Sustainable Finance – It is here to stay. Here’s why.

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Introduction

Back then, it is known that investors focus mainly on financial returns, regardless the impact their investments have on society and the environment. Now, it is a different story. Environmental and social issues continue to be the main highlights of today’s news globally and there is a significant rise of interests made from stakeholders including the investors. 

Apart from that, in many case studies, sustainable funds are observed to be outperforming conventional funds, such as during the covid-19 pandemic period. So, this creates a win-win opportunities situation for investors to reap financial return and at the same time do good for the society and environment.

 

What is Sustainable Finance?

The short definition of sustainable finance is investment or financing that considers environmental, social and governance (ESG) factors into account on top of financial returns. Terms such as green financing and also social impact financing also constitute the sustainable finance spectrum; the former is related to finance activities that stimulate economic growth while simultaneously reduce environmental risks and impacts, and the latter is related to the positive impact created in regards to specifics group of the society.

 

Why is it a big deal?

The struggle to combat climate change impacts varies from ecosystem and biodiversity restoration as well as how we manage natural resources. But this is not enough. Sustainable finance can be the answer to get the win over climate change impacts. Globally, the economy requires up to USD800 billion each year to mitigate the climate crisis by 2030. This is a huge amount. Thus, private entities and public entities around the world have to collaborate on the sustainable finance agenda.

Financial institutions are the key players when it comes to sustainable finance through capital allocations towards sustainable projects and programmes. Financial institutions can provide critical financial support for companies towards sustainable investments and operations.

The role of financial institutions in sustainable finance has been on the rise. On top of that, there is a growing trend for companies to come up with business strategies and commitments that are linked to sustainability i.e.to create positive impact on the environment and society. This results in rising demand for investment through sustainable finance.

Though financial institutions have a vital role to play, sustainable finance initiatives also depend on the involvement of non-profit organisations (NGOs), regulators, investors and governments. Innovation for sustainable finance product offerings depend highly on the alliance of all these entities.

 

Companies are getting serious with sustainable finance

Sustainability in general, brings significant values for companies. Furthermore, there has been greater expectations from employees, to investors, clients, and regulators towards the integration of ESG factors into business model.

Employees demand for a more sustainable business working environment and operations, especially the younger workforce where sustainable values on top of attractive packages are core for them to stay with a company. On top of that, employees also want to affiliate working with companies that invest in projects and programmes through the funding from sustainable finance.

Investors and clients also want to move towards ‘greener’ portfolios where financial returns would also come with positive environmental impact. They want that ‘added’ value so they know they are making a difference in this world.

Regulators all around the world are becoming more and more aggressive in setting their expectations across all sectors to adopt sustainable business.

All of this means that, there is both opportunities and risks elements of sustainability integration for companies which indicates that sustainable finance is important for key and external stakeholders for a company.

That is why, sustainable finance is here to stay.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation  

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Net-zero Emissions – What Can Banks Do?

 

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The urgency to slow the effects of climate crisis is higher than ever. According to the latest data, the world needs to reach net-zero by 2050 in order to avoid the disastrous impact of climate change. All stakeholders play a critical role, from governments, consumers and businesses of all sectors, including financial institutions. In fact, banks contribute a huge part to achieving the net-zero target. This is because, the market requires manor investment to mobilise climate action. Concurrently, this needs to be supplemented with the global commitment to shift away from financing carbon-intensive activities and projects.

Nowadays, we are seeing more and more banks are committing towards net-zero targets. However, as the definition for net-zero or net-zero finance has yet to be standardised, there are still many of these banks do not understand what ‘net-zero’ commitment really entail. This brings limitations towards creating the right and relevant changes throughout their business model to ensure climate action is being assigned effectively.

 

Net-zero. So, what does it mean?

The Paris Agreement recognizes the importance for the world to step up in the fight against climate change, including towards achieving net-zero emissions by 2050 and reduce emissions 50 percent by the year 2030.

There are three long-term targets set by the international Paris Agreement on climate change i.e. (i) focus on climate mitigation, (ii) focus on climate adaptation and (iii) focus “to make all financial flows consistent with pathway towards low-emissions, climate-resilient development”.

