February 14, 2011
Despite the recent economic downturn, sustainable investment is extending beyond the United States and Europe, and into countries where it was previously not widely practiced. Nearly one out of every eight U.S. dollars under professional management in the United States is represented by socially responsible investment (SRI) assets. SRI approaches integrate social and environmental criteria into investment decisions with the goal of aligning financial activities with social and environmental objectives, values, or beliefs, and can include the incorporation of environmental, social, and governance (ESG) criteria by money managers, shareholder advocacy, and community investment. According to a 2010 report by the Social Investment Forum, at the start of 2010, professionally managed assets in the United States following SRI strategies amounted to US$3.07 trillion—an increase of more than 34 percent since 2005, compared to 3 percent growth for total assets under management (AUM). The growth in Europe is even more pronounced, with total SRI AUM increasing 87 percent in just two years, from €2.7 trillion to €5 trillion at the end of 2009, according to Eurosif.
Although SRI and ESG investments are growing in the United States and Europe, sustainable investment is still very new around the world, and particularly in China, which has overtaken Japan as the world’s second biggest economy. The awareness and capacity of Chinese domestic investment institutions to integrate ESG issues is generally low, and there is lingering skepticism about market demands and the business case for ESG investing. Nevertheless, a few institutions in different segments of the market have started exploring and developing ESG investing products and services to test the market. For example, Aegon-Industrial Fund, the China Securities Index, and CCB-Principal have each created an SRI fund or index in the last two years. The growing number of Chinese companies that strategically manage ESG issues as well as the stronger ESG regulatory environment should create fundamental opportunities and an impetus for increased ESG investing in the country.
ESG Integration Into Traditional Investment Approaches
The more significant story, however, is that more traditional researchers, analysts, and money managers are beginning to integrate ESG data from CSR reports, annual reports, conversations with stakeholders, and public informational portals such as the Carbon Disclosure Project into core investment decisions based on the belief that management of ESG issues is linked to financial returns. ESG data is used to develop a more comprehensive picture of a company’s overall health and management quality, and its ability to expand into new markets, attract knowledgeable and skilled workers, and manage long-term risks and opportunities—a few indicators of strong financial performance.
While ESG integration is still not mainstream in China, increasing demand from institutional investor clients; growing academic research linking ESG with better financial results, improved reporting, and greater data availability; and a rising number of small firms that have established track records are all trends that indicate it is headed in that direction. The rapid uptake of the UN Principles for Responsible Investment is another indicator of this trend: The principles now have over 870 signatories, representing about US$25 trillion in assets. And finally, we’re seeing sustainable investing starting to reach across asset classes—from equity and fixed income to mutual funds and alternative investments.
The Role of Governments and Regulation
Globally, an increase in regulations is driving sustainable investing as well. Efforts around mandatory disclosures by national and regional governments as well as a variety of stock exchanges are likely to continue to drive the consistency and comparability of ESG data that can be used by mainstream investors. Last year’s U.S. Securities Exchange Commission guidance on disclosure of climate change risks and draft conflict minerals reporting rules are two prime examples.
Political pressure on sustainability issues is one of the predominant drivers of the emerging ESG investing trend in China. The Chinese government’s reforms include a combination of ESG-related laws and financial regulations that affect the environment in which firms and investors operate. There has also been tremendous reform of ESG regulations over the past five years, leading to higher standards for business and improved enforcement. In addition, investment managers are leveraging financial regulations to drive improved ESG performance. For example, the Green Securities Policy requires companies in certain sectors to pass an environmental assessment from the Ministry of Environmental Protection (MEP) before applying for a public listing. In the first year of policy enforcement, the MEP inspected 73 companies going public, and of 38 completed inspections, only 18 enterprises passed.
Implications for Public Companies
At present, investors who are integrating ESG data are not looking for one single issue or data point that may affect stock price. Rather, they are seeking to holistically assess a company’s most material issues as an indication of management quality and a company’s positioning for long-term risks and opportunities. Regardless of whether your company is located in Beijing, New York, or Paris, BSR’s overall recommendations include:
- Disclose and communicate ESG performance: Disclosure of ESG data is increasingly seen as a base-level requirement, especially as data providers like Bloomberg begin to aggregate ESG data for use by hundreds of thousands of analysts around the world. Investors view non-disclosure on ESG issues as a lack of awareness and proper management.
- Focus on material ESG opportunities and risks: A strong company should be able to articulate their most material issues and how those issues have an impact on business strategy. Investors want to see that companies can demonstrate how strategic ESG management contributes to profitability, cost-savings, risk management, and/or revenue generation.
- Increase management and board awareness on ESG issues: A part of investors’ due diligence is to evaluate management quality. As ESG issues become increasingly important, investors expect the board and management team to have a strong understanding of ESG issues.
- Involve investor relations: We’ll provide specific recommendations for investor relations in a future article, but mainstream investors want to see that investor relations and the related departments that manage ESG issues are integrated. This is an important indication that a company is aware of and actively managing material issues. Corporate responsibility/sustainability teams should work to build those relationships internally.
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