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Corporations have been grappling with the Business Roundtable’s all-important statement of intent — to move from financial shareholder primacy to broader stakeholder capitalism — and how to translate these goals into practical, measurable, and trackable ESG efforts in their businesses. According to Bloomberg Intelligence, Global ESG assets could exceed $53 trillion by

Based on more than a decade serving in corporate board rooms, here are 10 questions I believe every company should address as they embed an ESG strategy. If corporations fail to address these questions, there is a risk that they will be overtaken by rivals and, at the extreme, could even cease to exist.

1. Is ESG undermining your company’s competitiveness?

Fears that excessive emphasis on ESG could harm a company’s competitiveness are not misplaced. In fact, there are valid questions about whether, if a company places too much energy into ESG objectives, it risks losing its focus on growth, market share, and profits. In March , for example, Emmanuel Faber, Danone’s chief executive and chairman, stepped down amid pressure from activist investors, one of which suggested that Faber “did not manage to strike the right balance between shareholder value creation and sustainability.” More generally, if a company focuses too much on ESG, it could struggle to compete against companies from countries with less rigorous standards, such as China.

But if a company does not focus enough on ESG, it risks falling behind in the market, losing the support of employees, customers, and investors, and potentially even losing the license to trade in more stringent regulatory/ESG environments, like the U.S. and Europe. Finding the correct balance will be hard because the parameters will vary across sectors and geographies, as well as over time. What is essential is that boards consistently review their focus on ESG and judge whether they are managing the trade-offs.

2. Does driving the ESG agenda mean sacrificing company returns?

Business leaders should be aware of the risk that a dogged ESG focus could be seen by some shareholders as harmful or compromising financial shareholder returns. That said, ESG advocates suggest that returns from ESG investment funds are not lower than those of traditional equity funds. In fact, returns can be higher than on broad base indices.

Over the 18 months from November March , the MSCI World ESG Leaders index outperformed the traditional MSCI World by +%. At the same time the JP Morgan ESG EMBI Global Diversified index outperformed the equivalent non-ESG index by +%. However, it’s important to note that big tech companies are core holdings to many ESG funds — and that the technology sector has dominated strong equity index returns in recent years. This raises the question of whether the ESG agenda itself yields returns, or if it’s simply that the highest yielding sector also has strong ESG scores. Even so, investors should not discount the value that an active ESG agenda grants companies in terms of the license to trade — the right to operate a business, which is granted by governments and regulators.

3. How are you navigating ESG trade-offs?

The shift from a world of financial shareholder primacy to broader stakeholder capitalism encompasses a far-reaching agenda — including climate change, worker advocacy, the pursuit of gender and racial diversity, voter rights, and more. All these aspects of ESG are beset with trade-offs that business leaders must navigate.

For example, energy company boards have to weigh urgently tackling climate change against meeting the needs of the over 1 billion people who do not have access to reliable and affordable energy. In addition, business leaders are forced to balance the needs for climate action and decarbonization with the risk that curbing supplies of conventional energy sources could drive up inflation and the cost of living through higher costs of power, heating, and electricity bills.

4. How does ESG change due diligence?

Traditionally, evaluations of a company’s assets (such as in assessing the value of M&A transactions) tend to focus on a set of conventional factors. These include business synergies, tax consequences, and anti-trust considerations. Today, thorough due diligence efforts also require an audit of how an acquirer or acquiree meets certain ESG standards. ESG audits will also matter when raising capital; debt-rating agencies and investors require this additional data, too.

Areas that could come into ESG due diligence include adapting products and services to climate-friendly materials and processes, evaluating diversity and wider employment practices, as well as revamping how companies engage with communities. Corporations today must be ready to demonstrate that they are ESG compliant — with actions and results.

5. Should you become a public benefit corporation?

Traditionally, many U.S. corporations are formed legally under Delaware LLC structures that prioritize financial shareholders over environmental and social stakeholders. Although under Delaware LLC structure, the Business Judgement Rule allows boards to take broader stakeholder concerns into consideration, there remains a push by campaigners for environmental and social causes for companies to switch to either a public benefit corporation (PBC) or B-corps structure.

