Beyond Green Growth: the ESG Investment Market and the Era of Responsible Investment

Beyond Green Growth: the ESG Investment Market and the Era of Responsible Investment

* By Henrique Pissaia *

* * *

The Green Revolution

One trillion U.S. dollars is the actual size of green bonds issuance accumulated since its first emission in 2007. The debut of European Investment bank with EUR 600 million (US$ 800 million) was a timid first step, followed by the World Bank with US$ 400 million in 2008. From there on, the market gained momentum with issuances reaching around US$ 250 billion, even in 2020 despite the COVID-19.

The Earth Summit, or Rio Summit, in 92 was the first big international event held by the United Nations to discuss issues related to sustainable growth, climate change, and other climate-related topics. It led to the Kyoto Protocol in 1997 and the Paris Agreement in 2015, calling for actions to prevent and mitigate the effects of climate change and CO2 emissions. These Conventions opened up a new avenue for green finance, bonds issuance, and sustainable projects. Since the mid-90s and the beginnings of the 2000s, the world saw the creation of the first sustainable investment funds, agencies, and changes in methodologies in rating agencies and governmental investments until reaching the US$ 1 trillion mark.

Despite the popularity, the green market is just the tip of the iceberg of something more and more acknowledged by its acronym ESG (Environmental, Social and Corporate Governance). These three factors are core for measuring impacts of sustainable and responsible investment in companies, business, and, even to a lesser extension, governments.

The Rise of ESG

According to JP Morgan’s research (Why COVID-19 Could Prove to Be a Major Turning Point for ESG Investing) [1], “assets following global sustainable investment approaches could reach around $45 trillion AUM by the end of 2020”. And according to the Forum for Sustainable and Responsible Investment’s 2020 trends report, the ESG’s related investments represent 33% of the total.

These figures tend to rise more and more as the new generations of managers move towards a more sustainable and inclusive investment view. Environmental and social awareness, social inclusion, ethnics inclusion, gender, and equality, are changing the corporate maxim: shareholders’ wealth maximization. The ESGs revolution is forcing companies and governments to be more responsible in investments and also in its internal relationships and rights of its working force. Making deep compulsory changes on C-suite level and board members’ composition, with a more diverse group of decision-makers, and by consequence more inclusive and socially responsible.

The ESG is not a new initiative. In 2005, the United Nations Environment Program Finance Initiative and the U.N. Global Compact launched an independent initiative called The Principles for Responsible Investment Initiative (PRI) [2], as a framework to improve the analysis of ESG issues in the investment process and to aid companies in the exercise of responsible ownership practices. Moreover, rating agencies, such as S&P, already consider ESG factors for corporate ratings since 2012.

So why ESGs are just calling the public opinion attention in the last 2 to 3 years?

Social and governance are factors that were considered local problems. Equality and inclusion were also used to be polarized in public debate, discussed as a left-right debate, or a free-market vs. governmental intervention dichotomy. In the corporate culture, as ESG topics could, at the first moment, increase costs and thus, jeopardizing shareholders’ wealth maximization. A strong push by public opinion and a generation’s new tendency to consume more responsible products and investing in more socially responsible companies started to change the game. Several ESG investments, such as Invesco WilderHill Clean Energy ETF rising 170% in the last five years, showed that stocks from sustainable companies raised more than a regular business, compared to Russell 1000 that grew 101% [3] and S&P 500 with a 110% return [4] in the same period.

Even one investment giant, BlackRock, in February 2021, announced that “Generating sustainable returns over time requires a sharper focus not only on governance but also on environmental and social factors facing companies”. Also, BlackRock is undertaking efforts to “integrate ESG considerations into our investment processes, and we expect companies to have strategies to manage these issues”.

Additionally, movements like “Me too” and the LGBTQI+ movement, calling attention to gender issues, “Black Lives Matter” movement, calling attention to ethnics and race issues, and the links between the COVID-19 and environmental issues, and abuses committed by companies to its workers during the pandemic helped to put ESG in the spotlight. All these abuses and equality problems were realized to be global problems present in every society, to a bigger or smaller extent. These significant movements were boosted by social media interconnected in this globalized world, helping to call attention to a new way of doing business and governance.

The Key Challenges

The spectrum of topics to be covered by ESG investment are huge. In a short, they cover: climate crisis, sustainability, diversity, human rights, consumer protection, animal welfare, management structure, employee relations, executive compensation, and employee compensation. In this way, as most experts in ESG investment point out, the key challenges, considering these myriads of topics are data, credibility, reporting, monitoring, and auditing ESG investments and companies.

Some years ago, terms as “Greenwhasing” and “Green Sheen” became popular to refer to companies that used to deceive investors and consumers about the climate friendship of their products, projects, and investments due to the lack of definitions regulations, reporting standards and auditing procedures. The history is not different here, and concerns with the so-called “ESG-Whashing” are already in place, calling for regulators and other authorities’ actions.

Companies, Governments, and mainly regulators will need to implement ESG monitoring and oversight in the full cycle of the ESG investments and their projects. This need of constant monitoring and oversight will need to cover the: inception, initiation, due diligence, implementation, monitoring, reporting, and auditing of every ESG investment and project.

Another key challenge is that since all these aspects are new and multidisciplinary. A comprehensive group of well and constant trained professionals will be needed. Companies and governments will have to invest heavily in providing, creating, and keeping these capabilities inside their teams to keep competitive in this new reality.

So, what’s next?

Every disruption takes time. And companies and governments are having to adapt to this new era of responsible investment. The regulations, clear definitions, monitoring, and reporting standards are crucial for the development of the ESG investment market.

In the international arena, the 17 goals of the Sustainable Development Goals [5], by U.N., calling for action, try to harmonize and define some governmental actions towards a more sustainable and equal way of doing business. The “Equator Principles (EPs) is a risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in projects. Primarily intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-making” [6].  The E.U. taxonomy that “is a classification system, establishing a list of environmentally sustainable economic activities. The E.U. taxonomy is an important enabler to scale up sustainable investment and implement the European Green Deal” [7]. In addition, the U.S. Securities and Exchange Commission (SEC) announced that it is working on ESG investments and reporting regulations [8][9].

The E.U. taxonomy is the most advanced regulation in environmental and sustainable investment. Article 8 require organizations to include information in their non-financial statements about how and the extent to which organizations to include information in their non-financial statements about how and the extent to which their activities are “associated with” environmentally sustainable activities. This clear and harmonized reporting will start from January 1st, 2022, to climate change mitigation and climate change adaptation; and from 1 January 2023, as to the sustainable use and protection of water and marine resources, the transition to a circular economy, pollution prevention, and control and the protection and restoration of biodiversity and ecosystems (Article 27) [10]. These regulations will put pressure on other governments to adopt similar regulations and speed up the process.

All these needs for regulations and reporting, in an intricate relationship of International Law, International Policies, Global Policies, local regulations, and environmental sciences opens up lots of opportunities and challenges to lawyers, economists, governmental authorities, public policy professionals, and scientists, making interdisciplinary and constant actualization mandatory for this new era of responsible investment.