Why the need for ESG investing?

Traditionally, the role of a corporation was narrowly defined as “maximizing shareholder value”. The sole focus was on financial returns.

In recent times, there has been an increasing emphasis on understanding the true purpose of an organization. Various changes, events and advances in the societal, technological and regulatory realm have led to the business maxim of focusing solely on shareholder wealth coming under greater scrutiny. There is now higher emphasis on overall stakeholder wealth and improving business sustainability.

Consider some developments during the last few years -

1)   In August 2019, one of the preeminent business lobbies in the United States, the Business Roundtable (comprising 181 top CEOs), committed to drop the idea that they function to serve only their shareholders.(1)

2)   ­According to the World Economic Forum - Global Risks Report 2019, environmental, geopolitical and technological risks have grown in prominence during the last decade as compared to financial risks.(2)

Source- World Economic Forum

3)   At the UN Sustainable Development Summit held in September 2015, 193 countries adopted “The 2030 Agenda for Sustainable Development” comprising 17 Sustainable Goals. (3)

 

4)   According to research by Edelman, consumers are increasingly evaluating a company’s fair and responsible behavior when buying materials, products or services. (4)

 

Research by Nielsen indicates that Sustainability provides an immense opportunity for growth in many emerging markets. As the standard of living improves, consumers are eager for better, healthier products. This is especially true in regions where pollution levels are high and are having a direct impact on consumer health. As an example, India’s natural personal care market grew twice as fast, despite a price increase. India also tops the list of emerging market countries where consumers demand corporate sustainability. (5)

 

% of respondents who said it is “extremely” or “very” important that companies implement programs to improve the environment by country

 

5)   Regulators in a number of jurisdictions (US, UK and South Africa) are mandating asset owners to focus more on integrating environmental, social and governance issues in their investment and research process.(6) The EU and European Parliament formulated rules mandating consistent disclosures to be made by money managers, insurance companies, pension funds and investment advisers on integrating environmental, social and governance factors into their portfolios.(7)

6)   The global financial crisis of 2008-09 provided a fillip to the then nascent ESG movement. Many blamed the banks for the crisis, and said that financial institutions had become too greedy and lacked sound governance principles. The public and the government issued a strong voice asking the financial markets as a whole to revise their capital allocation policies. They wanted them to allocate more to areas to solve problems such as social or environmental issues more effectively, while using higher governance to oversee their overall activities.(8)

In an increasingly complex and interconnected world, the importance of actively managing risks and opportunities related to emerging environmental and social trends, in combination with rising public expectations for better accountability and corporate governance, presents a new set of challenges with far-reaching financial consequences for corporations. Ignoring these ESG factors and not accounting for “negative externalities” may lead to a material impact on a company’s financials and its valuation.

The mandate to maximize short-term shareholder value or “Quarterly Capitalism” drove a deep wedge between businesses and society. CEOs till recently have had little reason to think about the social and environmental consequences of their actions. And the result, whether in oil spills or credit derivatives, led to devastation far beyond the company's own shareholders.

Without social media, various social, ethical and environmental ills would have minimal visibility. Increased visibility of issues has shifted the balance of power from the hands of governments and corporates to the masses. There is increased social and political pressure now to internalize the social and environmental costs of business. Hence, greater emphasis on ESG factors, which play out over a long horizon, provide a counterweight to the constant pressure on companies to maximize near-term earnings.

 

Today, The United Nations Principles for Responsible Investing (UN PRI) is the World’s leading proponent of Responsible Investing. Since its founding in 2006, the UN PRI has attracted support from more than 2,300 signatories representing over USD $82 trillion in assets under management as of March 2019. (9)

Thus, ESG is a trend that’s not likely to go away. It is now time to evolve to a Stakeholder Centric Model and replace the question of “how much return?” with “how much sustainable return?”

Source

  1. https://www.irmagazine.com/esg/shift-shareholder-value-stakeholder-focused-model-top-us-firms
  2. http://www3.weforum.org/docs/WEF_Global_Risks_Report_2019.pdf
  3. https://sustainabledevelopment.un.org/?menu=1300
  4. https://www.business2community.com/branding/brand-trust-is-more-important-than-ever-for-consumers-02229321
  5. https://www.nielsen.com/wp-content/uploads/sites3/2019/04/global-sustainable-shoppers-report-2018.pdf
  6. https://www.oecd.org/finance/Investment-Governance-Integration-ESG-Factors.pdf
  7. https://www.pionline.com/article/20190308/ONLINE/190309872/eu-agrees-to-sustainable-investment-disclosure-framework
  8. https://www.fidelity.com.au/insights/investment-articles/esg-an-enduring-legacy-of-the-financial-crisis
  9. https://www.unpri.org/pri/about-the-pri