What is the Sustainability Challenge?
First, let’s discuss some of the problems that Environmental, Social and Governance (ESG) investing aims to tackle.
The United Nations (UN) defines climate change as ‘…long-term shifts in temperatures and weather patterns’ and highlights that human behaviour has been a major driver of this since the 19th century, with 2011 to 2020 the warmest decade recorded (UN, 2024). Consequences of climate change include droughts, wildfires and availability of fresh water (European Commission, 2023). While the problems associated with climate change and initiatives to mitigate these have gained traction in the past few decades issues related to biodiversity loss have recently begun to garner attention. Biodiversity loss is a broad term, with Lai (2022) describing it as ‘…the loss of life on Earth at various levels, ranging from reductions in the genetic diversity to the collapse of entire ecosystems’. The Living Planet Report (2022) states that there has been an average loss of 69% since 1970 in mammal, bird, reptile and amphibian species (WWF, 2022). Steffan et al. (2015) state that we are already breaking through our ecological ceilings in ways that threaten the planet and its ability to sustain life.
Social issues refer to human rights, labour and decent work and gender equality, among others (UN Global Compact, 2024). Raworth (2017) outlines twelve social foundations for humanity to strive to live above: Food security, Adequate income, Improved water and sanitation, Housing, Healthcare, Education, Decent work, Modern energy services, Gender equality, Social equity, Having political voice, Peace and justice.
Raworth (2017) combines these with nine planetary boundaries outlined by Rockstrom et al. (2009) resulting a ‘doughnut’ of social and planetary boundaries:
As Schoenmaker and Schramade (2018) state, sustainable development involves combining planetary and social boundaries. The 2015 Paris Agreement seeks to keep ‘…global temperature rise this century well below 2 degrees Celsius above pre-industrial levels…’ (UN Climate Change, 2022). The UN 2030 Agenda for Sustainable Development was adopted by all members of the UN in 2015, involving 17 Sustainable Development Goals (SDGs) with 169 targets of No Poverty, Zero Hunger, Good Health and Wellbeing, Quality Education, Gender Equality, Clean Water and Sanitation, Decent Work and Economic Growth, Industry, Innovation and Infrastructure, Reduced Inequalities, Sustainable Cities and Communities, Responsible Consumption and Production, Climate Action, Partnerships, Life Below Water, Life on Land, Peace, Justice and Strong Institutions, Affordable and Clean Energy.
We should all be familiar with the SDGs as the negative effects of climate change and biodiversity loss, as well as social inequalities, intensity. This understanding is also crucial for investors who wish to incorporate ESG factors into their investment activities.
What is ESG Investing?
ESG investing can be described as ‘..any investment strategy that emphasizes a firm’s governance structure or the environmental or social impacts of the firm’s products or practices’ (Schanzenbach and Sitkoff, 2020). Let’s discuss each component from a sustainability reporting perspective by following the European Corporate Reporting Lab (EFRAG) sustainability reporting standards (www.efrag.org, n.d.).
These state that sustainable reporting standards should address the following aspects of the environmental pillar of ESG:
Climate change mitigation, Climate change adaption, Water and marine resources, Resource use and circular economy, Pollution, Biodiversity and ecosystem.
The following aspects of the social pillar should be addressed:
Equal treatment and opportunities for all, Working conditions, Respect for human rights, fundamental freedoms and democratic principles
The ‘G’ in ESG can sometimes be overlooked but it still has an important role to play in the sustainable transition. S&P Global defines it as ‘…the governance factors of decision-making, from sovereigns’ policymaking to the distribution of rights and responsibilities among different participants in corporations, including the board of directors, managers, shareholders and stakeholders’ (S&P Global, 2020).
The ESRS state that sustainable reporting standards should address the following aspects of governance:
The role and composition of administrative, management and supervisory bodies
The features of the undertaking’s internal control and risk management systems, in relation to the sustainability reporting
Business ethics and corporate culture, including anti-corruption and anti-bribery
Political engagements of the undertaking, including its lobbying activities
Management and quality of relationships with business partners.
What Are Some Types of ESG Investing?
Fenili (2023) outlines seven ESG investing approaches categorised by Eurosif:
Exclusion policy and negative, or worst-in-class, screening:
Excluding, or avoiding, particular sectors, specific companies, specific issuers or some other ESG-based criterion. ‘Worst-in-class’ implies that the issuer or security performs worst relative to its peers according to some ESG metric.
Norms-based screening:
Using a minimum standard based on international standards.
Positive, or best-in-class, screening:
Selecting investments based on how well they perform, relative to their peers, on ESG metrics.
Sustainability themed investing:
Investing according to sustainability related ‘themes’.
Fully integrating ESG scoring into portfolio management:
Explicitly including ESG factors in the financial decision-making process.
Voting policy and shareholder activism:
Shareholders using their power to impact the actions and/or behavior of corporations.
Impact investing:
The Global Impact Investing Network (GIIN) defines impact investing as ‘…investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return’ (GIIN, 2019).
How Big Are ESG Financial Markets?
Overall market share of responsible investments totalled 36% in January 2020, amounting to $35.3 trillion assets under management. Growth of these assets continued throughout most regions, with Canada leading at 48% growth, followed by the USA at 43% growth (Schoenmaker and Schramade, 2018).
Since 2020 the absolute value of sustainable investing assets increased in Europe, Australia, New Zealand and Japan. However, in Europe the percentage of assets classified as sustainable declined by around 5% each year (Sustainable Investment Review, 2022). This could be due to an increase in greenwashing concerns and greenhushing. The Cambridge dictionary defines greenwashing as ‘behaviour or activities that make people believe that a company is doing more to protect the environment than it really is’ (Cambridge Dictionary, 2019). Greenhushing is an even more recent phenomenon in which companies are reluctant to disclose their sustainable activities for fear of being accused of greenwashing.
ESG investing is an evolving area and new strategies being constantly developed. These markets are likely to continue to grow as the need for sustainability increases.
