April 26, 2021

Commerce with a conscience – the unstoppable rise of ESG

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It’s often said that we live in a changing world, a world where awareness of human rights, the environment and equality are growing exponentially.  It would be naïve to expect – or perhaps even permit – business and commerce to act in isolation from this new mindset.

It is in this ethically-rich soil that environmental, social and governance (ESG) investments – in other words, investments that are responsible, sustainable and principled – are set to prosper.  Today’s investors increasingly think about their investment decisions differently.  They want their money not just to earn something, but to do something.

But is ESG a uniquely modern concept?  Arguably, one can trace its roots back to the 1960s and 1970s when conscientious investors channeled the ‘protest spirit’ to shift their financial allegiance from the morally dubious to the socially beneficial.  As such, many rerouted monies from industries supporting divisive regimes into projects such as affordable housing and healthcare facilities.

The idea gained further traction in the 1980s when sociologist James S. Coleman argued for ‘social capital’ to become a valid measurement of value – a concept seized upon by contemporary environmental activists. 

In the 1990s came the notion of the ‘triple bottom line’, tying social and environmental concerns to the more traditional financial yardstick of success.  By the 2000s, the first environmental financial research group was established.  This so-called ‘virtuous circle’ comprised City of London bankers, lawyers and NGOs, who demonstrated a link between financial performance and environmental/social standards.

The orthodox view that return on investment (ROI) and philanthropy were incompatible was at last beginning to recede, and in 2011 a list of the hundred best companies to work for published in the Journal of Financial Economics showed stock returns more than 2% better than their rivals.[1]

As awareness and concern around climate change increased rapidly throughout the 2000s, ‘people power’ gave new energy to the once fringe view that business had a function beyond generating profits – and propelled environment-driven ESG up the financial priority agenda.

What we have witnessed over the past few years is an acceleration of that original, pure ideal: can one make money while simultaneously making the world a better place?

The answer is unequivocally ‘yes’ and the strength of the data reinforces this opinion.

An environment worth trillions

The ascendancy of ESG funding demonstrates how investors are increasingly aligning their goals with hot-button topics such as climate change.

Even in a COVID-blighted 2020, ESG investments have rallied globally, despite widespread market turmoil[2].  Banking colossus Goldman Sachs has taken note, telling clients that “prior to this crisis there was a meaningful and increasing focus on ESG investing and it is likely that this focus will only increase following coronavirus.”[3]

The Financial Times tips ESG funds in Europe to treble in scale between now and 2025, reaching €7.6 trillion over the next five years, accounting for more than half of the European fund sector.[4]  It’s big business, and the word is spreading fast. 

A Morgan Stanley survey showed four out of five asset owners were now factoring ESG considerations into their investment choices[5], while a poll from KPMG revealed more than a third of top company executives were increasing their focus on ESG due to investor concerns.[6]

For green investment in particular, ESG is a true game changer.

At its most basic level, the rising focus on ESG will compel businesses to be more open about their environmental impact.  More importantly however, investment translates into infrastructure, talent and research.  Logically, ESG will therefore dictate which businesses are destined to flourish amid a transformative influx of funds.

With technology trumping heavy industry in the eyes of ESG investors, for instance, we can begin to forecast which sectors are primed to soar in the coming decades.

With the world braced for radical climate change (a temperature rise of at least 2.5˚C is predicted for this Century[7]) it is the E in ESG – the Environment – which will likely fuel the ESG investment surge in years ahead.  Whether it will save us from our hubris remains unknown.  Its impact on the market is more quantifiable.

How ESG energizes ROI

A more habitable environment is essential for a prosperous world and has long-term ramifications, as I discussed in a previous Spotlight article.  Accordingly, investments with a green bias inspire long-term confidence – a potential ‘holy grail’ in any portfolio unevenly weighted towards short-term results.

