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Increasing awareness of matters such as social inclusion, climate change and political achievements like the Paris Agreement has led society forward in the goal of sustainable development. And the financial sector has had and still has its own role to play. Institutional investors have made their voice heard through prominent divestments from controversial assets.
In addition, the new investors known as the Millennials are changing market perceptions of finance. Assets in ESG (Environment, Social, Governance) funds have surged massively in the past years. Even the most traditional managers and early critics are now structuring products to become ESG-focused, while others have already made the switch to ESG years ago. We seem to be finally getting most on board to do the right thing. Or do we?
Why substance matters
Sustainability has become a big deal and an appealing sales story, which certainly brings advantages but undoubtedly also poses challenges. Leaving out substance makes the industry a fragile bottleneck. Every other actor is now claiming to be sustainable, which makes it necessary to differentiate the real drivers of change from the pretenders. What matters is what lies underneath and how it is communicated. Would you think it honest if a company heavily marketed its newly issued financial instrument, but at the same time continued to do 99% of its business non-sustainably?
In addition, it is not enough to focus only on the E or the G and leave the S completely out of the mix (or indeed any other combination of focusing on two factors and leaving one out). Even though a company might have very low carbon emission rate due to the industry it operates in, working conditions and social factors should also be accounted for. Recent examples have proven models to be wrong, with entire villages being displaced to build dams in Asian cities for example. It is imperative to take into account both the positive and the negative impacts of an investment decision. This is why sustainable investment funds in particular need to do the right thing, proving to their investors that there is substance behind the companies in which they invest.
The good, the bad and the ugly
Even though the majority of companies already publish Corporate Social Responsibility reports, about 20% of the largest companies worldwide do not report at all on sustainability matters according to the Global Reporting Initiative. ESG data therefore remain challenging to collect. However, data sources in general and the quality of reports have improved vastly in the past few years. Reporting will adopt an even more important role in sustainability frameworks and the setting of standards in the future, making it easier to identify the good, the bad and the ugly. Recently published proposals by the EU Technical Expert Group (TEG) are geared towards disclosing not just how climate change might influence the performance of a company, but also the impact of the company itself on climate change. In future, integrated reporting, combining financial and extra-financial factors, will help to build sustainability into strategic decision-making.