Since 2016, and the ratification of the Paris Agreement, the investment decisions and priorities of asset managers and advisors have evolved significantly. Environmental and social governance (ESG), the framework which captures a wide range of ‘sustainability’ indicators, is now a core part of the investment decisions made by asset managers.
The global COVID-19 pandemic has accelerated this trend. According to Morningstar, in the first half of 2020 net inflows into ESG funds in the US reached $21 billion, nearly equalling the total amount for the entirety of 2019, which was in itself a record.
In a world where consumer and investor decisions are increasingly influenced by sustainability credentials, ESG is now seen as a base for opportunity, growth and value by asset managers. The major global investor Invesco now ‘focuses on integrating ESG risk and opportunity factors into investment decisions’. According to the latest data from 2018, a third of investors are using ESG assessments to decide what companies to exclude from their portfolios, while an additional third are integrating ESG into investment decisions.
European Regulations aim to make financial services an agent of change by requiring the sector to report the ESG performance of its investee companies. And, the EU regulation on Sustainability-Related Disclosures, taking effect March 10, 2021, hopes to enhance transparency as it requires asset managers to integrate ESG considerations into their practices.
Key stakeholders in the corporate reporting world, such as the IFRS, the UK’s FRC and ESMA, have made it clear that more standardised, relevant and comparable information is required to support this new regulatory environment. For businesses, this increased focus on their ESG reporting provides an opportunity to showcase sustainability in their business models, link it to performance, and capture a lower cost of capital.
Yet it also represents a clear challenge. Many companies have made strides towards giving ESG a greater focus. However, it remains the case that a great number are still far too reliant on legacy ESG reporting tools, manual processes and a lack of dedicated resource. Most businesses are fully cognizant of the direction of travel for ESG reporting and they’re making headway with more sophisticated reporting, providing investors with the assurance they need alongside internally highlighting inefficiencies that need reforming.
However, there is significant work needed to provide investors with the clear, authoritative and error-free reporting that they demand to take advantage of the opportunities many believe ESG will provide.
From a company’s perspective, failure to rise to the challenge of improved reporting means that investment may find its way elsewhere to competitors. As investment flows become more and more influenced by the quality of integrated reporting and sustainability performance, the cost of capital for better performers will continue to fall relative to that of poorer performers.
With sustainable investment portfolios growing around the world, the business case for ESG reporting improvement and transformation is clear. It’s now down to businesses to harness the new tools available to them, and to make changes that will benefit their business, their investors and the planet.