A seven-year study by Barclays showed portfolios with a high ESG component consistently outperformed those with a low ESG component.  The combined environmental, social and governance performance boost averaged 0.36%, or 0.27% for environmental criteria alone.[8]

Ample demonstration, according to the report, that “incorporating an ESG tilt in an investment-grade credit portfolio is not detrimental to returns but can be beneficial”.  Higher ESG ratings also tally with stronger credit ratings.

In investment circles, ‘knowledge is power’.  US finance giant MSCI argues that ESG factors are increasingly important in identifying better managed companies, while raising red flags over those likely to face headwinds due to environmental decline.

Performance, predictability and confidence are powerful motivators for investors, and high ESG profiles can be a hallmark of all three.  In a risk-based game, it’s no wonder ESG is the buzz-phrase about town.

The energy market is especially sensitive to trends in environmental investment.  Indeed, the International Energy Agency (IEA) points to a record slump in global energy investment during the pandemic of 2020.  Yet the headline figure – an 18% fall in capital expenditure across the energy sector[9] – conceals further promise for ESG investment, with smaller contractions (and greater resilience) in renewable power, such as wind and solar.

While power generation investment was estimated to dip 7% overall in 2020, annual spending on renewable power was down only 3% year-on-year, sustained by projects with long lead times such as offshore wind and hydropower.

Investments in oil and gas supplies declined by a third during the same period, driven by cuts of around 45% in shale companies in the United States, beset by bankruptcies and layoffs.  Unsurprisingly, oil and gas companies are swiftly diversifying, which usually means investing in low carbon technologies.  

The IEA notes financial commitments have clustered around renewable power, with US$ 3.5 billion of final investment decisions (FIDs) taken by oil and gas companies in 2020, two-thirds higher than their capital spend outside of core areas in 2019.

Shrewd investors have an instinct for spotting where the momentum lies.  With the world gradually – and unstoppably – turning greener, the environmental elements of an ESG portfolio begin to look more enticing by the year.

Nor is it only about changing institutional investing patterns.  Private businesses – like Abdul Latif Jameel – can help to catalyze both business and government investment into solutions to combat climate change and accelerate a green recovery.  Organizations like the Clean, Renewable and Environmental Opportunities Syndicate (CREO Syndicate), of which Abdul Latif Jameel is a member, are already helping to change attitudes and explore private investment opportunities across the global ESG marketplace.

As the CREO explains in a white paper, “Overall interest in sustainable investing is growing as many institutional investors and wealth owners re-evaluate their exposure to fossil fuels and as political discourse on climate risks builds.”[10]

Why ESG is a winning formula

Even if ESG concerns are heartfelt among employees and investors, for businesses it is the bottom line that makes the difference between sinking and swimming.

Management consultancy McKinsey has identified five key ways in which ESG investment can become “much more than a fad or a feel-good exercise”.[11]

  1. Top-line growth: Governing authorities are more likely to trust businesses with a strong ESG proposition, opening up potential new markets; customers, meanwhile, demonstrate more loyalty to sustainable companies and products.
  2. Cost cuts: Efficient use of energy, water and waste can affect operating profits by as much as 60%.
  3. Regulatory and legal benefits: Clear ESG priorities can attract subsidies, government support and deregulation, while avoiding fines and enforcement actions.
  4. Productivity boost: Establishing social credibility has been shown to lure better talent to the workforce and increase employee motivation.
  5. Optimization of assets and investments: Targeting capital to long-term, sustainable activities can enhance investment returns, and avoid losing ground to greener rivals.

Of course, successfully designing an ESG strategy can be easier said than done for many businesses.  

McKinsey advises focusing on a limited number of environmental goals to avoid competing projects working at cross purpose, and planning for potential short-term hits to operating profits.  It also recommends tailoring any pitch to investors to emphasize ‘value’ rather than ‘saving the planet’.

Financial and communication nuances aside, other roadblocks might threaten the smooth adoption of ESG principles.  Businesses can, depending on jurisdiction, face a legal obligation to maximize shareholder wealth above all other considerations.[12]

Such cases have shown how delicate the tension can be between a community and a commercial ethos – or more pointedly, between the public good and private enrichment.