Both PBC or B-corps registrations aim to legally enshrine the interests of broader stakeholders, not just financial shareholders. However, PBCs are signed up to a governance code that is recognized in 37 states, whereas B-corps are corporations that are certified by the non-profit B-lab as meeting higher standards of accountability, transparency, and social purpose than traditional listed companies.

Financially, companies need to examine the implications of changing their status from Delaware LLC to a PBC or B-corp — for example, whether or not PBCs are allowed to trade on various stock markets around the world. Business leaders must be alert to any changes in decision rights and restrictions of a PBC structure— for example does it restrict how the company raises capital or pays dividends? Can valid like-for-like comparisons can be made with Delaware registered peers when reviewing performance?

6. How should corporations address societal concerns such as racial equity?

Business leaders must be guided by a framework that is transparent and consistent in addressing current events that highlight injustice. Recently, boards have been challenged to ensure that they are consistent in defending racial justice across all racial, ethnic, and religious groups. For example, in , while the murder of George Floyd was met with near universal condemnation and statements of intent to redress inequality in support of Black Lives Matter, acts of violence against Asians were met with a less consistent and assertive corporate response, as Shalene Gupta highlighted in HBR.

For the sake of employees, customers, and clients, corporations must be more transparent on how business leaders will handle these concerns, and broader ESG issues, as they emerge. An inconsistent approach risks fostering division among employees and creating a culture of “us versus them.”

7. How do you develop a global approach to ESG?

A more comprehensive ESG approach must be inclusive of different countries and cultures. For example, Western workers advocating for work-life balance, notably in the technology sector, sit in stark contrast to some Chinese employees willing to work — that is, from 9 AM to 9 PM, 6 days a week. Political and business leaders must weigh the risks, not only of Chinese values being rejected by employees and customers in the West, but also of western liberal attitudes being rejected by workers and customers in China.

Likewise, in the case of the environment and climate change, it is impossible to make meaningful progress globally without having China and India on board — even if their desired speed of change might differ materially from those in the Western world.

8. How do you build an ESG framework that is future-proofed for tomorrow’s economic realities?

Business leaders need to focus on ESG design and a system of thinking that applies to how the economy will be shaped in the future — not just how it is structured today.

For example, many retail companies point to strong diversity data within their staff today. But the reality is that a large proportion of the workforce are less-skilled workers who are most vulnerable to losing their jobs to increased automation and digitization, such as the prospect of driverless cars. According to the World Economic Forum, 85 million jobs will disappear due to automation by

While 97 million tech-driven jobs will be created, many of them will require higher levels of skills and qualifications. Schools and education public policy must ensure that new generations of workers are equipped with the knowledge to thrive in the workplaces of the future. But there is also an onus on companies to take active steps to reskill their existing workforce — and specifically to aid its most vulnerable members — to be able to transition into new roles. This can be achieved through well-developed trainee programs, apprenticeships, and on-going internships, such as in different areas of coding. Inaction will lead to greater net unemployment of precisely the diverse set of employees this ESG strategy is hoping to protect.

9. How do you vet company performance of ESG?

Business leaders must decide how their ESG results will be vetted for compliance. Companies already use independent external auditors for financial, operational, cyber, and worker audits. The question is whether ESG standards will need to be assessed and monitored by independent third-party accounting or law firms, or whether ESG will be overseen by a global body or by national regulatory organizations.

For now, although independent firms and regulatory bodies continue their efforts to design metrics and standards, ESG benchmarking remains highly fragmented. Therefore, the challenge for boards is to assess which metrics to choose and use.

The trend is to make companies accountable to external bodies: not only regulators, but also industry associations and trade bodies. The SEC, for example, is seeking greater clarity on the sustainable credentials of ESG-labeled investment funds. But simply obtaining clarity on how many different organizations define ESG is not enough. For the market to function properly, an open audit system requires harmonized rules followed by all.

One notable step came in , when the International Capital Markets Association (ICMA) launched harmonized principles for green bonds, used by corporations to finance environmentally sustainable projects.

How should corporations navigate the ever-changing landscape of ESG?

