Sustainable Investment for a secure Future

**ESG: Environmental, Social and Governance Principles - these are considered the “Three Pillars of Sustainability”**

COVID-19 has been a catalyst for change, where overnight the world was forced to reconsider how we live, work, and engage with the world around us.

As the price of crude oil plummeted to -$37 a barrel in May earlier this year, companies and investors alike turned to the renewable market, and global demand has grown for “sustainable investments” to ensure finances are secure for the future.

Things have progressed from the Paris Climate Agreement in 2016, ratified within the United Nations Framework Convention on Climate Change, and dealing with greenhouse-gas-emissions mitigation, adaptation, and finance. Since then, organisations have been focusing on “sustainable finance” and “ESG”, as regulations and conventions from multiple levels of government are implemented.

What is ESG?

ESG - the Environmental, Social and Governance Principles - are considered the “Three Pillars of Sustainability” and defined by the UN’s Principles for Responsible Investment (PRI) as “The systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions”. What can companies do to ensure they are using the best ESG practice within their firms? The following sections give some examples to help firms and asset managers integrate ESG at different levels of their organizations and decision making.

Environmental sustainability focuses on ensuring that companies are not contributing to damage to the planet and climate change.

One metric for measuring such impacts is Green House Gas (GHG) emissions. Firms should note the extent and scope of these emissions due to their operations using the Green House Gas Protocol, which provides the following kinds of emissions:

Source: Sustainability Exchange/Arup Reports

Scope 1: The direct emission by an organisation of greenhouse gasses such as automobile use and any combustion mechanism used or controlled by the organisation.

Scope 2: Indirect emissions from items or services purchased and utilised by the organisation, such as electrical energy costs.

Scope 3: Additional indirect emissions owned, controlled or generated by others, but resulting from the organisation’s activities, such as the carbon footprint of business travel and waste management.

As part of the EU’s Green Deal to be climate neutral by 2050, sustainable business models and products will become standard, and adopting these practices early will ensure firm-wide transitions are easy, exemplifying a company’s status as a firm focused on a sustainable future

What is Carbon Neutrality and why is it Important?

The concept of Carbon Neutrality (or “Net Zero”) refers to the notion of ensuring that no NET carbon emissions are achieved.

This does not mean carbon cannot be used. It refers to ensuring that carbon material is recycled, repurposed, or reused and feeds into the concept of a “circular economy.”

Carbon neutrality is important, and although we cannot help exhale carbon to exist, the processes in which we choose to create, manufacture, and supply goods can be regulated and ensured that through this creation, environmental harm is mitigated.

More and more firms are contributing to Net Zero through innovations in electric cars, polymer recycling with minimum emissions, and using recycling entropic heat - all concepts which – not that long ago - were unimaginable.

Ideas such as the Circular Economy, where products are made to be recycled, and all materials used within the product can be reused or repurposed in the future, can help in reducing the environmental risks and GHG emissions for a firm, and help achieve carbon neutrality.

The social aspect of ESG looks at how companies engage with social responsibilities and their employment practices. Firms will need to engage with their diversity and gender metrics and might have to focus on sourcing more Black and Minority Ethnic (BAME) employees/directors. While these metrics may not exist as a legislative framework like gender pay discrepancies, Finland, Ireland, and the United Kingdom equality metrics must be noted, alongside active equality planning.

For example, in the UK and Iceland, firms with over 25 employees are expected to publish details regarding gender pay-based discrepancies. Similar developments in France occurred earlier this year, where companies with 50 or more employees are now expected to release annual data, and likewise, within the Netherlands - organisations will be fined if corrections have not been made within companies with large pay discrepancies. Any discrepancies will be expected to be eliminated within 3 years. In Germany, firms with more than 200 personnel, allow employees to request a higher wage if they have received an unfairly low wage in comparison, and firms with over 500 employees are required to create a report detailing how any pay discrepancies came to be, along with steps to rectify.