If ESG is still a work-in-progress from an individual business perspective, challenges also remain from an investor standpoint.

Inconsistency impeding full potential

The case for ESG investment appears inarguable from the evidence in hand, yet projections are only as reliable as the data upon which they are built.

The ESG financial ecosystem is still evolving, which puts pressure on issuers and investors when it comes to disclosing information.  While progress has been made by several key players in standardizing ESG practices, there remains a diverse array of terminology and disclosure frameworks.[13]  Such inconsistencies can deprive investors of dependable comparability measures.

Yes, ESG methodologies are improving and becoming more transparent, but scoring systems remain in transition, with ratings providers still refining their practices to unify key indicators, metrics and qualitative judgments.

The OECD highlights several steps necessary before investors can realize full value from ESG opportunities:[14]

  • relevant and consistent reporting frameworks
  • more clarity over scoring systems
  • measures to overcome market bias
  • greater alignment of ESG products with investors’ social and financial objectives
  • better public and regulatory engagement

The European Commission is aiming to make comparable standards mandatory via its new Sustainable Finance Disclosure Regulation (SFDR) legislation, which came into force in March 2021.  The laws are designed to increase transparency while discouraging ‘greenwashing’ – in other words, false claims of green credentials.

The new rules specify disclosure in several key areas: sustainability risks (including depreciation risks due to environmental or social events); investment in activities that contribute to environmental or social objectives; and the potential for adverse impacts on other ESG matters (including human rights, anti-corruption and anti-bribery.)  The UK is expected to follow suit in due course with its own version of the SFDR legislation.[15]

As data becomes more dependable, true value will be unlocked via improved analysis.

If investors wish to discover precisely where their money is going and what impact it is having on the wider world, they can increasingly turn to data-driven market research.  Organizations such as financial intelligence firm S&P Global use versatile data platforms to produce ‘normalized ESG benchmarks’.  Such specialist insights aim to inform investors at-a-glance whether a business’s ESG policy is worth the (hopefully recycled) paper it is printed on.

S&P’s Global ESG Scores system claims coverage of more than 7,300 companies, representing 95% of global market capitalization.  It draws on more than 1,000 data points and 100 questions to derive 23 separate criteria scores and an overall weighted rating.   A priceless tool for investors intent on making sustainability a core principle of their portfolios.

Armed with such validity, where might socially aware investors seek to invest their finances?  Increasingly, the answer lies in climate bonds.

Climate bonds offer stamp of authenticity

Reliable, measurable and transparent: climate bonds represent another step in the right direction for green funding. But what exactly are climate bonds and how can they help shape perceptions and power new investments?

Think of climate bonds as fixed-income financial guarantees promoting the funding of environmental projects worldwide.  Or, a way for investors to bet on all our futures, with confidence.

Such bonds can subsidize a range of climate change mitigation schemes: from enabling homeowners to equip their properties with solar panels, to capturing greenhouse gas emissions, helping coral reefs adapt to warmer waters, or building river delta flood defenses.

Certified bonds can be issued by thousands of bodies globally, from states and banks, to businesses and local governments.  And they’re growing rapidly, from US$ 70 billion issued in 2016 to US$ 255 billion in 2019.[16]

The range of projects securing climate bond funding is widening by the day, ultimately limited only by people’s imagination and enthusiasm.

The London-based Climate Bonds Initiative was the world’s first climate bond certification program, and has since been used as a model for other countries to design their own green bond listing bodies.