As companies devise metrics to track ESG progress, they must be able to compare performance across time, peers, other industries, and against evolving regulatory standards. As they do so, they need to anticipate where regulation on all aspects of ESG will land. Therefore, business leaders must maintain a dialogue with regulators and policymakers, and companies should look to cooperate and coordinate on best practices with their industry peers.

Global corporations must approach ESG in a way that is transparent, consistent, flexible, innovative, sustainable, sensitive to cultural differences, dynamic, and future-proofed. Furthermore, corporations should focus not only on mitigating the risks of ESG, but also on the opportunities it presents to continue to support human progress.

Investment professionals are proving that  responsible and ethical investing in emerging markets (EM) can go hand-in-hand with superior returns. At the same time, doing so may protect the environment and produce economic growth that is sustainable over the long term.

The success of investing through environmental, social and governance factors (ESG) is in the numbers. Over the last decade, the MSCI Emerging Markets ESG Leaders Index, which tracks companies with high performance in ESG metrics relative to their peers, outshone the broader MSCI Emerging Markets Index, with a percent annualised returns versus percent, according to data from indexing firm MSCI.

Over 10 years, the additional percentage points can make a difference in a portfolio. One million pounds invested in the "ESG leaders" portfolio would have grown to £ million in the recent decade, versus £2 million for the non-ESG portfolio.

"Increasingly, people are starting to appreciate that adding ESG is a source of alpha," says Phil Langham, head of EM equities at RBC Global Asset Management (GAM) in London. Alpha refers to the additional returns from selecting individual stocks relative to investing in broad indexes.

Langham says  RBC GAM has used such metrics for almost a decade, with results outperforming by up to five percentage points each year. In for instance the ESG EM leaders portfolio returned percent versus percent for the broader EM portfolio.

"Companies that pay attention to ESG have a real culture of excellence," says Langham. "They have much more engaged employees who are much more productive."

Environmental action

So far, the majority of EM economies such as Brazil, Russia, India and China (BRIC), have replicated developed markets by fuelling their economic growth with carbon-based energy, like oil and coal.

The problem is that such growth is no longer considered sustainable due to the destructive nature of fossil fuels on the environment. That impact includes flooding in places such as Bangladesh and potential water shortages in other locales, says David Storm, head of Multi-Asset Portfolio Strategy at RBC Wealth Management in London. Many poor economies don't have the resources to deal with such problems, so prevention of future problems is vital.

Some governments are tackling the problem head-on, including the leaders of the second largest economy in the world. "China has been the most proactive country," says Storm. "In it introduced a concept of 'ecological civilisation' and now that idea has a central position in the economic growth strategy." Specifically, the leaders emphasised public transport and green buildings as a way to cut pollution. And China is now the largest market for electric vehicles.

Beijing and Shanghai have suffered for years under clouds of smog. According to a United Nations report, 92 percent of Asia and the Pacific's population are exposed to levels of air pollution that pose a significant risk to their health. The report details how carbon dioxide emissions could be reduced by almost 20 percent in , if 25 measures are implemented.

Other countries are using so-called "green financing" to fuel sustainable economic growth, including Mexico. "Mexico City airport issued a green bond two years ago to fund solar energy equipment for its airport," says Storm. Such bonds are dedicated to financing environmentally friendly projects, which are typically audited for compliance with the stated use of the funds.

The market for these green securities has grown exponentially over the past few years. In a total of issuers sold green bonds with a face value of US$ billion (£ billion), up from less than $50 billion in , according to data from the Climate Bonds Initiative.

Tackling governance

Governance refers to how companies and other institutions are managed. In this respect, emerging markets are different from developed markets and that can be an advantage for investors who know what to look for.

"What you see in emerging markets are many more state-owned enterprises and lots of family-owned or controlled companies," says Langham. Both may be beneficial, but in different ways.

One potential advantage of family-controlled businesses is that managers and leaders they employ tend to stay in their positions for extended periods of time.

When executives take a long-term view of managing the company, profits may be more stable or sustainable; both are things investors appreciate.

State involvement in a company may also be helpful to companies because red-tape can sometimes quickly be eliminated or streamlined when a government has an ownership stake in the firm.

This helps reduce costs and boost profits for companies that benefit in such a manner from partial government ownership.

