Sustainability is increasingly becoming one of the top criteria for investment choices

The growing world population will result in additional burdens on food, energy, and water that may lead to shortages as time passes and the situation will be exacerbated by climate change in unpredictable ways. Climate change is threatening our natural environment and the overexploitation of natural resources worsens the situation.

Businesses need natural resources for their operations.  As the future of industries depends upon these diminishing resources; financial investors have become increasingly aware of this risk and have started evaluating sustainable business practices that manage natural resources sustainably. Sustainability is the long-term maintenance of well being, which has environmental, economic, and social dimensions which results in responsible management of resources.

As we know, investors or holders of financial assets decide where to invest their money predominantly on the basis of sound financial returns. The decisions are also based on various criteria such as political consideration, technology, team profile, geography, etc. However, sustainability is increasingly becoming one of the top criteria for investment choices.

Three major categories i.e. Environmental, Social and Corporate Governance (ESG) are considered as the central factors in measuring the sustainability and ethical impact of an investment in a company or business. Environmental threats such as pollution, natural disasters, and threats driven by deforestation can harm the operations of the businesses. Such threats can affect the revenues of the company that are not exclusively affected by market mechanisms but are instead driven by environmental causes. Social Concerns like human rights, stakeholders/community involvement, consumer protection, and Governance concerns like transparency and accountability, business ethics, employee relations and welfare, labor rights, preventing extortion, bribery, and financial crime, etc have equal importance in the decision-making process.

The world’s positive inclination appeared when “The Who Cares Wins initiative” was launched in 2004 to support the financial industry’s efforts to integrate environmental, social and governance (ESG) issues into mainstream investment decision-making. The Who Cares Wins initiative was launched by the UN Secretary-General’s Global Compact Office and was endorsed by financial institutions representing more than $6 trillion in assets (International Finance Corporation and the Swiss Government), has noted significant developments since its launch in 2004 (Read more on  UN- Globalcompact website).

This was followed by UN-PRI in 2005. The United Nations Secretary-General invited a group of the world’s largest institutional investors to join a process in developing the Principles for Responsible Investment. The United Nations-backed Principles for Responsible Investment Initiative (PRI) is a network of international investors working together to put the six Principles for Responsible Investment into practice. UN-PRI believe that ESG issues can affect the performance of investment portfolios.  Applying these principles help investors to align with the broader objectives of the society.  UN-PRI encourage investors to adopt the following principles. (Read more on UN-PRI website)

Many experiences and studies have consistently proved that ESG issues have a material impact on the financial performance of investments and hence many investors have started incorporating these categories of risks into their valuations. One of the examples is; In August 2009, Norges Bank Investment Management (NBIM), which runs the US$415 billion Norwegian Government Pension Fund, announced that it would begin evaluating the water risk management practices of 1,100 companies in which it is invested (Water is a crucial natural resource. Water scarcity is now increasingly becoming a threat to water-intensive industries).

Carbon Disclosure Project has done a great job – The Carbon Disclosure Project (CDP) is an independent not-for-profit organization holding the largest database of primary corporate climate change information in the world. Thousands of organizations from across the world’s major economies measure and disclose their greenhouse gas emissions, water use, and climate change strategies through CDP. CDP acts on behalf of 551 institutional investors, holding US$71 trillion in assets under management which helps somehow to trigger such disclosure among different sectors of businesses that have financial investments from these investors.

Companies that do not monitor and report on this ‘non-financial’ performance are vulnerable to denied access to substantial pools of global capital which are managed according to sustainable principles. Analyzing risk and opportunities associated with ESG related risks allows institutional investors to assess a company’s significant social and environmental impacts and its ability to manage those impacts.

World Bank, International Financial Corporation (IFC), European investment bank, HSBC, Standard Chartered, etc have shown their intention towards sustainable investment practices and this is a positive initiative that helps businesses transitioning towards resource-efficient future.

The integration of ESG factors into investment processes is recognized as a way to enhance value. A large number and range of asset owners and managers believe that responsible investment is becoming part of the mainstream. They also believe that investment should be used to manage and mitigate ESG risks and take advantage of ESG opportunities to safeguard assets for future beneficiaries.

References;

UN-PRI, World Bank, International Financial Corporation (IFC), European investment bank, UN-Globalcompact.