In investing, ESG stands for more than good environmental, social and governance practices. It’s the understanding that as well as generating a return, your investment should have a positive impact.
The EU’s regulatory agenda has had a strong role to play in shaping this landscape, says Sandra Rockett, director, retail and wealth distribution, Irish Life Investment Managers. The new Sustainable Financial Disclosure Regime (SFDR) makes it easier for retail investors and their advisers to identify and compare funds which meet their specific preferences in terms of investment or sustainability objectives.
Under it, funds fall into various categories, including Article 6 funds which do not have a direct sustainability scope but address ESG risks, Article 8 funds which promote ESG characteristics and Article 9 funds which target a very specific sustainability objective.
“At Irish Life, we have been long-term advocates of responsible investing and have incorporated ESG factors throughout our flagship funds like Maps, Reps and Forum, ensuring they all meet the new SFDR Article 8 status,” says Rockett.
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“In simple terms this means that, compared to typical funds or market benchmarks, we invest less in companies that negatively impact the environment or society and more in companies that are making things better. And just as importantly, it means that we use our investment to positively influence all those companies to do better when it comes to ESG issues.”
In recent years there has been significant global growth in ESG investing underpinned by, Rockett believes, both a strong investment case and a strong regulatory agenda.
Investors engage
“At Irish Life we capture issues like climate change by using our two levers of influence – firstly, we invest less in companies more exposed to the risks of climate change and more in companies better positioned from a sustainability perspective,” explains Rockett. “Secondly, as an investor we use our shareholding to influence investee companies to ensure our customers’ best interests.”
Engagement is a vital part of Aviva’s investment process too. “We use our influence through engagement and voting to promote sustainable business practices, gain insights into the quality of a company’s business strategy and governance, and reduce investment risk,” says Peter Smith, investment director, Aviva Investors. “We also use our voice as a leading asset manager to call out poor corporate practices.”
Aviva’s ESG philosophy promotes the relative merits of engagement over divestment as the more effective mechanism for delivering positive outcomes, both for clients and society. “We prefer to stay invested, stay engaged, and partner with companies as they develop their strategies,” Smith explains.
That includes companies dealing in fossil fuels. Under Aviva’s Climate Engagement Escalation Programme (CEEP), launched in early 2021, 30 systemically important carbon emitters from the oil and gas, mining and utilities sectors, which together contribute a third of global carbon emissions, were targeted for engagement.
More than 70 per cent of the companies in CEEP have announced or strengthened their ambition to achieve net-zero by 2050 or sooner. All companies have taken steps to strengthen ESG structures at the board and management levels and provide greater transparency over existing structures and processes, in alignment with Task Force on Climate-Related Financial Disclosures recommendations.
It conducts similar exercises in relation to social and governance factors, including, in one instance, engaging with a global provider of customer relationship management services which had been at the centre of controversy in recent years in relation to employee health and safety and freedom of association.
The current cost-of-living crisis has seen Aviva focus more on what investee companies are doing for employees and customers. “We have focused more on CEO/employee pay ratios and whether the gap between CEO and average workforce pay has fallen,” Smith says.
“Businesses have a responsibility to protect their most vulnerable stakeholders during periods of extreme stress and we will be encouraging more to commit to paying a ‘living wage’ for all workers, support vulnerable customers and show restraint on executive pay.”
Various approaches
How asset managers approach ESG varies. “It could mean, on one hand, coming at it from a business operations perspective – is the company running their business in an environmentally friendly way? Or, on the other, is this company producing products and services that are environmentally friendly?” explains Eileen Rowsome, senior investment analyst with Davy Private Clients.
Varying approaches to ESG can make it hard for consumers to navigate, a fact exacerbated by the investment world’s love of confusing acronyms. Perhaps adding to the retail investor’s confusion is the fact that last year fossil fuels performed better than renewables, a result of the energy crisis. However, over the longer term most progress will be seen in renewables, says Rowsome.
Oil companies can’t just “turn off the taps”, she explains, so when it comes to investing in fossil fuels it may be about investing in those making transformational change or those that have set science-based targets to reduce emissions.
One of the things to look for when considering investing in them is to see where an energy company’s ‘new’ money is being directed, suggests Rowsome. If capital expenditure is going into renewables, that’s one thing. If it’s still going into oil and gas exploration, that’s another.
“Investors have moved away from exclusion, except perhaps for tobacco and cluster-munitions manufacturers, and are looking at the proactive engagement piece, particularly around climate and energy, encouraging companies to change for good,” she adds. The increasing number of publicly held companies signing up to science-based targets is evidence of this.
Perfect storm
With so much happening in relation to ESG right now and so much regulation either already here or on the way, “it’s like the perfect storm,” says Kara McGann, head of social policy at employers’ organisation Ibec.
It includes the new Corporate Sustainability Reporting Directive (CSRD), under which a broader set of large companies, as well as listed SMEs, are required to report on sustainability, and the new Corporate Sustainable Due Diligence Directive (CSDDD) which will significantly change the way companies look at their supply chain from human rights and sustainability perspectives.
It isn’t just listed companies either. “Even if you are not in scope, if you are in the supply chain of a company that is, you are going to be impacted by this,” says McGann.
On top of this comes the new EU Taxonomy, a classification system for sustainable economic activities.
In many ways investors are leading the way on ESG. “The finance sector is probably ahead of general business on this,” says Patricia Callan, Ibec’s head of sectors and director of its Financial Services Ireland Group.
The group believes sustainable finance is now the biggest opportunity facing Ireland’s financial services sector. To capture this opportunity it has worked with the Institute of Bankers to develop the new professional diploma in Sustainable Finance for Compliance Professionals, a world first.
New developments are coming hard and fast. Last year the Central Bank of Ireland established a Climate Forum and published a Sustainable Investment Charter. In March the Aircraft Leasing Ireland (ALI) published its report on Ireland’s potential to shape the future of sustainable aviation fuel manufacturing.
Much work is being done in relation to diversity and inclusion too, including the establishment of a Women in Finance Charter that sees companies set targets for the percentage of women they have throughout their organisation, with the ESRI overseeing the data. “Having key hard metrics will be a game-changer,” says Callan.
In the past investors spoke of the ‘greenium’, whereby investors were expected to pay extra, or accept lower returns, in exchange for sustainable impact. Increasingly that looks set for landfill. “With ESG and finance, it’s not an either/or situation, it’s very much intertwined,” says McGann. “Looking beyond traditional financial measures is here to stay”.
