The changing world of ESG investing

With ESG investing continuing to captivate investors, institutions, fund groups and the financial services industry at large, Oliver Oehri, FE fundinfo's Co-Head of the ESG product group takes a look at some of the emerging trends, technology, potential barriers to adopting ESG principles and tackles some of the myths around the subject.

How has ESG/sustainability, and the ways businesses approach it, evolved in recent years? What trends have driven these changes?

The interest in ESG and sustainability among businesses and their customers has not so much evolved in recent years but grown exponentially. Ten to fifteen years ago it was seen in the business community as a specialist or niche interest among select organisations catering for a distinct type of customer, but today almost every business is considering how their operations impact on the wider world. Those that are not, or who are choosing to ignore it, are potentially harming themselves from a reputational point of view as an increasingly aware consumer population are asking some very pertinent questions.

It is of course consumers who are one of the key drivers of this change. In the investment world where FE fundinfo operates, a younger consumer base, with a global outlook, are as aware of the ethical and sustainable impacts of their financial decision making as they are about the returns on their investments. Like most consumers, they want greater transparency about how and where their money is being invested (or where they are spending it) and naturally, this filters down to fund managers, financial advisers and ultimately the companies in which they invest.

Regulation is another key driver and great steps have been taken in recent years to formulate an effective regulatory system which meets consumer need. Where once ESG was seen as a ‘wild west’ type of market with few restrictions (indeed, the issue of greenwashing is still a persistent concern), regulations like the Sustainable Finance Disclosure Regulation (SFDR) in Europe and the Task Force on Climate-related Financial Disclosures (TCFD) in the UK are attempting to define what exactly constitutes an ‘ethical’, ‘sustainable’ or ‘governance’ product or service. Businesses that want to incorporate ESG factors into their operations will need to consider this carefully.

What have been the common perceptions around the costs and challenges to entry associated with ESG? Which perceptions are accurate, and which are myths?

When ESG and sustainability were seen as more niche, there was a falsehood which said if a business wanted to behave in an ethical or sustainable manner, then it would impact on their bottom line. Ethically or sustainably produced materials, produced by companies with strong governance and the oversight that goes into that for example invariably cost more than materials or services which had no set of standards associated with them whatsoever. Nonetheless, as we have seen with recent scandals (such as the supply chain issue with retailer Boohoo), it is more costly in the long run to not incorporate ESG into your supply chain. This is not only from a sales and numbers point of view, but also reputationally as customers and investors do not want to be associated with a company which does not consider these factors.

Another common perception is that ESG integration into a businesses’ operations is costly and time consuming. This does largely ring true. Procuring reliable ESG data and reporting on which to base operational decisions is costly and requires a certain degree of expertise for its interpretation. Customers are increasingly looking at companies’ ESG reporting and taking active decisions based on it, so ensuring data and reporting is clear, timely and accurate is essential, as is ensuring the right expertise is available in the business to interpret the data. Nonetheless, third party solutions and technology are rapidly evolving in this area and making the process easier as it moves from manual to automated systems. By working with specialist ESG data providers and reporting companies, businesses can reduce their overheads and increase their capacities. In the long run, although it is costly, it should be seen as an investment decision and a necessary cost of doing business.

What barriers to entry do still exist for businesses considering more sustainable operations and strategies?

As ever, it is a question of resource. The speed of uptake of ESG and sustainability as concepts in the business world will undoubtedly have taken many by surprise, particularly among larger organisations who may not be as nimble as SMEs or start-ups. But time is not a commodity which organisations will have a great deal. SFDR product reporting among fund groups starts at the beginning of 2022 and investment firms will increasingly be asking for more data and reporting on the ESG strategies of the businesses in which they invest.

Because of these time pressures, the need to find the right people (ESG specialists, compliance professionals, data analysts, report writers and IT support) will become sharper in the coming years, as will finding the right data and reporting partner if a company chooses to outsource it ESG operations.

What role does technology have to play in helping companies meet their sustainability/ESG goals?

Technology is a gamechanger in terms of costs and processes for businesses. From reporting and data requirements to meeting regulations, software as a service solutions can help businesses understand and mitigate risk as well as being able to demonstrate to their customers – and investors – how they are meeting their ESG strategies and sustainability goals. AI processes are equally important as the world becomes more interconnected. In previous years a car manufacturer for instance may have looked at the carbon they produce in creating their product. Now, with better data sophistication and technology, that same manufacturer can look at the carbon in the whole value chain from their suppliers they use to the carbon emitted by their end customers. Ultimately, this will lead to better reporting and make it easier for businesses to integrate ESG and sustainability into their operations, when it will become the normal way of doing business.