What is Environmental, Social and Governance-based Investing?

Environmental, Social and Governance-based investing, or ESG, is moving to the forefront of many institutional investors’ set of priorities. What started off as a way to passively screen companies for their records in important areas of environmental sensitivity or social benefit, is now becoming a more active approach to investing.

ESG has been a way for portfolio managers to keep tabs on the ethical ingredients of their portfolios – what are the companies they are investing in actually doing and are they socially beneficial? What started as screening out tobacco or arms companies has become a much more comprehensive approach that now includes actively investing in technology and industries that will bring greater benefit to society as a whole.

But beyond that many professional investors use ESG criteria not just to satisfy reporting standards but also as part of their overall risk management. They argue that ESG screening can also remove some additional risk from their investment portfolios – e.g. around governance issues.

ESG is playing a growing role in investment strategy

Within the asset management industry, most investors now use the United Nations’ SDG (Sustainable Development Goals) criteria* . These are a globally agreed sustainability framework which include an obligation to consult with stakeholders on their sustainability preferences.

According to BNP Paribas, 78% of institutional investors now say that ESG is either playing a growing role or becoming integral to what they do as an organisation~.

Investors are taking such investment very seriously – according to PwC, as much as 57% of mutual fund assets in Europe will be held in funds that consider ESG factors by 2025. In addition, PwC has found that 77% of investors plan to stop buying non-ESG products within the next two years**.

Measuring social as well as environmental impact

In the two years since BNP Paribas last conducted its survey, investors have found that it has become easier to measure the environmental factors in their investments but have still found it difficult to measure social impact.

Climate-based investing, the actual allocation of investment towards funds that are helping to build next generating green technology, for example, can also have a measurable social impact. In areas where Prestige Funds is active for example – lending to green energy projects in rural areas of the UK – we are helping to create jobs as well as deliver a higher proportion of green energy to both national and local grids.

A good measure of impact investment in the climate investment sector is the amount of new clean energy wattage that is being brought online and the number of UK households that now enjoy some or all of their energy from non-fossil fuel sources. Beyond that is the number of new jobs we help to create in rural communities which have been suffering from progressively fewer full-time employment opportunities for decades.

ESG criteria are going to become a more important factor for investors of all sizes in the next few years, especially as the physical evidence of climate change becomes more apparent.

Regulators are now focusing on ESG

In Europe, the European Commission launched an Action Plan for Sustainable Finance in March 2018. The regulation clarifies investors’ roles and responsibilities when it comes to reporting the environmental benefits of their activity and how investment products can be certified as environmentally friendly.

While it has not come into force yet, the proposal would require all financial entities that manage investments on behalf of their clients or beneficiaries to inform the European Commission about how their activities are impacting the planet and/or the local environment.

Data from BNP Paribas*~ has also found that Asian investors are even more bullish on ESG than their European peers, with 84% of investors and fund managers claiming to have ESG as part of their decision making. Asia Pacific investors (64% polled) say they are now likely to award a mandate to a fund manager based on their ESG capabilities.

ESG investing is going mainstream for investors all over the world; with further climate crises stakeholders will be asking their fund managers and pension schemes to incorporate a more active environmental agenda into their ESG criteria.

* https://www.unpri.org/sdgs
~ BNP Paribas: The ESG Global Survey 2019
** PwC: 2022 – the growth opportunity of a century
*~ BNP Paribas Global ESG Survey 2019