Why does ESG need to be considered in investments?
Emin Altiparmak Summarised into three broad reasons – which are distinct, but certainly linked.
The first is increased social pressure for accountability and obligation to society. This comes from a range of internal and external stakeholders such as investors, employees and community. A failure to consider this could lead to serious business reputation harm.
Jessica Choong The second is that ESG considerations are desirable to create sustainable value.
- There is growing evidence that ESG funds have outperformed their non-ESG peers over both the short and long term.
- This has evolved out of ESG considerations being considered as risk mitigants, to now being a driver of improved investment decisions and returns.
Stephanie Malon Last but not least are the legal imperatives.
- Incorporating ESG into investment decision making and processes is increasingly recognised as a legal obligation – whether we're talking about directors duties to act in the interests of companies, or a superannuation trustee's duties to act in the best financial interests of members.
- APRA's recently released prudential guidance on climate change financial risk is just one illustration of the increased regulatory focus on ESG.
- And, as mentioned in our previous videos, we're also seeing entities exposed to litigation if they don't adequately address ESG considerations.
What trends are we seeing in ESG investment considerations?
- ESG factors are impacting the full lifecycle of investments, from assessing the value of opportunities, to mitigating risk, and seeking to enhance value through asset management.
- Investors are also focusing on broader aspects of ESG than they have before. While environmental issues such as climate change have more traditionally featured in investment decisions, we're now seeing social and governance issues such as health and safety, labour rights, corporate culture, risk management, ethical behaviour and diversity become more prevalent.
Emin Altiparmak At a macro level, the approaches to implementing ESG considerations can range significantly. These include:
- impact investing (that is, trying to generate specific social or environment benefits through investing);
- negative screens (that is, excluding companies who perform poorly, based on selected ESG criteria);
- imposing obligations on investee entities (for example, to pass through your ESG policies or obligations); and
- ensuring appropriate disclosure of ESG outcomes.
What can you do now to ensure you are in the best position to capitalise on opportunities and address challenges in ESG investments?
1. Understand your legal obligations and stakeholder views
- While you might want to be quick off the mark in adopting and marketing progressive ESG policies and procedures, it's important that that approach is founded on a firm understanding of your legal obligations and regulatory expectations. It should also take into account the obligations and views of your stakeholders.
- These are rapidly evolving – so even if you already have well-developed ESG policies and procedures, now might be a good time to review them.
2. Set policies and procedures
- Investors and fund managers need to ensure their ESG policies and procedures appropriately reflect their legal obligations and their chosen ESG approach.
- This may involve embedding ESG risk assessment in investment processes – such as investment strategy, governance practices and risk frameworks.
- It might also involve passing on appropriate obligations to fund managers or your supply chain.
3. Apply and adapt ESG measures
- You then need to be ready to put these measures into place as 'business as usual'.
- This might mean:
- firstly, updating your due diligence practices, or being ready to respond to investors' questions on ESG;
- secondly, updating your contractual documentation to address your ESG requirements – such as in relation to reporting; or
- thirdly, gearing up for investment opportunities – we've seen the rising interest in ESG-focused investments translate into M&A both on the acquisition side (as investors look to strengthen their ESG-driven portfolios) as well as on the divestment side (as investors look to reduce their exposure to non-ESG focused assets).
Stephanie Malon Investors and fund managers will need to be really proactive in monitoring developments in this dynamic area. As just one example, APRA's looking at international regulatory developments on linking remuneration with climate change financial risk. One thing that we can say for certain is that it's going to be a really busy period ahead for investment and ESG teams.