Addressing social issues

Social initiatives are integral to the emerging market investment thesis.

Health care is one such key area and has the potential to improve the lives of EM citizens and also offers opportunities to investors.

Analysts, such as Langham, expect health spending in EM to grow disproportionately faster than their economies as these countries become richer. Currently developed markets, such as the U.S. and UK spend more than double the percentage of GDP on health care than EM countries such as China, according to World Bank data.

That difference in spending is likely to decrease. For instance, as China grows its economy the dollars spent on health care will increase even faster. When that happens, some health care providers could see big boosts in profits and investors could see gains.

"In general, the thesis is a catch-up thesis," says Graham Stock, EM senior sovereign strategist at BlueBay Asset Management ¹ in London. "We should expect emerging markets to grow faster because they're starting from a lower level of GDP per head and there's a catchup as the middle class grows."

Of course, that catchup idea applies not just to health care but also to access to education and quality sanitation, which are key social issues in many EM.

Strategies for implementing United Nations goals

All three ESG factors fit well within the United Nations Sustainable Development Goals (SDG), which were adopted by member states in They outline 17 targets economies should strive to achieve. One such goal is to provide "access to affordable, reliable, sustainable, modern energy". While the list of goals is extensive, it also provides a useful framework through which business leaders can evaluate their own strategies.

"It's like a road map to development that is sustainable, and it means economically you'll be sustainable and successful," says My-Linh Ngo head of ESG Investment Risk, at BlueBay in London. "That makes intuitive sense. Those companies don't exist in a vacuum. If they have good relations internally and externally with their stakeholders, they're more likely to be successful financially."

Yesterday, we started a conversation with Georg Kell, considered one of the fathers of environmental, social and governance (ESG) investing. His new book, Sustainable Investing: A Path to a New Horizon, takes a close look at the historic convergence between corporate sustainability and ESG-lens investing as a force for good that, together,  help drive systemic market changes.

Since his retirement from the United Nations, Kell has been advising executives from diverse industries on questions of business transformation and sustainability. And for four years, he has been chairing the Volkswagen Sustainability Council and working to lead the company out of its crisis following the "dieselgate” scandal in

TriplePundit: What are the main challenges in building a more sustainable financial system and to bring climate risk and resilience into ESG-lens investing and, really, the heart of financial decision making? You note in your book that we’re talking about a massive reallocation of capital, creating unprecedented risks and opportunities, in what you describe as a VUCA (increasingly volatile, uncertain, complex and ambiguous business context). Can you expand on that?

Georg Kell: There are short-term challenges for investors and sustainable investing at large. It's still difficult to get the right tool off the shelf at the right moment. The data world is still not up to speed. There's a lot of inconsistency and incoherence. However, at the same time, there is a lot of innovation happening and I'm quite confident that much better data analytics and capabilities are being brought to the marketplace. This will enable financial institutions to embrace this agenda much faster.

Another challenge is that there's still uncertainty about the bigger framework conditions on the regulatory side.  The new taxonomy being released in Europe, however, will be a major regulatory push for this movement, which the market is watching closely.

Another problem is: How do you change financial institutions from within when the leadership is reluctant to embrace change or give up established practices? Again, COVID, I am convinced, will accelerate that change at the institutional level.

I also think business education needs an overhaul. Business students today are still looking at finance as a black box isolated by and large from societal changes. There's a major transformation happening in societies where ESG issues are gaining relevance, and it affects all industry sectors. Getting a handle on that will be increasingly necessary to be successful in the field of business.

3p: What are the main drivers that will determine if we can rise to the challenge of sustainability?

GK: In my mind, there are three forces, and they’re universal. They play out across all countries and regions and they're irreversible, at least in the short or medium term. The first is technology. Clearly the pace of innovations has been accelerating. Technology allows transparency. It allows measurement and quantification of externalities. We couldn’t handle that just a few years ago. What's happening right now is nothing short of a revolution, especially in the world of finance where big data, self-learning and AI are now kicking in to make sense out of ESG factors and offering much deeper insights into risks and opportunities. This is helping financial analysts who may not necessarily have the knowledge about ESG issues, but want to apply some off-the-shelf tools.

