ESG: From the margin to the mainstream

By Trevor Allen, product manager, risk and performance, BNP Paribas

Heralded as a ‘new lens’ into a company’s performance and work culture, ESG metrics (Environmental, Social and Governance) are fast gathering momentum as a new way of assessing investment risks.

ESG data measure how well a company is performing as a steward of the natural environment, in its relationships with staff, suppliers, customers and the wider community, and in the way it is led.

Many investors now recognise that ESG factors can affect the performance of their investments, both in terms of risks and returns, amid evidence showing that companies with strong ESG scores can deliver better financial returns. Indeed, in a wide ranging survey we conducted of more than 460 professionals from asset manager and asset owner companies*, we found that 80% incorporated ESG data into their investment process in some way.

ESG data can also highlight potential risks such as those related to climate change which can directly impact investments, for example by increasing production costs.

Another factor is that the millennial generation is more demanding in wanting to know that their money is being invested responsibly and is not contributing to climate change or supporting corrupt governments.

Investment strategies

The United Nations-supported Principles for Responsible Investment, agreed by 100 investors in 2006, provide a framework that investors can use to incorporate ESG into their decision-making and ownership practices.

The number of signatories to the principles has grown strongly over the past 10 years, and now stands at more than 1,500, including 300 institutional investors.

In fact long term asset owners are a significant positive factor in changing how money is invested. Over recent years we have seen many large pensions funds in particular make commitments to decarbonise portfolios and to divest from other potentially harmful sectors – whether that is related to the environment, health or society.

But it is more than sentimentality that is driving this change. There are now market forces which are shaping investment portfolios. Take fossil fuels – coal and oil specifically – as an example. At COP21 in December 2015 – almost 200 countries pledged to keep global warming to two degrees centigrade above pre-industrial levels. In order to achieve this then substantial amounts of the carbon-emitting fuels already discovered must remain in the ground and these so called “stranded assets” will therefore have no value.

Stranded assets are of deep concern to institutional investors, with their long-term fiduciary duties, and as such many are already rotating their portfolios towards a low carbon economic future. External forces are also driving change, with governments, regulators and ratings agencies also putting increasing emphasis on ESG reporting.

In December 2015 France became the first country in the world to adopt a law requiring large institutional investors to disclose information about the way they manage climate risk and how they integrate ESG into their investment strategies. Article 173, is due to come into force this June and was heralded by France’s ecology minister as “the most advanced and ambitious piece of environmental legislation in Europe, and probably the world”.

The law introduces binding energy targets for transport, housing and renewable energy and aims to cut France’s energy consumption in halve by 2050 and to reduce its use of fossil fuels by 30% by 2030.  Crucially, there is an onus on investors – large institutional investors with more than €500m on their balance sheet – to disclose how they address climate change-related risks, split into “physical” and “transition” risks. They are also required to assess and report on their contribution to international efforts to cap global warming and to supporting France’s “energy transition”.

Meanwhile, the European Union has agreed a directive on the disclosure of non-financial and diversity information that will require large companies to report ESG data. And in May last year, Standard & Poor’s, Moody’s and four other ratings agencies announced that they would start including ESG risks in their assessments.