At Abdul Latif Jameel, we have seized on the vast potential of climate bonds to expand our program of clean energy projects, principally through FRV, a leading global developer of renewable utility-scale projects and part of Abdul Latif Jameel Energy

FRV has a presence on five continents and has developed over 50 renewable energy plants.  It has a global project portfolio in markets including Australia, Europe, and Latin America; and over US$ 3.5 billion in total financing managed with some of the leading banks and financial institutions.  Over 15 years, FRV has been putting ESG principles into practice, engaging with communities and providing higher education scholarships to promising local students.  FRV has a strong track record at the forefront of renewable energy solutions with a development experience of over 5GW including assets currently under development, and plans to invest over US$ 1.5 billion in fixed assets to double their total installed capacity, from 2 GW in 2020 to 4 GW by 2024

In September 2020, it took its ESG activities a stage further when it partnered on the first ever Climate Bond Certified green transaction in Spanish history, securing €64 million financing for its San Serván solar plant in Extremadura.

The photovoltaic plant will become operational in 2022, generating 291 GWh of clean energy each year, enough to offset 216,000 tons of CO2 annually and power more than 100,000 homes.  Investment bank Natixis was underwriter for the deal.  ESG rating and research agency Vigeo Eiris provided verification against the solar criteria of the Climate Bond Standard, ensuring it aligns with the 2˚C warming limit, outlined in the Paris Agreement.

A few weeks after the San Serván deal, FRV secured its second climate bonds deal, for the 90 MWac Sebastopol Solar Farm in New South Wales, Australia – one of the first renewable energy financing deals of its type in the country.  The Sebastopol project, FRV’s seventh solar farm in Australia, is funded by ING in compliance with the Loan Market Association (LMA) Green Loan Principles and the Green Projects requirements.

With San Serván and Sebastopol as templates, it is clear climate bonds will play a central role in unlocking ESG’s near-limitless potential.

Most recently, the US-based tech giant, Amazon announced its global commitment to The Climate Change Pledge, becoming the world’s largest renewable energy purchaser.  The announcement also heralded Europe’s largest ever Power Purchase Agreement (PPA), and in FRV’s Spanish home market, we are proud to continue FRV’s pioneering heritage by being part of this with plants located between Extremadura and Andalucia Regions.  FRV’s long held vision of driving the transition to a more sustainable energy future is a perfectly synergy with Amazon’s pledge to be net zero carbon by 2040, making Amazon’s decision to collaborate with an experienced independent power produce in their Spanish home market a natural choice.

An environment rich in rewards

Only the boldest of prophets would claim ESG will transform the global investment market overnight.  Rather, its steady rise in profile over the past few years heralds an evolution of mindset.  It signifies a newfound recognition of the potential of ethical investment to tackle the most pressing issue of our time: saving the environment.

If ESG is still in low-gear, or even feeling a post-COVID drag, be not dissuaded.  Its influence will only expand as regulatory and reporting methods achieve global standardization.  Why?  Because ESG provides a measure of how money can serve a good beyond merely generating more of itself.  

It provides a tool for businesses to differentiate themselves from their rivals and secure make or-break funds.  Winning investment in today’s climate-conscious world increasingly means mirroring the concerns of investors.  That means businesses not only reducing their carbon footprint but also increasing their transparency on environmental performance.  Not only being green but being seen to be more green.

From an investor perspective, meanwhile, ESG is a pathway by which money can be directed to reflect the concerns of a more socially aware population.  With ESG-weighted investments outperforming the alternatives, more money will naturally follow. In the world of commerce, success breeds success.  And in this respect, the pressure for transparency and regulation is most definitely ‘on.  The US Securities and Exchange Commission’s Acting Chair, Allison Herren Lee recently stated how “The staff of the SEC plays a critically important role in ensuring compliance with disclosure obligations, including those that implicate climate risk, through its review of public company filings and its engagement with issuers.  The perspective the staff brings to bear is invaluable in helping to ensure that issuers comply with their obligations and that investors receive the information they need to properly inform their investment decisions”.

If governments are somewhat limited to being merely reactive, the critical role that can be played private sector capital has the inherent capacity to be positively preemptive.

Together we can encourage big business and governments to ‘do the right thing’ and, in doing so, drive our society towards a greener, more sustainable future.


















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