ESG you said?

Let us deep dive into ESG investing and see how we may answer the latter question. 

Unless you have been hiding in a bunker since before the oil crisis of the 70’s (you may have aged a bit in this case), you know that Mother Earth or Gaia or whatever you prefer to call it has not been doing particularly well, and if we refer to the latest 2022 International Panel on Climate Change (IPCC) report, it will further experience dramatic changes.

To give you an idea on “how bad”, here are a few of the bullet points mentioned in the 2022 IPCC Report’s Summary for Po licymakers:

• Human influence has warmed the cli mate at a rate that is unprecedented in at least the last 2000 years
• Many changes due to past and future greenhouse gas emissions are irreversible for centuries to millennia, especially changes in the ocean, ice sheets and global sea level.
• If global warming increases, some com pound extreme events with low likelihood in past and current climate will become more frequent

Some of the dramatic consequences listed by the NASA Global Climate Change in clude threats to humans such as more droughts and heat waves, intensive floods, stronger and recurring hurricanes, declining water supplies, damaged or re duced agricultural harvests. Now whether you are a climate change skeptic or not, we will see below that the market is already 2 feet in the game of positive cli mate actions.

Many if not all players in almost every in dustry are committing pledges and rolling out big plans to be the top ESG performer. And even, if some do it for the buzz, one must admit that the topic is taken seriously enough in the European Union.

Indeed, the EU, through its President Ursula von der Leyen, committed to become the world’s first climate neutral continent by 2050. And it seems like the EU is putting their money where their mouth is. Indeed, a slew of regulatory initiatives are in the midst of taking form or already live:

• Corporate Sustainability Reporting Directive (CSRD): A new set of reporting guidelines to replace the current outdated reporting framework (NFRD for Non-Fi nancial Reporting Directive
• European Sustainability Reporting Standards (ESRS): The European Financial Reporting Advisory Group (EFRAG) released the draft of these new standards which are to be included in the CSRD mentioned above.
• The European Green Deal: Transforming the EU into a modern, resource-efficient and competitive economy
• The European Climate Law: a set of rules to ensure that all EU policies and all sectors of the economy and society play their part in making the EU climate-neutral by 2050. It lays the European Green Deal principles into law

The European Investment Bank (EIB) also set forth new standards in its 2022 Group Environmental and Social Sustainability Framework. The EIB Group Environmental and Social Sustainability Framework is an overall policy framework used by the EIB to focus on sustainable and inclusive development, in order to transform our economies and communities into environmentally sound and more resource-efficient ones. It consists of new requirements that all EIB-financed projects must meet.

As we just saw, European regulatory bodies are serious about making our environment more sustainable and we will later see why it is a must in ESG investing. However, lawmakers and governing bodies are not the only ones who have caught the green finance train…

Companies also prove to take concrete action, or at least they try their best. Corporations participate in these grandiose climate initiatives. For example, they may contribute to the European Green Deal by making a pledge. As such, according to the European Union website, they have to — - Identify their carbon footprint and reduce it

• Identify their environmental footprint and lower it
• Increase circularity in their activities, that is increase the use of recycled and/or more sustainable material, generate less waste, and lower energy consumption in production processes
• Respect social sustainability

A couple of companies already jumped on the bandwagon, such as Engie, H&M Group, Philips, Colruyt Group, L’Oréal, just to name a few.

Financial institutions also made headlines by pledging to monitor more carefully ESG factors from their investments portfolios and to invest more into climate-neutral companies.

All in all, it seems like everyone is going green, and that may raise the case of greenwashing.

Impact investing, sustainable investing, green investing, etc. These are all synonyms of ESG investing and it sells well for any company boasting these terms in their communication. Yes, with rising concerns about the ecologic state of our dear Earth, there are numerous consumers willing and ready to pay more for eco-friendly products. So it is with no surprise that some advertise their products as helping the ESG cause, when the contrary actually occurs… A pure act of what it is commonly called greenwashing.

Below is a list of several companies accused of greenwashing:

• Unilever: It was found out that the green packaging and sachet recycling programme of the firm was actually based on a controversial method of chemical recycling. Uniliver is currently ranked 3rd worldwide in terms of plastic pollution. Some of its most popular products include Knorr cooking products, Dove skin care products and Magnum ice-creams
• Volkswagen: The car manufacturer advertised its vehicles as the lowest emitters of harmful gas for years. It was revealed that they had been using a cheating device during tests, and they were eventually fined billions
• BMW, Mercedes Benz, Coca-Cola, H&M, Inditex (Zara, Pull & Bear, etc.), Shell and other dozens of multinational groups market themselves as being positive climate change activists when they clearly net a major negative eco-impact.

Now our goal here is not to pinpoint wrongdoers or the class’ best students. We may just hope that climate panels at major international groups are actively working to change old ways and find the best solutions to lower their climate impact while staying in business.

This entire climate activism clearly finds different engagement rates whether we look at the older or the younger generation of investors. The older generation actually grew up or lived through the worst polluting times we know, as well as through rough social unrest and this climate and social activism is not yet very much anchored in their mind. On the other hand, the younger generation grew up and is now living through the climate urgency awakening and social activism, so there seems to be 2 states of mind when it comes to ESG factors.

Now as always, we may just look at where the money is, and at the end of the day, the older generation of investors, along with its older mentality remains the main force in the investment world. This generation is still mainly looking for returns in their investment, and ESG factors account for a very small part of the factors that they weigh in when it’s time to make an investment decision. While it is not all ESG friendly in the younger generation, we can expect that the rise of awareness they experienced, and the strong activists (or not depending on your political views) that this generation birthed (Greta Thunberg, Assa Traoré, etc.) should push future investors to incorporate more ESG factors in their investment analysis.

A 2020 study of analytics and advisory company Gallup on sustainable investing, which polled investors with a series of questions to determine which factors they prioritize when investing, has the following results:

• The expected return is ranked their top priority
• The risk for potential losses is their 2nd top priority
• The policies of a company rank 3rd — The leadership social values come in at 4th
• The environmental impact is last in this list of 5

Hence, we may conclude that investors, today and regardless of their generation, still first look for the expected return and last, other factors such as ESG ones. We can only wish for a future generation which will make ESG factors more of a priority in the future.

You may wonder how the investment culture can really change and have ESG factors becoming one of their top priorities. Well, investors still decide to put their money where they will get the highest return, and companies try their best to provide the highest return to their investors, while remaining compliant regarding regulations.

Thus, the answer to how we can make positive ESG factors a must into the investment culture seems to be at regulatory levels. Indeed, only effective and efficient regulations may force businesses to incorporate more positive ESG factors in their business. Any business will try their best to avoid potential fines imposed for not respecting their ESG factors threshold. These fines would reduce their results, which would make investors pour their money into other more profitable companies. Other companies which we may expect to have positive ESG factors incorporated in their business, since their results would not be lowered by regulatory fines.

Now of course, we may still have companies with such high profits that fines would not really impact the decision of investors investing in it. What could be a solution would be to have fines as a percentage of the profit, or reserves in case of a loss. These would be extreme measures, but the extreme urgency of the climate situation may require such methods.

Regulators must and will be at the forefront of positive climate change actions in the future. Only regulators can force businesses in the right direction. People, through investors, could have been the driving force in changing businesses behaviors towards climate change, but their appetite for investment return over positive environmental, social and governance impacts prevents them from investing in more ESG respectful companies with less investment return. The EU already made a nice start, and we may only hope that other parts of the world and their regulatory bodies will follow through. What it all means in the end is a better world for everyone, so let us all play our part.

By Anthony Somian, Consulting Manager Square Management.