By Marta Maretich @maximpactdotcom
Here’s a riddle: Investors are demanding them. The global business community is boosting them. Companies large and small are trying to figure out how to produce them. What are they?
You guessed it: Extra-financial performance results—the environmental, social and governance (ESG) metrics that demonstrate that a company is acting responsibly as it conducts its business. In a major shift in global attitudes toward sustainability and the role of business in society, this fast-growing area is now a major focus for businesses and investors alike.
Not new, but moving fast
The movement behind making ESG criteria for investing has been gaining ground for four decades, with pioneers like Hazel Henderson and Joan Bavaria of Trillium leading the charge. But the pace of change has recently been accelerating across non-profit, public and business sectors alike leading more investors to look to ESG when making decisions.
Several factors are driving the shift. Increased concerns about the effects of climate change are leading citizens and governments to demand tougher environmental regulations for businesses (E). Social factors (S), such as human rights abuses, are now recognized as material risks. Poor governance is widely seen as a factor in the financial crash of 2008, sparking investor demands for more information about the G in ESG. Meanwhile, evidence is mounting that shows companies that pay attention to extra-financials actually perform better in the long term.
Extra-financial and ultra-influential
All these factors contributed to making 2014 a watershed year for investment decisions based on extra-financial factors. Fossil fuel divestment was one area where investors were seen to make decisions for reasons other than financial performance.
Investors controlling billions of dollars, such as the Rockefeller Brothers, The Wallace Fund and Ben and Jerry’s, all divested their holdings in fossil fuels in an effort to combat climate change. More of this is coming. Major institutions such as museums, universities, city governments and pension funds are all feeling the pressure to divest.
Private investors are an important part of the trend with some 70% now expressing an interest in investing with a conscience. As a result, asset managers in many parts of the industry are climbing on board and looking to expand their expertise in what is a strong growth area of the market.
Changing attitudes to ESG in business
These trends are putting new ESG-related obligations on companies and investors alike.
For companies, there is increased pressure to track and report ESG performance, an activity that costs organizational resources and must be carefully managed for good results. Luckily, attitudes toward ESG are changing across the business world. Top executives no longer see it as mainly a reputational or branding exercise. Rather, ESG-competence is emerging as good business practice that can foster innovation, lead companies to identify efficiencies and help manage risks. Embracing ESG reporting provides greater access to capital, too. It’s a necessity in a climate where investors will turn down deals with companies that don’t disclose well enough or don’t disclose at all.
Across the world, companies are racing to incorporate ESG into their monitoring and reporting frameworks. To help them, the Global Reporting Initiative (GRI) provides a range of resources, including this one for absolute beginners. GRI starter kit. Other groups, like the EVCA, a European group of private equity investors, have developed their own framework to help businesses disclose ESG performance.
Investors incorporate ESG in decision-making
The EVCA framework—for businesses but developed by investors—is one example of how seriously investors are now taking ESG. And there is further evidence that the investing sector is taking positive steps to get better at incorporating extra-financials into decision-making processes.
The UN-sponsored Principles for Responsible Investing (PRI) initiative has been around since 2005 and today has 1,371 signatories around the world. The PRI provides a framework for incorporating ESG concerns into investment practice as well as reporting. It now includes a climate change pledge for asset owners.
Global investors are banding together around ESG, joining groups like the Global Sustainable Investor’s (GSI) Alliance. The Alliance supports progress in sustainable investing by identifying trends and acting as a network for national groups. It has attracted important national members including Europe’s Eurosif, British UKSIF, American US SIF, Canadian RIA and the Asian region ASrIA.
Standards are also being developed to help investors compare ESG performance across companies. The CDP amasses disclosure data on climate change issues and works with investors and companies to improve performance and reporting. Today its membership includes more than 822 institutional investors representing in excess of US$95 trillion in assets. In 2014 the CDP scored over 4700 companies on climate-related performance.
Meanwhile, the Sustainability Accounting Standards Board (SASB) is establishing the materiality of sustainability issues, applying an accountancy approach to determining their value. Operating as a non-profit, SASB makes its standards in areas like healthcare, infrastructure and renewable resources available online to investors and businesses alike. Like the CDP and the EVCA, SASB offers paid consultancy services to help clients embed ESG into their reporting and decision-making processes. (Note that this kind of service provision around ESG disclosure looks set to be a growth area for the sector.)
Burdens and opportunities
Extra-financial disclosure presents both a burden and an opportunity for companies and investors. On the burden side, it takes time, resources and in some cases a profound change of attitude for companies and those who capitalize them to embrace ESG and make it part of normal business practice. On the opportunity side, the link between non-financial performance and long-term organizational health and profitability is becoming clearer. That of course leaves aside the core argument for ESG reporting: that it is a powerful tool for reigning in the damage business can do and turning its efforts to benefit in the larger sense. This is something both companies and investors should get behind.