Secondly, we have the concept of the nine planetary boundaries that provide a safe operating space for humanity, as developed by climate scientist Johan Rockström, a contributor to the book. The boundaries include climate change, biodiversity loss and extinction, land-system change, freshwater use, and ocean acidification, among others. Crossing these boundaries increases the risk of generating large-scale abrupt or irreversible environmental changes. We are just now realizing that the pace of disruption to the these planetary boundaries is happening much faster than even scientists have predicted, as we see with the wildfires in California now and the ones in Australia earlier this year.

The third force, and this also makes me feel positive, is young people. I have lived in the U.S. for over 30 years, and I am delighted that young people are taking to the streets around social issues. It shows they care about their future and they want to contribute to the public good. This intergenerational change is powerful.

3p: How should company leaders demonstrate to investors that they are serious about ESG in a new financial system with climate resilience at the center?

GK: Businesses have long understood that efficiency is important to reduce costs and reduce potential liabilities. But it is only recently that corporations have started to understand that their emissions and footprint are more than just the cost factor in the equation. Many of them did just enough to comply with regulation — a game of compliance optimization. That has changed radically because carbon and emissions are now seen as one of the central pillars for a future license to operate. It goes beyond a fundamental cost aspect into a strategic component. That is also because carbon pricing is bound to increase; negative carbon is bound to become the currency of the future. Corporate executives are starting to understand that regulators over time will be quite tough on these issues, and there's no escaping anymore that consumers and customers increasingly want to know their footprint.

And increasingly investors are aware of the risks of companies being too exposed on the emissions side and then all of a sudden falling into the trap of stranded assets or negative backlash. Investors want to hear from executives: What is your plan to reduce carbon and other emissions? How do you think you can achieve this? What kind of technologies were you betting on? How is your value chain organized and can you carry them with you? What are the bottlenecks? They want to have a compelling narrative. And of course, we want to know if companies can tell us their current footprint. Amazingly, many corporates still don't have a good accounting for their emissions. In today’s world of risk management, that is inexcusable.

Corporations have to move from compliance optimization to advocate a policy framework for carbon pricing. In other words, they need to see their role as no longer blocking climate action policies but actually supporting them, because if your new business model is to be successful, we need a change in policy frameworks. In the end, there’s just no way around committed leadership. Increasingly, disruptions are ahead of us. It’s becoming the new normal. You need to have clear understanding of the issues. And then you build your processes, your operations, and you retool them. And if you have the ambition, you design the leap for the future.

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​With the growing focus on social responsibility globally, many investment management companies are including environmental, social, and governance aspects in their decision-making, aided by emerging technologies such as AI and advanced analytics. Not only might this help build credibility with investors, it could also create opportunities for alpha.

The sustainability movement is growing

Social consciousness has spread throughout many facets of life, and many companies are making a concerted effort to align with these principles. This effort has likely contributed to the steady rise in the media coverage afforded to “sustainable” brands over the past two years.¹ Evidence suggests a similar growth in a desire for what are characterized as “sustainable” or “socially responsible” investments. Globally, the percentage of both retail and institutional investors that apply environmental, social, and governance (ESG) principles to at least a quarter of their portfolios jumped from 48 percent in to 75 percent in ² While directing investments based on one’s values has been around for decades, discussions between advisors and their clients about ESG investing have become commonplace.

Despite greater adoption within the investment community, the varying approaches to ESG incorporation by investment management firms, regulators, and investors suggest the full potential has yet to be realized. This will likely happen if investment managers routinely consider ESG metrics in all investment decisions.³ While this scenario seems unlikely in the short term, the Deloitte Center for Financial Services (DCFS) expects client demand to drive ESG-mandated assets to comprise half of all professionally managed investments in the United States by According to the DCFS, investment managers are likely to respond to this demand by potentially launching up to a record new ESG funds by , more than double the previous three years. Firms may capture a greater share of this growing allocation to ESG by utilizing emerging technologies for incorporating quality ESG data into the investment decision process, developing products with clear ESG objectives, and embracing an ESG-driven culture across the organization to gain credibility with investors.

