First published on Pro Bono News
ESG is a strange beast because what it means to the average person in the street and a fund manager is not the same thing.
Despite a growing enthusiasm for impact investment, many asset owners are constrained because of a baffling array of unverified, opaque and incompatible measurement frameworks.
If you’re a portfolio manager and you’re looking at ESG you incorporate all those factors into the decision-making process for your assessment of the future value of that investment. And that’s completely legitimate, but for most people in the street that’s just doing the job properly. Most normal investors think about how ESG risks pertain to them and their society, their country or their children’s future. So they’re looking at it through a much broader prism.
At a meeting of the UN General Assembly in 2015, member states went some way in mapping out a blueprint to achieve sustainable peace and prosperity for people and the planet, both now and into the future. Underpinning this plan, 17 Sustainable Development Goals (SDGs) were adopted, which are a call to action for the public and private sectors to end poverty and tackle climate change.
But how do we get to a world where there is zero hunger, good health, and economic growth? The United Nations Development Programme estimates that $6trn of annual investment is required to achieve the SDGs. It’s a sum equal to the GDP of both the UK and France combined, but a drop in the ocean compared with the $88.5trn in assets under management worldwide.
A recent survey from OnePoll has shown that around 62% of us would opt to put our pensions and other savings to work in investments that positively impact both society and the environment. Amongst millennials, 86% say that sustainability is a priority when it comes to their investments.
Key trends in ESG
Looking back on 2020, I see these key trends shaping ESG data and ratings:
- One of the most reported facts is the rate of overall sustainability reporting within the S&P 500, the key large-cap US benchmark. Indeed, 90% of index constituents issued a sustainability report in 2020, a massive increase from 20% in 2011.
- Sustainability reporting will be more common throughout broader equity benchmarks. Within the S&P 500, issuing a sustainability report is already basically standard practice. The quality and assurance of these reports will continue to steadily improve, driven by increased use of common frameworks like SASB, TCFD, and others. Look to mid- and small cap companies, private from companies, and other issuers for signals of true growth in corporate disclosure. Formalised ESG reporting will quickly expand in companies outside the large-cap equity benchmarks.
- In 2010, a few voluntary frameworks guided companies reporting ESG data, which was then gathered by investors and specialized data services. In 2020, there’s an abundance of detailed guidance and tools for corporate reporters and other market participants.
- Regulatory schemes mandating more detailed corporate ESG disclosure will continue steadily expand. ESG standard setting done outside of formal government agencies is aligning and becoming more detailed. These soft and hard forms of regulation tended to be optional guidance and phrased broadly, but are increasingly formal and required.
Investor ESG Uptake
- Morningstar tracked a 4x increase in ESG assets from 2018 to 2019 alone, from $5.5 bn to $20.6 bn. Participation in the UN Principles for Responsible Investment has soared as well, from 700+ signatories with $21 trillion AUM in 2010 to 3000+ signatories with over $100 trillion AUM in 2020. ESG investing has entered the mainstream in asset management.
- ESG investing has moved from niche equity products to an approach embedded in all segments of the capital markets. Broader ESG investor interest will amplify trends in ESG data volume and help drive quality improvements ahead of regulatory trends.
Does this mean that ESG data will quickly become as standardised as traditional corporate accounting? Of course not. Similarly, the ESG ratings that are commercially available will continue to have meaningful differences, causing consternation from many. For those who can look beyond this, there are opportunities in this significant expansion in the detail, volume, and overall quality of ESG data.
Companies once had only vague guidance, but now have more information and tools to guide their technical and strategic work on ESG management for businesses. Investors who can step beyond the ratings to assess the wider set of ESG information can deepen their investment analysis through smart ESG integration and compete for assets better in an increasingly competitive marketplace.
Finally, the regulators and others who seek to understand important ESG trends will have a far richer set of data to inform actions and research.
The push for consistency will continue, both by market-led efforts and regulatory mechanisms, driving standardisation in ESG data slowly but surely. However, when it comes to ESG ratings, the most interesting immediate trend will not be alignment, but democratisation. ESG ratings that used to be only available through expensive subscriptions are now more available to those who wish to find them for free. Investment firms are also building out ESG capacity and will be more able to develop ratings internally. It won’t be long before ESG data firms need to adjust their business models.
I expect a few specific issues to develop quickly in 2021, such as climate, impact metrics, and diversity. Corporate risk disclosure may also be quickly transformed by COVID response. However, at this time next year we would not be surprised to find transformation in currently nascent datasets in biodiversity, water, diversity, and human rights. The convergence of these trends may make one year seem like a decade.