Environmental, Social, Governance (ESG) investment is not breaking news but in recent years there has been significant market momentum in sustainable investing with the growth trend expected to continue, particularly with the transition to a low-carbon economy in line with environmental policies materializing.
Let’s start with the basics
More and more consumers demand ESG, companies implement ESG strategies, investors develop ESG financial products, and regulators introduce ESG regulations. So, what exactly is ESG? The term ESG was first coined in 2005 by UN Global Compact in the landmark report “Who Cares Wins” which, together with the 2005 “Freshfield” report by UNEP/Fi, formed the backbone for the launch of the Principles for Responsible Investment (PRI) at the New York Stock Exchange in 2006 and the launch of the Sustainable Stock Exchange Initiative (SSEI) the following year.
In 2015, the United Nations introduced their 17 Sustainable Development Goals (SDGs), a ‘blueprint to achieve a better and more sustainable future for all’. There are many parallels between these goals and ESG objectives.
Image source: Allens
Investor demand remains the key driver. Social pressures and environmental challenges have exposed investment risks posed by climate change and poor corporate governance, accelerating the growth of ESG investing. The pandemic has only accentuated these trends. And regulators are catching up – although we still have ways to achieve global harmonisation of policies and sustainability standards.
The role of sustainable finance is now more important than ever for at least two reasons:
The Planet. Until we find planets as habitable as Earth, our Earth is all we have for generations to come. Sustainable finance encourages a shift in the historical business mindset of “for-profit” and maximum margins at any cost to introducing “necessary actions” to address industrial climate pollution, preservation of biodiversity, and the circular economy.
Transparency. A new business imperative in a world of ESG-led investing. In a recent EY survey, three-quarters of investors surveyed worldwide said they are more likely to divest from companies with poor ESG track records. The rise of the millennial generation of investors (and increasingly Generation Z), set to inherit trillions over the coming decade, empowered by social media and a heightened corporate activism on social issues, is accelerating the transition to a more environmentally friendly, socially responsible, and climate-resilient global economy.
There is a third reason – Profits. As a McKinsey study points out, “paying attention to environmental, social, and governance (ESG) concerns does not compromise returns—rather, the opposite.” Key factors cited include an increase in top-line growth via new customer segments demanding more sustainable products, cost reductions through optimisation of resource consumptions, government subsidies and support, and better investment returns when allocating capital to opportunities that benefit society.
“Global ESG assets are on track to exceed $53 trillion by 2025, or more than a third of the $140.5 trillion in projected total assets under management. While Europe accounts for half of global ESG assets, the U.S. is now picking up the fastest and may dominate the category starting in 2022. The next wave of growth could come from Asia — particularly Japan, according to BI research.” —Bloomberg Intelligence
Europe is the worldwide leader in sustainable investing, home to almost half of global sustainable investment assets. Sustainable Trade Finance is playing a “key role in delivering on policy objectives under the European green deal as well as the EU’s international commitments on climate and sustainability objectives.” In April 2021, Europe introduced the Corporate Sustainability Reporting Directive (CSRD), which defines a common reporting framework for non-financial data for the first time. This new piece of legislation will come into effect in 2023, with companies expected to submit their report aligning with CSRD on 1 January 2024, for the 2023 financial year.
Ranking second, the United States’ ESG investments continue to expand at a rapid pace, growing by more than 40 percent in 2020, representing one-third of all assets under management. Unlike in Europe, ESG investment in the United States remains largely unregulated and has seen the sector dive into a crisis of integrity and misuse of “greenwashing” due to the lack of well defined and agreed sustainability metrics.
Japan has been practicing Gapponshugi, or “ethical capitalism” since the 19th century. Studies show that Japanese companies often put the interests of employees, customers and society ahead of shareholders. Unsurprisingly, ESG investing is so popular in Japan that even Buddhist monks are getting into it. Policy and regulatory drivers have been key to the development of the sustainable investment market in Japan as is the recent Green Growth Strategy Through Achieving Carbon Neutrality in 2050 introduced in 2021 by the Ministry of Economy, Trade and Industry (METI) and other ministries.
Australia has no overarching source of ESG regulation. Whilst most ESG efforts in Australia have historically focused on governance priorities, and despite Australia’s economic reliance on fossil fuels and commodity exports, Australian investors and investment providers are among the most ESG aware globally. Australia currently has 141 signed and active ESG investment providers that have products aligning with the United Nations Principles for Responsible Investment (UNPRI).
In November 2020, the Australian Sustainable Finance Initiative (ASFI) – comprising major banks, insurers, super funds, civil society, academia and others released its Roadmap, setting out a bold plan to reshape Australia’s financial system to support a thriving Australian society, a healthy environment and a strong and prosperous economy. The Roadmap sets out 37 recommendations that will be required to be delivered across the financial services sector, together with regulators and governments, to strengthen Australia’s financial system with the aim of recovering from the impacts of COVID-19 and delivering a transition to a net zero, resource efficient and inclusive economy.
What are the challenges?
Sustainability considerations are a pivotal part in investors selection criteria, a lack of which can be a deal breaker. The challenges for businesses and investors include:
Information gaps. Many counties have no legal obligation to make ESG related data publicly available. It can be difficult for investors to make thorough ESG analysis with lack of benchmarking and measures available. Businesses are faced with similar difficulties with accessibility and quality of data and will need additional resources in staffing and technology to ensure reporting integrity.
Lack of Global Uniformity. Currently, there are multiple ESG frameworks and a gallimaufry of standards across the globe which, again makes guidance and comparability of data difficult for investors and businesses.
The International Financial Reporting Standards (IFRS) Foundation formally announced the establishment of the International Sustainability Standards Board (ISSB) at the 2021 United Nations Climate Change Conference (COP26) in Glasgow. The ISSB has already made headways and launched a consultation on its first two proposed standards on the 31st March 2022 and aims to issue the new Standards by the end of the year.
Road ahead: future-proofing trade and trade finance
Trade finance has been facilitating international transactions for many years, bridging the gap between exporters and importers. However, there is still a significant gap to close for companies that lack the resources in making the transitional journey to becoming sustainable. Trade Finance has a monumental part to play in this respect, to direct capital towards investments that deliver measurable ESG benefits, and incentivising others to jump on the bandwagon.
Game changing technologies, such as big data, artificial intelligence (AI), digital platforms, blockchain and the Internet of things (IoT) are accelerating existing trends in trade finance, especially in connection to sustainability, transparency and digitisation.
Author: Rachel Davis is the Finance Business Partner at JOST Australia and New Zealand, a supplier in the heavy vehicle industry specialising in truck and trailer connection systems. Rachel’s work at JOST extends from finance functions to all touchpoints of the business’ international relations. With strong experience in Accounting Information systems implementation and enhancements, her focus is on data accuracy and operational improvements. Rachel has Bachelor degrees in Law and Accounting, is an admitted lawyer and most recently a full member of Chartered Accountants Australia & New Zealand. In her spare time, Rachel also volunteers at a Community Legal Centre.