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2019 Investment Views

Sustainable Investing

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Evolving and expanding ESG focus

By Therese Niklasson

At a glance

  • Responsible investing has gone mainstream, moving beyond value screens to consider a deeper understanding of the relationship between society, nature and the economy.
  • There has been a surge in the quality and depth of ESG-related investment products, as well as reporting by companies and industry.
  • Regulators and policymakers are strengthening their messaging and focusing on more long-term sustainable capital markets.
  • We are moving towards key milestones, including the UN Sustainable Development Goals (SDGs), post-2020 Biodiversity Framework and COP26 in 2020. Progress is mixed, but with hope.
  • Efforts to avoid ‘runaway’ climate change are stepping up and the investment community has come under increasing pressure to demonstrate action.
  • ESG in China continues to evolve.

Moving beyond negative screening

Never has the focus on environmental, social and governance (ESG) been greater within the investment community. It has evolved and changed profoundly over the past two decades. Some of the biggest differences with today’s approach include a broader reach to ‘responsible investing’ by moving beyond screening values and ethical considerations to allowing the investment philosophy to benefit from understanding the relationship between society, nature and the economy – in other words, sustainable development. We have never been more reminded that long-term economic growth can only be achieved if it is socially inclusive and environmentally sustainable.

Momentum around these issues has also increased dramatically. There are more organisations, throughout the investment community, building teams, systems and solutions than ever before. The quality and depth of the research has benefited from this surge of investment, resulting in a constant flow of new research reports, some providing convincing quantitative results in support of the value of integrating material ESG factors. At the other end, we have seen more focus by regulators and policymakers. We can expect the current number of c. 300 responsible-investment-related policies across the world to increase and, hopefully, harmonise.

Europe has, in many ways, taken the lead on sustainable finance by adopting the European Commission’s Action Plan on Sustainable Growth, and updating Institutions for Occupational Retirement Provision (IORP) II by placing ESG considerations more firmly on pension funds’ agendas. The action plan on sustainable growth was particularly interesting as it proposed some concrete actions, including:

  • establishing an EU classification system for sustainable activities
  • ccreating standards and labels for green financial products
  • incorporating sustainability when providing financial advice
  • developing sustainability benchmarks
  • requiring integration of sustainability considerations into the investment decision-making process
  • increased transparency for investors.

At the other end, shareholders and companies are impacted by the Shareholders’ Rights Directive which aims to stimulate shareholder long-term engagement, further transparency and better investor-issuer dialogue. The driver behind all these regulatory efforts is not only to encourage more responsible and sustainable capital markets, but also to attract required investments to achieve the targets set out in the Paris Climate Agreement.

One thing we know for sure, is that addressing climate change or the SDGs will require investment – between US$5-7 trillion by 2030 according to the United Nations Development Programme. This is all, of course, to avoid much greater costs at a later stage, as we respond to the impacts of these issues. For example, the costs of weather and climate disasters in 2017 was US$ 206 billion (Forbes, 2018).1 This has resulted in a more sophisticated dialogue and approach to ESG that is starting to influence investment decisions and support the effort to allocate assets as efficiently as possible. At Investec Asset Management we are proactively engaging on these issues, aiming to protect and grow our clients’ capital by ensuring that we integrate these issues.

Progress on the UN Sustainable Development Goals

2020 will be five years since countries across the world adopted the UN Sustainable Development Goals (SDG). Progress towards these goals is mixed. For example, the UN SDG Progress report in 2018 highlighted that there are 38 million more hungry people in the world, rising from 777 million in 2015 to 815 million in 2016. 2017 was also the most costly season for North Atlantic hurricanes with an economic loss estimated at over US$300 billion. Nine out of ten people living in cities breathe polluted air.

On the other hand, more people than ever before are leading a better life. The proportion of the world’s workers living with families on less than US$1.90 per day has declined from 26.9% in 2000 to 9.2% in 2017.2 The mortality rate has continued to drop, and in the least developed countries the proportion of population with access to electricity has more than doubled between 2000-2016.

Figure 1: Percentage share of people living in extreme poverty

Figure 1

Source: World Bank, Jan 2018

Integrating SDGs within investments

The SDGs were developed as a blueprint for countries to achieve a more sustainable future for all. Companies and investors have supported these goals by adapting them into their own approaches to managing and understanding sustainable development priorities and progress. At Investec Asset Management we have used them in translating the pure impact our Emerging Africa Infrastructure Fund (EAIF) has had in Africa, including providing access to affordable energy (SDG 7), decent work and economic growth (SDG 8) and creating jobs and economic development, and industry innovation and infrastructure (SDG 9). Across our other asset classes and investments, we have applied them through developing frameworks around impact investing, including the focus on transformational needs (environmental and social).

