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The Rise of Sustainability in Capital Markets

Whether you like it or not, Environmental, Social and Governance (ESG) performance issues are no longer just for environmentalists and social-do-good.

Written by Elizabeth J. W. Spencer

ESG has expanded from a baseline of ethical “negative investment screens” that prevent excessive environmental harm, creation of destructive products and overall negative impact on society. ESG performance now demands meaningful contributions from businesses to address the myriad of issues our planet is facing at home and abroad. Additionally, there is a growing body of evidence that ESG isn’t just a cost to business but actually an investment in your business: good ESG performance translates to increased financial performance. That means that investors are actually seeking ESG leaders.

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Firms with a better ESG record than their peers produced higher three-year returns, were more likely to become high-quality stocks, were less likely to have large price declines, and were less likely to go bankrupt.

- June 2019, The Investor Revolution, Robbert G. Eccles

Written by Elizabeth J. W. Spencer

The Genesis of ESG:

The ESG concept was born from a joint initiative between the United Nations (UN) and top financial institutions to integrate sustainability into capital markets. In 2004, UN Secretary General Kofi Annan asked top financial institutions to join in an experiment to mature from the negative screening of Socially Responsible Investing (SRI) by driving deeper relevance in financial markets for ESG.

The term ESG wasn’t actually used until 2005 in a report called, “Who Cares Wins” where the results of the experiment were outlined. This report became the basis for the Principles of Responsible Investing (PRI) in 2006 which started with 63 investment companies representing $6.5 trillion in assets under management (AUM) at the New York Stock Exchange and has since grown to over 2,300 signatories representing nearly $82 trillion AUM. All of these signatories have committed to integrate ESG into their regular financial analysis.

The rise of ESG has stalled at times because many believe that the sole fiduciary duty of business is to maximize financial returns to shareholders. However, time and research have proven that ESG performance and financial returns go hand in hand. Currently, ESG is a big business, rising 34% to almost 31 trillion dollars of investment products worldwide between 2017 and 2019.

So, why have sustainability and transparency risen to the forefront and why are they here to stay?

Government driven ESG regulations and disclosures

Increasing ESG integration into everyday business is credited to the UN, large financial institutions, investors, and consumers, but governments are now following suit with mounting pressure to see consistent disclosures. The European Union (EU) is the leader on regulated ESG risk disclosures for companies and investors. Even though the US Federal Government isn’t yet regulating these non-financial disclosures, that hasn’t stopped states like Illinois messaging what is to come with passing the Sustainable Investing Act in September of 2019, implementing responsible investment policies across publicly managed funds. There are similar laws pending in other States and Illinois serves as the national model for sustainable investing.

The demand for value chain transparency

The E part of ESG has already received significant attention, but now the S and G are catching up as governments, NGOs, customers and investors are not only demanding internal ESG compliance, but also demanding the same of those businesses’ suppliers. Companies need traceability and transparency in their value chains; partnering with suppliers that have similar ESG values and that are making contributions toward the UN Sustainable Development Goals is paramount. Failure to demand the same compliance from supply chains results in human rights violations, significant environmental degradation and other unforeseen negative environmental and social impacts. Increasingly, investors aren’t willing to buy into companies with such supply chain risks. Countries are also stepping up their game to hold companies accountable for supply chains across borders.

Millennials as consumers, employees and investors!

As customers, millennials seem to finally be making good on their convictions. In a research study from 2013-2018, the New York University Center for Sustainable Business (CSB) found that shoppers are actually following through on their convictions for sustainable products with a 50% sales growth in consumer packaged goods.

As employees, 75% of millennials say they would decrease their pay to work for a socially driven business or organization. Not only are millennials wanting to see an impact from their work, but they are willing to take a stand against their employers when they aren’t making a difference. For instance, the Wayfair employees that protested against the sale of furniture to migrant detention centers or the Amazon employees that demanded a climate change plan from their CEO.

As investors, 89% of high networth millennials consider an ESG track record critical for businesses. This is evident in the 34% increase in ESG investment products between 2017-2019. Millennial stakeholders are demanding an increase in ESG performance, as they divest from fossil fuel products, vote against boards of companies where climate change risks aren’t disclosed, and move toward companies that can withstand the future shocks.

Climate change is today.

Unfortunately, climate change has become a divisive partisan issue when it actually isn’t a political issue at all. It’s a fact — maybe not a very convenient fact for the people’s way of life, but it’s still a fact that is no longer in the distant future. Climate scientists agree that climate change is the result of human activity and if the warming of the globe is not reduced to 1.5-2 degrees Celsius above pre-industrial levels, catastrophic damage can occur, forever altering our planet. This has particular financial relevance to whole industries with multi-billion dollar consequences and the Task Force on Climate-Related Financial Disclosures (TCFD) is now pushing for climate-related financial risk disclosures. Larry Fink of BlackRock, a seasoned ESG advocate states, “climate risk is investment risk.” This push for disclosures has spurred many companies to take action to prepare for such risks and in turn reduce and mitigate their carbon footprint.

The integration of ESG into capital markets is signaling a brighter future for a planet where there is less of a disparity between privilege and poverty, where our environment’s protection is valued more than financial profit, and where the UN Sustainable Development Goals are integral to the bottom line of business.

This is the future our team is working toward.


What future are you working toward?

About Elizabeth J. W. Spencer
With a varied career in international politics, social enterprises and a tech start-up, the common thread for Elizabeth over the past decade has been the pursuit of sustainable development in emerging markets. Writing has been the medium to synthesize her experiences in between changing diapers and kissing skinned knees. Elizabeth believes that power of purpose-driven businesses to deliver profitable products at the intersection of societal and environmental benefits can change the world. She lives in an ‘01 converted Blue Bird school bus with her husband, two kids and a Vizsla.

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