Ileana Sodani, Head of EMEA Business Development, BNY Mellon Asset Servicing discusses what exactly constitutes 'good' ESG and how companies can monitor this.
Performance measurement has never been simple for institutional investors. Opinions often differ on the most appropriate metric or horizon for a particular investment. Even so, the financial return can at least be represented by a single numerical value.
As asset owners and managers are finding, it is considerably harder to describe, quantify or compare the ‘real-world’ or non-financial impact of an investment decision, either through a number, letter or even colour. But this is a riddle the industry needs to solve, due to investors’ desire to develop a more sustainable approach to investing, built on environmental, social and governance (ESG) factors.
According to the Global Sustainable Investment Alliance[1], US$30.7 trillion was invested sustainably at the start of 2018, a 34% increase on 2016. Further, a recent EY survey[2] found that 97% of institutional investors evaluate the non-financial disclosures of target firms when deciding future investments, adding that such information had occasionally (62%) or frequently (34%) played a pivotal role.
Impact assessment
Every investment has multiple non-financial impacts. Consider a proposed new mine in a developing country that could create thousands of well-paid jobs but at a significant cost to air quality and C02 emissions.
Some investors will have screened the mining stock out of their portfolio already; others might try to calculate the positive and negative impacts of the project, perhaps relying on third-party evaluations; still others may decide to engage more directly, working with the firm to minimise environmental damage and maximising the upside of the investment, in terms of health and safety, labour conditions and social infrastructure benefits.
"Models are becoming increasingly sophisticated, potentially enabling assets and managers to be judged on specific impacts, e.g. reducing carbon emissions, increasing board-level diversity or improving water supply."
As a highly diverse group – including sovereign wealth funds, insurance firms, charitable foundations and public pension finds – asset owners will inevitably take varying views of this or any other investment. And although we’re in the early stages of developing the evaluation frameworks and information services to make informed ESG-based investment decisions, the priorities of asset owners are unlikely to converge significantly.
Very broadly, they are taking one of three approaches: ESG screening (both negative and positive); integration of ESG principles into the investment process; and more proactive strategies such as impact investing and corporate engagement. Some have migrated along the spectrum, with rising expectations and information requirements, but this journey is not inevitable.
Mind the information gaps
As such, information needs will remain diverse, but the gaps are being filled, with data and service providers, standards setting organisations and regulators all potentially playing a role in helping asset owners and managers to separate quantifiable non-financial impacts of investment (good and bad) from ‘greenwash’, i.e. inaccurate or incomplete information designed to improve perceptions of a company’s activities or project’s effects.
Already, ratings agencies, index providers and market data firms have been joined by new specialists in developing ESG-based methodologies. But attempts to boil down the impact of even a single project – let alone company or portfolio – remain fraught with the risks of over-simplification.
Models are becoming increasingly sophisticated, potentially enabling assets and managers to be judged on specific impacts, e.g. reducing carbon emissions, increasing board-level diversity or improving water supply. But funds are being allocated vastly different ratings across benchmarking services and there remains the risk of focusing on the metric rather than on-the-ground impacts.
Standards setters and industry bodies are also providing more guidelines. Investors representing more than US$80 trillion[3] have signed up to a global framework drafted by the UN-backed Principles for Responsible Investment, which has also published best-practice guidance on ESG integration in partnership with the CFA Institute.
The Global Reporting Initiative’s Sustainability Reporting Standards framework outlines principles for ESG reporting for corporates, while the Task Force on Climate-related Financial Disclosures has issued recommendations on reporting climate-related risks and opportunities.
Role for regulation?
The EY survey not only found a strong desire among investors for better accounting standards for non-financial information (59%), but also for greater regulatory involvement, with 70% calling on regulators to close the gap between need and provision of non-financial information.
"Already, ratings agencies, index providers and market data firms have been joined by new specialists in developing ESG-based methodologies."
But regulation can be a blunt instrument. The European Commission’s action plan for financing sustainable growth included proposals to create a unified taxonomy for sustainable economic activities, as well as proposals defining both corporate disclosures and requirements on integrating ESG factors in investment decisions. The proposals drew criticism from trade bodies, reflecting global concerns that regulation can stifle the choices of investment professionals rather than making them more effective.
Performance measurement will never be simple for institutional investors, but by discussing the issues with peers at events such as Fund Forum, we stand a much better chance of building flexible and sustainable frameworks for ESG investment.
ESG Investing: Setting a Course for a Sustainable Future.
Watch Daron Pearce, CEO, BNY Mellon, EMEA, Asset Servicing below discuss where well-established trends in fund management are heading.
The views expressed herein are those of the author only and may not reflect the views of BNY Mellon.
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[1] http://www.gsi-alliance.org/trends-report-2018/
[3] The PRI 2019/20 Work Programme: Delivering for Signatories (April 2019)