For financial institutions, banks in particular, the third goal is where banks act a vital role to materialize the objective of the Paris Climate Agreement. It’s paramount to make climate financing a success as banks have a unique and absolute role through investments, lending and advisory services. In line with the Greenhouse Gas Protocol and the Partnership for Carbon Accounting Financials, nowadays, companies would not only need to recognize the environmental impact of their own operations and supply chains, but they need to also be wary of the impact arising from their products and services. For banks, this is tied to their financing activities for instance, though banks nature of operations may not be directly involved in fossil fuels extraction but financing the fossil fuels extraction projects affiliates the emissions associated with the project.

So, back to the discussion on banks’ net-zero commitment, whether it is in alignment with the Paris Agreement or not, they are committing to take a big action to reduce and eliminate the carbon-intensive financing over a period of time.  “Net zero” is achieved when the amount of emissions added is no more than the amount taken away or the achieve the balance between the amount of greenhouse gas produced and the amount removed from the atmosphere.

 

Net-zero Commitment – How Far Have Banks Come?

Even before the Paris Agreement in 2015, some of the major banks have initiated the journey towards Sustainable Finance. The embrace was sparked not only due to the environmental trends but also due to its commercial opportunity. Since the Paris Agreement was established in 2015, we are now seeing more and more banks are following the likes of the JPMorgan Chase, Citibank, Bank of America, Wells Fargo, Goldman Sachs and Morgan Stanley that *pledges towards net-zero.

However, despite the global focus on mitigating climate change impacts, we still have not seen any fundamental transformation towards Paris Agreement from some of the large banks. This is because we are still seeing banks financing and even expanding their fossil-fuel portfolio.

On the bright side, we are witnessing an upward trend of banks promoting values-based banking that highlights that sustainable financing or the shift towards net-zero can also be profitable and at the same time gaining recognitions from various key stakeholders including investors, shareholders and NGOs. These banks also advocates their net-zero journey with the customers and clients and are already becoming the bank of choice for customers and clients that are more keen towards Environmental, Social and Governance (ESG).

 

What Do Banks Need to Do to Shift Towards Net-zero?

Based on industry best practices and experience gathering from bankers across the globe, two common factors have been identified that can help accelerate the transition toward net-zero financing; client engagement and product innovation.

First of all, from the very beginning, banks need to comprehend that committing towards Paris Agreement will enforce changes to the business model, including on how effective and fast it can respond to the climate risks as well as how all of this can be monitored.

Only then banks can take the necessary steps to innovate their product offerings and at the same time proactively engage their clients on the bank can tailor the climate financing journey over short, medium and long-term, to achieve net-zero.

 

Client Engagement

Banks should commit to put in place policies that are ambitious, yet realistic to align their client engagements with the Paris Agreement strategies that centralised towards supporting them towards climate transition. Obviously, as stated earlier, there are still many banks that have the strategy or the affordability to exclude most of its clients that include those in the climate-intensive sectors. Mostly, banks would state a forward limited restriction on some of these sectors such as financing coal.

Banks need to clearly state the expectations that their clients’ climate transition is necessary over a specific period of time, monitor their progress and assess whether it is all in pace with the banks’ net-zero commitment. Banks must also inform clients of the consequences if the clients are unable to meet the banks expectations that might also include an exit strategy.

There are some practical steps banks may adopt in client engagement process to achieve net-zero:

·         Banks should gather and monitor clients’ emissions data from their operations. The availability of data allows banks to develop low-carbon transition plans for their client engagement strategies.

·         Banks should set emission-reduction targets for the client to align to the banks’ net-zero commitment, guided by the completeness of emissions data as well as credible methodologies such as Science Based Targets.

·    Banks should present peer benchmarking for their clients to the industry best practices. This will indicate whether the clients are on the right track of aligning to the banks’ net-zero commitments or require improvements in terms of progress and reporting.

·   Banks should craft structured client-engagement policies to get clients on board towards the transition to low-carbon activities. The policies should also include a realistic timeframe for the transition as well as the standards that will lead to dismissal.

·      Banks should equip relationship managers with knowledge on climate change and the banks net-zero commitments. On top of that, setting the right KPIs on net-zero for the relationship managers could also be implemented to ensure the effective implementation.

 

Product Innovation

Apart from client engagements, banks also have a key role to play in providing the product offerings that can enable their clients towards low-carbon activities, such as green bonds or Sustainability-linked loans. The objective of green bonds is like any other conventional bond issuance, but green bonds raise capital for specific green activities or projects. Green bonds usually involve interest rates that are tied on clients’ activities Sustainability KPIs such as emission targets, pollution index, or even waste management. This is pretty much similar to the concept of Sustainability-linked loans with conventional loans.  

