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Look past the acronyms and you’ll see increasingly valuable work that will affect both how we invest, and how we address climate change

The Paris Agreement on climate change took place in December 2015 with signatories agreeing to keep the rise in global temperatures below 2 degrees Celsius (above pre-industrial levels). This summer, a number of wildfires, and continued coverage of climate change in the news, has meant that this issue is rightfully gaining greater public awareness. Yet achieving that 2 degrees goal will not happen without the financial sector.

At a European level, the European Union (EU) is examining how to integrate sustainability considerations into its financial policy framework in order to mobilise finance for sustainable growth. As part of this process it has asked for recommendations from a High-Level Expert Group on Sustainable Finance (HLEG) who published their final report on 31st January. This report sows the seeds for large-scale changes to European financial policy and thus the greater use of ESG factors in European investments.

What’s ESG? Why’s it important? What’s next? Read on and you’ll find out.

ESG – what is it?  

ESG refers to Environmental, Social, and Governance factors that can be considered as part of the investment decision-making process. This can be done at an institutional or at an individual level. The United Nations-supported Principles for Responsible Investment (PRI), is one of the leading groups working on understanding the investment implications of ESG factors.

It has more than 1,750 signatories from over 50 countries representing approximately US$70 trillion and is actively working on helping its signatories in incorporating these ESG factors into their own investment and ownership decisions. The PRI note that examples of ESG factors are numerous and ever-shifting. They include:

Environmental (E): climate change; greenhouse gas (GHG) emissions; resource depletion: including water, waste and pollution; deforestation

Social (S): working conditions, including slavery and child labour; local communities, including indigenous communities; conflict; health and safety; employee relations and diversity

Governance (G): executive pay; bribery and corruption; political lobbying and donations; board diversity and structure; tax strategy

 

ESG – why’s it important?

Providing accurate, comparable and readily understandable non-financial data as part of a company’s reporting process allows investors to get a broader perspective on a company’s performance. Long-term investors can therefore see which companies are performing well amongst their peers, but importantly they can also see which are performing in a sustainable manner.

Increasing transparency has to be a good thing for the investor, and also for the companies involved, as those that are acting sustainably and responsibly can be rewarded.  Global standards are evolving, and it is still early days, but momentum is building, and not just in Europe. To give one example alone, the number of Chinese companies who produce sustainability reports has increased from just 19 to over 3000 in the last 10 years.

ESG – what’s next:

The European Commission’s (EC’s) Action Plan published on 8th March, aims to mobilise green investment and integrate sustainability into all aspects of the financial system. Elements of this plan include a unified EU classification system/ taxonomy for sustainable assets/ activities and a proposal to clarify asset manager and institutional investor duties regarding how they take sustainability into account in the investment process.

EU criteria and labels for green bonds and investment funds are proposed, as is lowering the capital requirements for certain climate friendly investments. The EC has already proposed the inclusion of ESG factors in the mandates of the European Supervisory Authorities (ESAs). It has also conducted a public consultation on institutional investors’ and asset managers’ duties regarding sustainability.

If we want to live in a safer, cleaner, greener world, whilst also earning a return on our investments then I hope that you’ll agree that the EU’s HLEG report should be welcomed, as should the pending work of the EC, the ESAs, and the PRI, as we focus on ESG.

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Tim Fright
Tim Fright is the Founding Director of Climate Friend. Tim and his colleagues use Hedge Fund-style analytics and Big Data to create an Environmental Social and Governance (ESG) investing framework that can offer responsible investment opportunities with superior risk-adjusted returns. Tim is a graduate of the University of Cambridge and King’s College, London and has more than ten years’ experience in technology and government. He is a communications adviser to, and investor in, several tech start-ups, a Fellow of the Royal Geographical Society, and was part of a 2008 Antarctic expedition which undertook environmental research analysing the effects of climate change on the Beardmore Glacier. @Climate_Friend

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