ESG Investing For Dummies. Brendan Bradley

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ESG Investing For Dummies - Brendan Bradley


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rel="nofollow" href="#fb3_img_img_5a579f4c-f593-5c19-a59b-d95c47b06a0d.png" alt="Warning"/> However, while disclosures on ESG factors are becoming more standardized and widespread in general, social aspects are still seen as the most difficult element to analyze and integrate from an ESG perspective. Chapter 4 introduces you to the social factor of ESG.

      Meeting corporate governance requirements

      While corporate governance practices have always been a key valuation factor for companies, for fixed income as much as equities, governance has also received a lot of attention during the COVID-19 pandemic — not only for how corporate boards are ensuring the health and safety of their employees and business partners, but also their wider reach into their supply chain management and how they are coping. At a time when their employees may be on government-supported job retention schemes, attention is also being paid to how management is playing its part in executive compensation plans.

      Investors are also pushing for executive pay to be tied to ESG initiatives, so that boards will be compelled to achieve social and other key targets, rather than paying “lip service” to ESG integration. Already, it’s clear that governance is much more about stewardship (see Chapter 18), assuming a given level of accountability as well as responsibility to generate sustainable benefits, rather than hiding behind the preordained rules that have been handed down through the organization. Some would argue that ESG could be transformed into ESS (Environment, Social, and Stewardship) to recognize the role of stewardship in this process. Regardless, there should be a seamless link between stewardship and wider ESG integration, with investors systematically assessing companies based on ESG risks.

      Flip to Chapter 5 for the full scoop on the governance factor in ESG.

      The global regulatory ecosystem is moving fast, with many countries upholding ESG requirements in regulations. A recent study suggests that in the last decade, governments have enacted over 500 new measures globally to advocate ESG issues. Numerous market participants feel that regulatory developments are a key driver in the uptake of ESG investing. While many voluntary disclosure bodies have contributed to an increase in the availability of ESG data by pushing for greater disclosure and creating frameworks and standards, and therefore the success of the ESG explosion in recent years, the sense is that we’re at the point where we need further mandatory disclosure requirements.

      

Although companies report a lot more sustainability information than in the past, much of the disclosure is aimed at a broader set of stakeholders, which limits its usefulness to investors. They are more interested in a subset of sustainability issues representing key business drivers for value creation, such as the industry-specific factors identified by the Sustainability Accounting Standards Board (SASB). Corporate sustainability reporting has generally lacked an investor focus, encouraging companies to primarily report information on broader ESG factors, which affects the ratings that data providers have been able to produce. The majority of ESG risks that investors want to see are more industry-specific factors.

      The following sections emphasize the increasing shift to regulatory oversight on sustainability as well as the roles played and foresight shown by the United Nations and the disclosure reporting standard-setters in building the agenda that has contributed to the success of ESG.

      Leading the charge: European legislation on ESG

      In Europe, the EU Commission has introduced new disclosure requirements related to sustainable investments. The Sustainable Finance Disclosure Regulation (SFDR) requires all financial market participants in the EU to disclose on ESG issues, with additional requirements for products that promote ESG characteristics or that have sustainable investment objectives. This regulation aims to limit the risk of greenwashing by financial market participants while increasing transparency, which allows investors to better understand how ESG and sustainability influence their investments.

      Parallel to this, the EU Commission has also introduced the Taxonomy Regulation, which establishes an EU-wide taxonomy (akin to a dictionary) of economic activities that can be viewed as environmentally sustainable, using reference to six environmental objectives. This will enable investors and clients to identify environmentally sustainable investments, while bringing greater clarity for asset managers.

      Ahead of its time: The United Nations

      

Going back to much earlier days, one has to applaud the foresight of the United Nations and their influence on the development of sustainable investing in this century. In all, the United Nations have provided a significant contribution to supporting investors’ drive to sustainable impact:

       Starting early in the century, the formation of the United Nations Global Compact is a non-binding pact to encourage businesses worldwide to adopt sustainable and socially responsible policies and report on their implementation. See www.unglobalcompact.org/.

       The Principles for Responsible Investment (PRI) initiative then corralled together a network of international investors to work to put the six principles into practice. The principles were developed by the investment community and signaled the view that ESG issues affect the performance of investment portfolios and therefore should be given suitable consideration by investors in order to fulfill their fiduciary duty. This allows investors to incorporate ESG issues into their decision-making and ownership practices and so better align their objectives with those of society at large. See www.unpri.org/.

       The


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