As emerging technologies, such as AI, enable better-quality ESG data and the regulatory landscape becomes clearer, institutional, and retail investors are expected to increasingly demand that ESG factors be applied to a greater percentage of their portfolios. In this scenario, ESG assets should continue to grow at a 16 percent compound annual growth rate (CAGR), totaling almost US$35 trillion by (figure 1).

New ESG fund launches to accelerate as demand spreads across geographies and investor types

The largest amount of sustainable investing assets is in Europe, totaling US$ trillion, followed by the United States with US$12 trillion.⁴ While Europeans may hold the highest amount of ESG-aligned assets, much of the world’s recent growth in this space may be attributed to investors’ increased interest in the United States. From to the beginning of , assets under management with an ESG mandate held by retail and institutional investors grew at a four-year CAGR of 16 percent in the United States, compared with 6 percent in Europe.⁵

Flows into ESG funds in the United States picked up the pace in Barring a dramatic turnaround in the final few months of , equity and bond ESG mutual funds and exchange traded funds (ETFs) are likely to achieve record inflows for the fourth straight year.⁶ Flows into sustainable funds reached US$ billion through the first six months of , compared to US$ billion in all of ⁷

The driving force behind ESG at investment management firms is evolving and leading to increased fund launch activity. Client demand from both retail and institutional investors is now the top reason reported by money managers to incorporate ESG factors into investment decisions.⁸ Client demand for ESG mandates has increased over the past three years, supporting the rise in investment management firms’ product portfolios.⁹ DCFS expects a record number of ESG fund launches over the next three years as client demand increases. Investment management firms may benefit from this rise because ESG funds tend toward active management, with 92 percent delivered through actively managed portfolios.¹⁰

The ESG investing regulatory landscape remains fluid globally

While many clients are becoming comfortable with incorporating ESG into their portfolios, there are some concerns about the transparency and quality of ESG disclosures. Some institutional investors petitioned the Securities and Exchange Commission (SEC) in the fall of for rules to harmonize ESG investments.¹¹ Without a consistent framework governing ESG principles, investors are left to navigate through the seemingly ever-changing landscape of definitions. Providing consistent definitions for “environmental,” “social,” and “governance” will likely generate more efficiency in the ESG data value chain and drive more effective investor engagement—including between asset owners and asset managers.

Regulators have recently been demanding more depth and transparency from public firms regarding their environmental impact. Bringing uniformity to the ESG taxonomy seems to be the goal of both US and global regulators—although both appear to view ESG investing through different lenses.

Traditionally, US disclosure requirements from the SEC on shareholder resolution votes have provided investors with information concerning a company’s ESG practices. Investment managers have utilized these disclosure rules to influence a corporation’s adoption of ESG principles. Updating disclosure requirements to include language related to ESG has received attention from the Congress, with a proposal that requires companies to include ESG metrics in their annual SEC disclosures recently passing out of committee.¹² The proposed bill calls for a committee of industry experts to recommend specific ESG metrics to the SEC for required disclosure.¹³

Apart from disclosure rules, an Executive Order released in April directed the Department of Labor, through its power granted under the Employee Retirement Income Security Act (ERISA), to review all pension fund investments to determine whether the funds’ implementation of ESG principles excluded energy companies and thereby hindered the return of plan assets.¹⁴ In other words, US-based institutional investors, such as pension funds subject to ERISA, must demonstrate that ESG investing benefited the long-term growth of plan assets.

In the European Union (EU), the European Securities and Markets Authority (ESMA) recently clarified questions surrounding ESG investments. ESMA proposed several additions to existing regulations that set out how financial market participants and financial advisors must integrate ESG risks and opportunities in their processes as part of their duty to act in the best interest of clients.¹⁵ The proposed amendments dictate that advisors must explain why sustainability factors were not considered as part of the process. The necessity of ESG integration in investment decisions might help explain why 97 percent of institutional investors in Europe are interested in ESG investments.¹⁶ EU regulators have also taken the lead in developing a common ESG taxonomy to facilitate sustainable growth financing and investing.¹⁷ The stricter standards now applied to sustainable investments may explain why the percentage of ESG assets to total assets shrank in Europe between and even as interest in sustainable investing increased.¹⁸