These product could further accelerate the adoption of Sustainability from clients as through these products, companies may benefit lower interest rates and at the same time be more sustainable.

Green products of banks need to be based on international standards that can provide credibility and assurance on the real impact of the clients low-carbon transitions. This is extremely crucial to avoid greenwashing from higher-polluting clients as part of the banks green financing. Hence, the monitoring of the client’s activities and projects and getting a third-party verification on the low-carbon standard alignment may be applicable.

 

Conclusion

Through financing, banks have indirect impact across every sector. The exposure highlights the significance role of banks towards the world economic sustainability. To achieve net-zero, banks cannot move alone. They need to collaborate and work together with businesses towards the common climate objective through series of engagements and delivering climate product solutions.

Regulators and governments must also be in the picture to set the tone of getting all stakeholders on board towards climate-resilient world and economy.

A lot still needs to be done. Banks, in particular, have to up their climate game to achieve this global agenda.

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation  

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Why Should Companies Engage on ESG Issues to Its Investors?

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Introduction

Environmental, Social and Governance (ESG) has unquestionably becoming the centre of attention in corporate strategy for organisations across industries and regions. Not that we have come to the desired maturity of adopting ESG in the overall business decision making process, but the increase ESG commitment should be taken positive and applaud. However, how can companies excel in communicating their ESG progress to one of their most important stakeholders i.e. investors?

 

Investors are Assessing Companies ESG Management

Recently, the world’s largest asset manager, BlackRock in a report had identified 244 companies that have not showcased their mitigation plans on climate change adequately enough through their business practices as well as corporate disclosures to their stakeholders including investors. Subsequently, BlackRock has drastically voted against directors at 53 out of those 244 companies while assuring to vote against the directors from the remaining companies in the following year if the companies fail to demonstrate ‘significant progress’ within a year.

This action would have ripple effect for other managers for sure. It’s important to be reminded that even before the COVID-19 pandemic crisis, ESG issues have already been gaining interest from asset managers worldwide. Now that the pandemic has shown great impact on a large group of stakeholders, and have cause constant social unrest, it would only mean that companies are pressured to not only initiate to reaching out to institutional investors and stakeholders on ongoing and future ESG risks and threats that could (and will) impact the entire value chain of all businesses regardless of their size.

Following is the overview of some key voting results for 2020 according to the report:

• 2020: 5 environmental proposals passed (0 in 2019), including three    large-cap companies i.e. Chevron Corporation, J.B. Hunt Transport  Services, and Dollar Tree 
• 2020: 55.1% increase in support for employment diversity proposals (38.5% increase in 2019), including for Fastenal Company, O'Reilly Automotive, and Fortinet.
• 2020: 32.5%  Increase in average support for Board diversity proposals (18.7% in 2019)
• 2020: Increase in percentage of political contribution-related proposals proportion i.e. 24 out of 27 (37 out of 60 in 2019).

Due to time restrictions because of the requirements for investor and shareholder proposals submission, the majority of the ESG items for 2020’s ballots were issued on quarter 4 or late 2019 i.e. prior to the COVID-19 crisis as well as the recent racial tension and economic inequality issues had peaked. All of these global developments have and will continue to require companies to see the rise in proposals related to diversity and inclusion, racial justice, socioeconomic inequality, health and safety, climate change and other ESG-related factors in the 2021 proxy season.

Understanding and responding these changes is one thing, but communication is another thing. During a pressured time like this, it’s important to stress repeatedly that if stakeholder engagement with investors are not being conducted strategically, frequently and quickly pertaining these emerging issues, companies could be swamped with proposals but most severely, with frustrated investors communicating their agitations through formal and informal channels. Thus, the responsible parties from the companies such as the Board, Senior Management, and particularly investors relations, public relations and legal will face excruciating pressure to address convincingly the companies’ responses to these issues. If not, the repercussions will turn out to be more complicated that could only mean companies will be affected financially.

 

How Should Companies Approach Investor Engagement Process?

Communicating ESG Issues to Investors

Regardless of the size of the investors, many investors nowadays are well-informed on current and arising ESG issues. Some of them also care about the companies’ efforts in ESG management. Questioning of companies’ ESG or Sustainability agenda has becoming more common and confirms the investors’ keen on the issues. So, when companies conduct engagement with investors on ESG issues, it is absolutely critical for companies to be aware of the best approach to take, what metrices are appropriate and easy to understand in order to monitor ESG performance and also to evaluate the level of acceptance of the responses by the investors. Making progress in ESG performance is certainly good to be transparent with the investors but it is also very important to ensure that investors obtain the most information on how effective the companies manage their ESG agenda.

