Transforming the ESG landscape
Updated: Apr 22
The amount of money flowing into environmental, social and governance (ESG) funds has exploded in recent years. Thirty one trillion US dollars invested sustainably according to the Global Sustainable Investment Alliance as of last June. And with climate change now recognised as the defining issue of the decade and dominating discussions amongst asset managers and other investment professionals, you might think the majority of that thirty one trillion dollars would be invested in environmentally sustainable activities. But you’d be wrong.
The ESG landscape is wide. And it is getting wider. The number of issues and metrics tracked by ESG scoring and ratings agencies such as SustainAnalytics and MSCI is huge. Refinitiv ESG scoring, for example, covers 10 themes and tracks over 400 ESG metrics. Which sounds like a lot, until you discover that MSCI covers 37 ESG key issues and tracks more than 1000 data points.
And ESG scores can vary tremendously between providers due to differences in definitions and methodologies. Frustration with existing ESG frameworks has given rise to a new initiative led by Brian Moynihan, chief executive of Bank of America, which aims to "tame the unruly field" of ESG metrics, as the FT put it in an article on January 14th. Moynihan aims to engage the big four accountancy firms to develop standard ESG measures aligned with the United Nations Sustainable Development Goals.
In the meantime, climate change is just one of many ESG issues asset managers look at in making investment decisions. In fact, according to last year’s Russell Investments 2019 Annual ESG Managers Survey, 86% of ESG managers consider Governance, not Environment, to be the most important ESG component.
Good corporate governance is of course necessary. And there are certain governance issues – in particular diversity of senior management and boards – that need more work. But does the fact that a company is well run, that as an investor you have reasonable confidence in the ability of the management and the board to do their jobs and to obey the law, for example, in relation to anti-corruption and bribery regulations, necessarily merit the award of a special ESG label?
In fact only about 9% of ESG managers in the Russell survey thought environmental factors the most important ESG component. Which means that, perhaps, only around $2.8 trillion of the $31 trillion shown in the above chart are actually invested in an environmentally sustainable way. And not all of that is based on climate-related criteria.
But this is set to change. More asset managers are realising that climate change is now such an overarching issue that it can no longer be ignored. As BlackRock’s CEO, Larry Fink, recently wrote, “Climate change has become a defining factor in companies’ long-term prospects”, one which “Every government, company, and shareholder must confront.”
Fink now believes that we are “on the edge of a fundamental reshaping of finance”. He urges companies to disclose climate-related risks in line with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD) so that asset managers and other investors have the information they need to make better-informed investment decisions about the sustainability of corporate business models in the face of climate change.
As Fink puts it: “In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.” Climate change should therefore soon emerge as the dominant factor amongst ESG criteria, with the TCFD recommendations acting as the catalyst allowing this to happen.
The above article is based on a talk entitled: “Why the TCFD recommendations will transform the ESG landscape”, given recently at the London Institute of Banking and Finance as part of a panel discussion on sustainable finance with Sir Roger Gifford, Chair of the Green Finance Institute, Nick Robins, Professor in Practice – Sustainable Finance at the London School of Economics and Jennifer Thompson of the FT.