governance.
But what is in it for an Investor?
To understand this, let’s first let’s take a look at Where Do ESG Regulations Currently Stand now?
The EU has been an active participant in continuously taking a number of concrete steps to regulate sustainable investing.
The regulation mandates data disclosures include:
How an entity integrates sustainability risks into their investment decision‐making or advising
A statement of their policies on PAIs
Proof that remuneration policies are made with sustainability risks in mind
Evidence of pre-contractual disclosures on sustainability risk integration
It is also involved in implementing the Sustainable Finance Action Plan, aiming to redirect capital towards sustainable companies and green bonds and away from sectors involved with fossil fuels and other unsustainable practices.
Finally, the EU Taxonomy Regulation which came into in July 2020, provides a classification system of conditions companies must meet to be considered environmentally sustainable.
From January 2022 onward, companies will be required to report how their financial products align with the Taxonomy.
The US Securities and Exchange Commission has committed to developing similar regulations in the future, though what exactly those will contain has not been formalized.
To summarise, these types of regulations formalize requirements for ESG finance much like GDPR’s impact on data collection and PCI-DSS’s impact on the payment card industry.
Any future regulations will only add more nuance to these broad regulations, further holding firms accountable for proving sustainable practices.
How ESG Regulations Can Help
SFDR and similar policies are not the first examples of increasing government oversight of industry giants in recent years, and it will not be the last.
So, it’s in the best interest of stakeholders to consider how such regulations can benefit their companies and their customers.
- There is no doubt that erroneously claiming ESG practices is a form of greenwashing, a harmful practice of overestimating the sustainability or eco-friendliness of a product or company.
- The ethical implications of this are hopefully obvious, both in terms of misleading clients and of the environmental and societal determinants.
- Therefore, a cultural shift to decrease financial greenwashing is ultimately beneficial because it gives credit where credit is due.
- If firms who are inflating their ESG compliance are called out, it will highlight the ones who are making legitimate efforts to consider PAIs in their financial advising and internal decision-making.
- Over the longer term, clients will recognize this differentiating factor and align themselves accordingly.
- While mandated ESG reporting will require additional input at the outset, it can also help firms reevaluate some of their current practices. For example, some firms may realize that investor relations are not prioritized in their current operations.
- Similarly, preparing for ESG data reporting will highlight the importance of maintaining transparent, responsible accounting practices, including using software that comes with critical features such as transaction monitoring and comprehensive reporting. Without using the right tools, firms will have a more difficult time assessing and proving their ESG compliance.
- When it comes to the finance market, while there are some more consistent trends, there is also a lot of uncertainty.
- That’s because market fluctuations are largely based on future trends – in a sense, attempting to predict the future. And lately, it appears that one of those trends is an increasing push for making ESG mandatory.
- Over the past 50 years or so, it has been a voluntary action, but with regulations increasing, it is becoming less so.
- This means there will only be greater scrutiny towards unsustainable sectors moving forward, and companies will need to respond if they hope to survive.
Consider an example, the tech sector has been criticized by environmental groups and even their own customers and investors for high consumption levels due to the electricity needed for data storage and processing.
This and other industries are now pushing to reduce their carbon emissions.
Many companies are also making other ESG steps a priority, such as increasing the diversity of the still overwhelmingly white, male leadership of the sector.
These efforts show that companies will respond to pressure, even if change can be slow.
Reporting these efforts is important to encourage firms to factor in ESG risk as a determining factor in how investors can find value in a company.
What’s more, firms should take note that younger generations – namely Millenials and Gen Z – are increasingly socially conscious consumers.
According to industry expert Alex Williams of Hosting Data, savvy investors are now taking advantage of online trading to educate themselves and invest responsibly.
Younger generations are well aware of this, and they are starting to invest earlier in life than their parents and grandparents, aided by digital resources.
Therefore, ESG reporting will encourage increased accountability, which could in turn reward sustainable companies with new customers and growth potential in the future.
What the EU has started will undoubtedly spread elsewhere.
This means, along with recent trends like increased cryptocurrency regulation and similar government interventions, ESG regulations may be the next policy surge for firms to comply with.
What began with data disclosure could end in even more significant policy shifts across the finance sector.
Firms must be ready to adapt if they hope to be compliant and competitive in an increasingly socially conscious market.
Undoubtedly this is going to be the revolutionizing sector!
Investors are you ready with the ESG picks already?
Happy Investing!
Until next time…