A good place to start is for companies to assess the specific processes and resources that all relevant investors undertake to assess the ESG policies and practices. The assessment should cater to all investors, hence there should not be one generic approach for this. BlackRock for example, are observed to be focused on ‘corporate purpose’ as well as ESG-related topics. This trend is accelerating as investment firms with a stated ‘core’ emphasis on ESG would most like consist trained and specialized function to conduct their own company evaluation.

For some other investors on the other hand, may not be as robust as they would normally involve ESG-related engagement to regular and unspecified portfolio management teams. This will change, as it is demanded in the future that asset managers are to be familiar with embedding ESG as their mainstream investment portfolio.  

 

Understanding ESG Risks

To achieve productive and effective engagement with institutional investors, companies must first establish high level of knowledge and vision pertaining ESG trends and issues as well as its impacts towards business, including across the value chain, affecting all relevant stakeholders. Companies should be able to equip themselves with the resources to manage material ESG risks and opportunities particularly that represents the substantial ‘risk to value’ issues to the business and should be strategic in communicating on these issues with investors.

Conventionally, it is well understood that personnel from the investor relations would undertake the duty to engage with the investors. Not that this should be necessarily changed but it is important to note that personnel that drive and support ESG-related functions (within the organisation and across different levels) would possess the most valuable input pertaining the ESG issues that the investor relations personnel may be restricted to, or facing difficulties to convey the response effectively. In specific ESG issues, ESG personnel should be the key representatives to address these issues so that more insights and transparency could be presented to investors. 

 

Oversight and Reporting

As covered earlier, investors are keen to substantiate companies’ ESG performance and progress through an appropriate, suitable and standardised ESG performance tracking metrices, normally via reporting. From the companies’ point of view, it is agreeable that this is not an easy task especially taking account that there are widely different services and frameworks that provide ESG-related measurements and ratings including the widely referred to such as the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) as well as the Task Force on Climate-related Financial Disclosures (TCFD) standards, that has been gaining attraction in developed markets. Recently, the GRI and SASB had announced a collaboration to standardise the two standards for better and effective adoption. This is just a proof or subsequent effect of how complicated these various frameworks is to reporting companies.

However, companies are still required to find the solution to ensure they can improve their reporting on ESG performance so that it meets the full expectations and understanding of the investors. Before adopting a framework, reporting companies must analyse which reporting frameworks are best suited for their institutional investors. At the end of the day, as long as the investors could maximise the input from the ESG reporting metrics, companies would be on the right track.

 

Now is the Time for Companies to Respond

Another matter that needs the attention from companies is on the most appropriate time to engage with institutional investors on ESG-related issues. Companies should never delay on the opportunity to engage so that communication on ESG matters are always up-to-date and observed as always one of the priorities by companies.

However, as stated, companies need to be mindful that prior engagement, they should be prepared and equipped with ESG issues and future trends as well as its impacts to the business explicitly on issues that have the highest level of priority and interest by each investors.

Rather than immediate financial returns, more investors are eager seeking long-term value creation from ESG risks so providing them the related information and would portray the companies are established with robust risk management process, market expertise, business resilient and overall, considered as sustainable companies to invest in in the long run. This being said, communicating with them on these information as quickly as possible, would increase confidence to the investors as they would view the companies as reliable and as future (or/and current) industry leaders.

 

Conclusion

It is a difficult time for public and private companies to strive in balancing financial and non-financial sustainability in this current disrupted economy due to COVID-19. The focus on ESG risks and opportunities is becoming more evident as all key stakeholders including customers, community, suppliers and governmental bodies are impacted. Investors should now be engaged more strategically than ever. Companies need to reset the traditional mentality on short and long-term targets and must incorporate ESG issues in the long-term targets – and educate and communicate the investors on the companies ESG ambition. Companies need to ask themselves, is the current investor engagement process still relevant and meets the demands for the future?

 

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation

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COVID-19 and ESG – Why it is Important for Asset Managers

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Introduction

Financial sustainability is the central focus for all businesses and individuals in light of the COVID-19 pandemic. This has also required the Wealth and Asset Management industry to stringently scrutinise the Environmental. Social and Governance (ESG) agenda in the current and future investment strategy. Many companies believe that the attention towards ESG integration can be delayed amid to the current crisis, but experts would disagree because they view that the pandemic is the catalyst to push businesses to dissect their business model and values like never before.