The SDGs have provided an important set of milestones and a framework to work within. They are not without challenges though, not least considering the different ways the SDGs can be interpreted and measured. In 2020, the SDGs project will be a third of the way through, so 2019 will become important in terms of starting to sum up the efforts made across the board, and making sure the SDGs have come far enough through the integration processes.

Can we avoid ‘runaway’ climate change?

Climate change is closely linked to many of the SDGs. We have been reminded by the recent Intergovernmental Panel on Climate Change (IPCC) report that we do not have much time before we face the risk of ‘runaway’ climate change, unless wide-scale action is taken to curb emissions. In response to climate change there are numerous investor initiatives. Investec Asset Management is party to many of the leading ones, including the Task Force on Climate-related Financial Disclosures (TCFD), which sets out several recommendations relating to governance, strategy, risk management, metrics and targets.

We believe the momentum this initiative has been gathering over 2018 will continue into 2019 and beyond. We are committed to improving the way we understand and assess our total and individual exposure to carbon risk through our business. Understanding this is fundamental to managing the two main financial risks: asset risk and transition risk. We engage extensively with companies where we see a lack in leadership or long-term strategies to address climate change.

Figure 2: 2100 warming projections

Figure 2

Source: Climate Action Tracker Project, 2017, UN IPCC estimates, 2016 – 2035, https://www.climate-kic.org/news/no-more-excuses-financing-1-5c.

2019 will, no doubt, see the publication of many more detailed reports and commitments around how firms are preparing for and responding to climate change. Interestingly, a significant large-scalea cademic survey in 2018, of a wide group of institutional investors on their attitudes to climate risk, showed the majority of investors thought we would stay within two degrees. The UK was the largest investor base that thought we would pass the three-degree mark.

Figure 3: Institutional investors climate change expectations

Figure 3

Source: The importance of climate risks for institutional investors, August 2018. Philipp Krueger, Zacharias Sautner and Laura T Starks.

The same report also noted that most investors expect regulatory risk to materialise soon and that physical risks were seen already, as well as expected in the short-term (<2 years).

Figure 4: Institutional investors climate change expectations, time horizon

Figure 4

Source: The importance of climate risks for institutional investors, August 2018. Philipp Krueger Zacharias, Sautner and Laura T Starks.

ESG in China

Finally, we think the outlook for focusing on ESG in China is very exciting. With the inclusion of China A-shares into the MSCI Emerging Markets Index, we expect to start seeing improvements in ESG reporting, particularly since ESG rating agencies will start covering them. ESG in China is still at a nascent stage, but momentum is picking up. Corporate Social Responsibility reporting began in 2008, but has been relatively slow. More recently, CSRC (China Securities and Regulatory Commission) and the Ministry of Environmental Protection signed an agreement mandating environmental disclosure in listed companies. Time will tell if this also addresses some of the content issues, which includes lack of social focus, excessive focus on the positives or limited links to operations or management. As an investor in China and the A-share, market Investec Asset Management is working hard at integrating both risks and opportunities for companies in China. The environmental challenges are still many, but we are seeing some good early results from, for example, the strict regulations relating to air pollution in some of the larger cities.

Furthermore, a recent report by ACGA (Asian Corporate Governance Association) stated that there is growing NGO pressures in China to publish corporate social responsibility reports and improve disclosure around environmental matters. A leading NGO in China, the Institute of Public and Environmental Affairs (IPE), an environmental research organisation, has highlighted that the largest number of companies breaching pollution standards are in the chemical sector and public utilities.

As investors we are using a wealth of information sources to determine the ESG performance of a company. We are encouraged by the role the NGOs have played together with policymakers as well as stock exchanges. Together with engagements by shareholders, we believe we can continue to encourage a move to more sustainable companies and markets.

1 https://www.forbes.com/sites/marshallshepherd/2018/01/09/cost-of-weather-climate-disasters-was-306-billion-in- 2017-what-could-you-buy-with-that/#266e210f71ed.
2 https://www.un.org/sustainabledevelopment/progress-report/.

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