Green Finance Advisor of Friends of the Earth (HK)
Year to date 2021 has been a banner year for ESG investing where many would argue the coronavirus kicked off a sustained shift of flows and invest interest into ESG themed investments. Flows into ESG themed investment products has reached historic highs and performance of ESG related investments have also proven to outperform traditional investments, busting one of the biggest refrains investors had regarding ESG investing in which many believed ESG investing is only in name and does not produce material benefits in performance for investors. As of August 31, 2021, the MSCI World ESG Leaders index registered 19.8% in return versus the MSCI World index at 18.3%, an outperformance of 1.5% in absolute terms and 8.2% in relative terms. The P/E of the ESG Leaders index stands at 24.82 versus 23.87 for the traditional index, which is a 4% premium over the traditional index. Last but not least, the Sharpe ratio since Sep 28, 2007 is 0.48 for the ESG Leaders index versus 0.47 for the traditional index. These data point to the arrival of ESG investing in the public markets as a mainstream and no longer a wished for but seemingly unattainable reform of the capital markets. This should ensure those public companies who have a demonstrated better ESG implementation and compliance cheaper access to capital and in turn help them to grow more competitively compared to those with a poorer ESG record, which cumulatively should have an incremental impact in achieving ESG goals such as mitigating global warming (MSCI, 2021).
However, it is not enough if public companies are complying with the ESG requirements whilst private companies are not impacted, in fact as the trend in the past decade has been for companies to stay private for longer, enjoying a highly active private equity market and multiple rounds of fundraising, regulators would be amiss if they fail to encourage ESG compliance for private companies. Yet being unlisted companies without quarterly reporting burdens make enforcing ESG frameworks on private companies trickier. There are two ways with which ESG compliance can be enforced for private companies, (i) LPs demanding more disclosure and making ESG scrutiny part of the investment process, and (ii) through value chain relationships, such as a public company demanding a private supplier to provide ESG related disclosures so the public company can comply with its own ESG commitments, for example a public garment manufacturer may demand a private cotton supplier to supply the public company with ESG data, and make ESG compliance a supplier selection criteria. Broad examples of greenhouse gas emissions throughout the value chain can be seen in figure 1 below.
Figure 1. GHG Emissions Throughout the Value Chain
For enforcing compliance through LPs, the
European Commission implemented sustainability-related disclosure requirements
which were first announced in 2018 in March 2021. The requirements are targeted
at asset managers and financial advisors for disclosures about what actions
they are taking on sustainable investing topics. In the US, the SEC announced
the creation of a climate and ESG task force in the Division of Enforcement to
develop initiatives to proactively identify ESG-related misconduct, which will
find and hold responsible those who make unsubstantiated claims (Wiek, 2021).
For enforcement through the value chain, the recent merger of Sustainability Accounting Standards Board (SASB) Foundation and the International Integrated Reporting Council (IIRC) to form the Value Reporting Foundation supports the SEC’s increased interest and initiative in the area of sustainability-related financial disclosures. The standards provide a consistent, comparable, and reliable sustainability information that is material to investment decision making, and has participation from 225 asset owners and asset managers representing approximately $72 trillion in assets under management from around the world (Cohen, 2021).
It is certainly encouraging that public markets adoption of ESG practices are now well accepted and established, however we as advocates for the environment should continue to push for full adoption in private markets in order to expedite to correct the trend in rising global temperatures, as we cannot lose more time in combating climate change, a monumental challenge that will take every incremental change to overcome.
Alexandra Tracy, Green Finance Advisor of Friends of the Earth (HK)
is vital to most long term business survival.
Businesses need natural resources and ecosystem services as inputs into
their production processes. They also depend on healthy ecosystems: networks of
plants, animals and microbes which support life by dealing with waste, maintaining
soil, air and water quality and much more.
the World Economic Forum suggests that US$44 trillion of economic value
generation – or more than half of the world’s total gross domestic product – is
dependent on nature and natural ecoservices.
business impacts on biodiversity
But businesses can have major negative impacts on biodiversity and natural habitats. Direct effects are often connected with land use and waste generation, which can lead to habitat loss, land degradation and erosion or air, soil and water pollution. Species loss may be compounded by the introduction of non-native species which can disrupt surrounding ecosystems.
potential for damage to previously pristine areas in South East Asia is
considerable. Four of the world’s
“biodiversity hotspots” are located in the region, which is home to many unique
species. In addition to the business
itself, construction of associated infrastructure, such as roads and railways,
can often harm or destroy the habitats of animals and plants in the area. They may also make poaching and illegal
resource extraction easier.
the indirect impacts of a business on biodiversity may also be highly damaging,
and are often most difficult to identify, manage and control. For example, they may arise out of sourcing
and production of goods and services associated with the company’s supply
chain. They might be caused by the use
or disposal of the company’s products by partners or consumers. Or they might come from changes in behaviour
by employees or local communities which leads to problems such as unplanned
migration or increased demand for natural resources.
failure to consider biodiversity and ecosystems could lead to disruption to
supply of essential commodities, economic loss from floods or fires and even
scarcity of food products. As well as
these practical problems, biodiversity loss can pose reputational, regulatory
and financial risks to businesses.
can be part of the solution
businesses can learn to develop better relationships with biodiversity and
step is to understand a company’s potential impacts on the environment, both
directly and through its supply chain, and the potential opportunities to
improve its performance. These
assessments may cover an analysis of the geographical localities – in
particular, any biodiversity hotspots – that may be affected by the company’s
operations, as well reviewing its upstream and downstream activities, including
the extraction or production of the materials used in the business.
analysis of biodiversity impacts, a business can define its priorities and set goals
for improvements. These may include
targets for sustainable sourcing or promoting regenerative farming practices
within the supply chain. Some companies
are also seeking to limit their land occupancy or to protect critical habitat
around their operations, for example, by creating ecological corridors that
allow for the movement of species.
Companies also can play an important role in protecting biodiversity by supporting external conservation efforts. The United Nations Environment Programme estimates that investment in biodiversity, climate change and land restoration efforts (which currently stands at a little over US$130 per year) needs to triple in real terms by 2030 and increase four times by 2050 if the world is to meet its climate change, biodiversity and land degradation targets. Currently, private finance makes up only 14 percent of the total investment, leaving enormous scope for business to do more.
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