 

ESG is Profitable during COVID-19 Crisis

Recently, the European Union has hired BlackRock which is one of the largest investors in the world with over $7tn in assets under management on 31 December 2019 prominently in the financial services and fossil fuel companies to conduct a research on the ways partnerships and alliances could encourage the integration of ESG issues into its banking supervision. The biggest percentage of assets under BlackRock’s management are in products that track equity and bond indices; hence they control large stakes in many of the world’s biggest companies. This means that verdicts made by European banking regulators on ESG issues will pay a substantial impact on significant number of companies under BlackRock’s portfolio.

In March this year, records have shown that responsible or sustainable investments outperformed other conventional investments up to 5.7% when markets are heavily impacted by the current pandemic. Asset managers should now start making important decisions pertaining ESG. What asset managers should learn from this is that ESG integration is not only vital to ensure long-term sustainable business resilient, but also provides great opportunities during volatile periods. ESG integration would open up doors to more innovation, and targeted solutions that are meaningful and purposeful when conventional investments would not.

 

What is Expected from Asset Managers?

Asset managers that are advanced in incorporating ESG into the investment portfolio are in the advantage in identifying companies that will outshine others during and after the COVID-19 pandemic. Asset managers would need to dig deep on how companies embed ESG into their business models, including in supply chain management, to evaluate better of the imminent effect of the current pandemic crisis and eventually predict the long-term impact on the companies. According to a paper by J.P. Morgan Asset Management (JPMAM) and BNP Paribas Asset Management that studied on the evaluation of the importance of ESG integration in companies operations, apart from better financial performance, companies that have invested in human capital management prior the COVID-19 crisis have showcased greater resilient during the pandemic compared to its peers.

There is a high possibility that asset managers that are not equipped with ESG expertise and guidance will be left behind.  From the investors’ perspective, it is much likely that from now on they will reevaluate the affiliation with the companies they invest in. ESG issues and its impacts to all stakeholders in the long run will be further considered and not just focusing just on short-term financial returns. Though that ESG is relatively ‘new’ in the current overall investment trend, it has certainly getting traction each year and coupled with COVID-19 pandemic (and other ESG issues), this will eventually be the new norm in the market. In his opening keynote speech, the State Street Global Advisors CEO, Cyrus Taraporevala had confirmed this. He also predicts that in the next decade, ESG integration in the investment market would be seen as the mainstream strategy rather than an alternative.

Another lesson we could take from COVID-19 crisis is that digitalisation is key for the future. Advanced technological infrastructures have now been pushed to a greater extent as means of engagements. The pace of sustainable investment would demand in robust ESG data and analytics to be a vital part of asset managers’ tools and investment decisions.

Asset managers should examine the alignment of ESG of the overall corporate goals of companies. According to the World Economic Forum survey, 61% from 20,000 emerging leaders view business models must only be pursued if it creates positive financial as well as societal impacts.

Asset managers must start (if they have not yet) looking at companies’ ESG ratings or social index scores on their financial performance and credit rating. This should form one of the compulsory components in investment decisions. Asset managers should evolve to be a well-rounded ESG expert that furnish their portfolio with ESG risks and opportunities.

Though the world is focused on COVID-19 issues, this certainly does not mean that asset managers should swift their attention away from other pressing ESG issues; climate change in particular. The impact from climate change should be as or if not, more severe compared to the COVID-19 pandemic. Hence, asset managers should keep up and equipped themselves on their positive and negative screening skills to ensure the vision to invest in companies that would persevere or even be in the advantage when climate change has extended its impact to businesses worldwide. They need to be able to identify the companies that embrace low carbon economy, circular economy and renewables and should be able to distinguish with those that are currently and are very much likely to be under ESG scrutiny.

This being said, asset managers should also anticipate to engage or be engaged with various unfamiliar groups of stakeholder as well as fresh capital allocation issues. Asset managers will be expected to cater their investment from specific ESG issues that are unique to the companies, industries as well as regional presence.

Conclusion

Asset managers of the future would function similar to the present; to achieve maximum profit and generating long-term fruitful returns. However, the only difference is that they would need to incorporate ESG not merely to remain resilient, but as the new norm to create sustainable long-term value.

All views and opinions expressed on this site are by the author and do not represent any particular entity or organisation

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