There is widespread suspicion that big companies do good things for society only when required to by regulators. If deregulation is on the horizon, many people would conclude, companies could start to drop their environmental and social conscience.
But the fact is, at some point sustainability became good business. Companies began to hire sustainability professionals, engage with stakeholders, set goals and measure their progress, and disclose environmental, social and governance (ESG) information to investors. They did all this voluntarily, because it gave them a competitive advantage. These companies managed risk better than other companies, put in place better long-term strategies, and performed better on the stock market.
Investors, eager to make a buck, got interested. "When you look closely, it turns out companies with good control of ESG risks have a lot of other things under control too," an investment banker recently said at a conference. "You begin to see a connection between the animal spirits of the markets and ESG. It's a financial opportunity."
Indeed, sustainability investing has reached a tipping point; it is infiltrating the mainstream. Two recent surveys show enormous growth in awareness, demand for, and supply of ESG investment products and practices. As investors reward corporations for ESG practices, more companies will adopt them, with or without regulatory requirements. Sustainability has acquired a forward momentum that won't be stopped even if government doesn't specifically support or incentivize it.
US SIF: the Forum for Sustainable and Responsible Investment, a trade association, has collected information on its members' activities every two years and tracked trends over time. Separately, Morgan Stanley's Institute for Sustainable Investing, together with Bloomberg, surveyed mainstream asset managers to gauge their appetite for ESG. Both recently came up with startling results: nearly 22% of all assets under management now fall into the ESG category, according to the first survey, and 65% of asset managers polled in the second say they practice sustainable investing.
US SIF says US-domiciled assets under management using ESG strategies grew to $8.72 trillion at the start of 2016, up 33% from two years earlier. The upward trend is likely to have continued throughout 2016, and no one expects it to slow down now.
Asset managers surveyed by Morgan Stanley said client demand is the most significant driver behind the increase in ESG investing. They ranked financial return potential second, followed by personal values held by company leaders, fiduciary duty and global investment trends. This marks a change, given that in the past, fiduciary duty towards shareholders, defined as the primary duty to ensure the best returns to shareholders regardless of other stakeholders' interests, had been cited as a reason not to focus on ESG. Indeed, environmental and social investments had always been considered a loss-making exercise, while today it is clear that, like other sound investments for the long term, they can create value and competitive advantage.
While sustainability investing began mainly with asset managers engaging in negative screening, excluding for example tobacco or weapons companies, 50% of asset managers surveyed by Morgan Stanley said their approach is ESG integration, meaning they systematically include ESG risks and opportunities in their financial analysis. 49% said they engage in impact investing, looking for positive social and/or environmental impact along with financial returns.
Climate change may still be debated in political arenas, but not in the investor community. "Climate change criteria shape the investment of $1.42 trillion in assets under management, a more than fivefold increase since 2014," reads the US SIF report, referring to the start of 2016.
The Financial Stability Board (FSB), an international forum of central banks, created a task force in December 2015 to develop recommendations for climate-related disclosures. The high-powered task force included representatives from the private sector, including Dow Chemical, ENI, Tata and Daimler, as well as JPMorgan Chase, BlackRock and UBS. A year later, the task force published a report recommending a framework for corporate disclosure in four key areas related to climate change: governance, strategy, risk management, and metrics/targets. There is supplemental guidance for certain sectors, such as insurance, energy, transportation, and food. FSB will present a final version of the recommendations at the G20 Summit in July.
Meanwhile, an EU directive requiring ESG disclosures by listed companies goes into effect this year, and major global stock exchanges, including Nasdaq, are coordinating their efforts to promote ESG transparency. Among other ways to report on their ESG progress and societal contributions, companies are beginning to use the UN's Sustainable Development Goals as a framework.
There are plenty of challenges. Among others, investors lament a lack of uniform quantitative data they can integrate into their analytics. But several projects and forums are currently at work solving this problem, and huge progress has already been made.
My prediction for 2017: the road may look bumpy, but a lot of alignment lies ahead. More investors will integrate ESG into their strategies, and more companies will reap financial rewards for contributing to environmental and social progress and for mitigating risks. Companies have the power to turn "development" into "sustainable development," and by doing good, they will also do well.
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