Companies wondering about sustainable governance metrics now have a defined framework and policies. Governance in ESG looks at the ethical and regulatory implications of a company, from their corporate governance structures and behaviours, where executive remuneration and structures are clear, and effective leadership is prioritised - to how the business conducts itself within its procedures, such as the elimination of bribery or internal corruption. Companies following ESG guidance will be expected to have a panoramic view of all behaviours and risks within the supply chain, ensuring breaches of conduct and protocol are not met with indifference. Correct reporting throughout the company will play a large role in the success of ESG adoption; from tax strategy and reporting to emerging risks within company developments being documented correctly and dealt with swiftly.

In addition, Conflict of interest disclosures and external financial contributions documentation provide transparency as to whether a company is operating in the interests of all shareholders and that equity valuations are linked to sustainable practices.

Timeline for EU Sustainability Directives/Regulations

In 2018 the European Commission met to further develop the taxonomy of sustainable finance and green recovery, where a strategy was developed to ensure the 2050 goals of carbon neutrality are met, involving: A EU sustainability taxonomy, labels, standards, benchmarking and disclosures to ensure that quotas can be met

The Taxonomy in place has had the legislative framework approved, with secondary legislation being introduced later this year in Q4, based on the EU’s Technical Expert Group on Sustainable Finance advice. Additionally, requirements like the EU Green Bond Standard have been introduced, with the framework for finance products arriving in 2021, while benchmarking has issued for ESG disclosures. This will ensure transparency for both the financial sector and governments for performance evaluation, and hopefully encourage a dialogue of sustainability between organisations. The adoption of the taxonomy is expected in December 2021, with additional strategies delivered in Q4 of 2020.

The Shareholder Requirements Directive II (SRD II) will be in effect in September 2020. This directive by the EU ensures that company decisions are in the interest of sustainability, ensuring that shareholders can be effectively identified (while shareholder rights are facilitated), information between relevant entities is correctly issued, costs of operation are clear including appropriate remuneration, and the public disclosures by the relevant bodies. These rules will ensure that effective practices are met by the following organisation types: Intermediaries, Asset Management Companies, Issuers, Advisors (by proxy), and Institutional Investors.

Shortly, by January 2021 it’s expected that a large proportion of the EU Sustainability-Related Financial Disclosures Regulation (SDFR) will take effect. This will mean that entities must discuss sustainability risks as well as their impacts with considerations to adverse repercussions of investments, by disclosing this information through their pre-contractual documents as well as through their websites.

With the majority of the EU Taxonomy requirements in effect by January 1, 2022, the standards will apply to all EU member states and, within that, any financial market participants who offer financial products. Additionally, any company which requires the use of the Non-Financial Reporting Directive (NFRD), will be obliged to disclose information. Additionally, non-EU market actors will need to comply. The legislation is currently being proposed this year to meet this target.

By 2023 the full taxonomy rules will apply and companies will be expected to comply with all of the reforms.

Citations are available below.

Conclusion

Companies are already engaging with existing ESG frameworks. Initiatives such as “B-Corporations” are on the rise, where companies are expected to act inclusively of employees and the greater community, where “products, practices, and profits should aspire to do no harm and benefit all”.

With the advent of social media, consumers have become ever aware of the impact of their investments, and are actively seeking ethically sourced, sustainable produce, whilst also being prepared to spend more on these items. This suggests a growing trend, and with time will likely cause a global shift in the market.

Additionally, consumers are becoming increasingly aware of poor company practice, and can actively influence sales, as seen when fashion brand Boohoo dealt with allegations of bad factory practice, which led to an 18% drop in share prices.

The EU has successfully implemented the legislature and change is on the horizon for the financial services industry. Institutional investors and asset/fund managers must consider the full ramifications of their investments as governments are clamping down on poor business practices.

The modernization of industry is transpiring, with plenty of new potential ventures and opportunities for growth so the verdict is clear, that while it may take time to implement the changes required to ensure ESG practice throughout your firm, the benefits of sustainable investments are explicit; as the world is plagued with pandemic, pollution, and instability, there’s hope for our future when money is directed to appropriate, responsible, sustainable investments.

References, background reading and citations for timelines:

1COVID-19 has been a catalyst for change, where overnight the world was forced to reconsider how we live, work, and engage with the world around us.