In Asia, regulators have determined that increasing disclosure requirements about sustainability practices can encourage foreign investment.¹⁹ In , the Chinese government, in a bid to increase transparency and investment, announced that listed companies and bond issuers will be required to disclose ESG-related risks.²⁰ Singapore was an early adopter of ESG-related standards in Southeastern Asia, which had a positive effect on the development of its capital markets. Investor confidence in the quality of ESG data was established in Singapore after sustainability reporting was mandated in ²¹

Globally, while different regulators may have taken different approaches to ESG, similar outcomes for investors may be generated. Ultimately, all investors stand to benefit from greater transparency of ESG factors in the investment process. Frameworks such as those created by the Sustainability Accounting Standards Board (SASB) can help companies report material information related to ESG in a consistent manner. Some companies have recognized that the increased value placed on transparency by investors can benefit them and have begun reporting performance on relevant ESG factors in much more detail than would be otherwise required by regulators. For example, BP p.l.c. disclosed to investors that it is testing blockchain to track natural gas produced using more environmentally friendly methods throughout its supply chain.²² Whether it be from the regulators or companies themselves, the trend of greater ESG data disclosure is likely to only increase.

Emerging technologies create opportunities for alpha and ESG product innovation

Some investment professionals have expressed concern that alignment with ESG principles may hinder performance. However, a recent research study demonstrates that ESG metrics may in fact aid the quest for alpha. The study back tested ESG metrics for materiality and found that a strategy that solely based its investment decisions on these metrics outperformed a global composite of stocks, strengthening the case for an active ESG investment strategy.²³ As a result, ESG may provide an opportunity to both meet client demand as well as improve returns.

While back-testing supports the case for finding alpha with ESG data, the challenge remains for investment managers to apply current ESG data to their investment process and client reporting. Much ESG data, such as carbon emissions, is provided inconsistently across companies and industries. Almost 80 percent of investment managers agree that they could improve client service by providing performance related to an investment’s ESG impact in addition to financial performance.²⁴ However, only 44 percent of managers share ESG data with institutional clients and even less (30 percent) do so with retail clients.²⁵

This conundrum of wanting to build material ESG data into the investment process and report ESG performance to clients yet finding it difficult to do so is largely due to the inconsistent availability and quality concerns of data. Global investment managers describe inconsistent data across assets as the biggest barrier to integrating ESG into investment processes.²⁶ ESG disclosures tend to be produced by larger companies with more resources. Skewed disclosure may cause ESG investments to flow toward the largest companies even though smaller firms may have a similar or better impact regarding ESG issues.²⁷ Investment management firms have recognized this disconnect, and as a result, spending on ESG content and indices is expected to rise from levels by 48 percent to US$ million in ²⁸ Larger investment management firms have accelerated their spending on ESG data and tend to supplement it with proprietary metrics.²⁹

With greater standardization of ESG measures progressing slowly, advanced data analytics has become an essential component of ESG analysis. Investment management firms can leverage AI, such as machine learning, as well as alternative data to develop ESG metrics for analyzing investments, making decisions, and informing investors. By aligning advanced analytics tools with sustainability metrics, investment managers may be able to move beyond simple screening methods to actively make the case for alpha (see sidebar, “Innovative firms provide solutions for integrating ESG data into investment analysis”).

AI allows investment managers to uncover additional material data that may not have been disclosed by a company. One investment management firm uses an AI engine to scan unstructured data to identify material ESG data and then prioritize investments with low valuations for the highest expected return.³² This approach may help gain insight into, say, a company’s carbon emissions regardless of whether the company chooses to report them. The AI engine also searches unstructured data such as patent filings to identify companies that may be close to deploying cutting-edge low-carbon technologies. Identifying these types of investments before the companies tout their achievements may be the basis for higher future returns.

ESG ratings firms also utilize alternative data in their ratings processes. MSCI Inc. estimates that only 35 percent of the data inputs used to compile a company’s ESG rating come from voluntary company disclosures.³³ In one case, the firm used satellite imagery to identify material risks to the environment and the safety of workers in a mining company’s operations to fill the gap between company disclosures and material ESG data metrics.³⁴ As a result, the use of alternative data to identify risks and opportunities for ESG investments is expected to accelerate over the next year.

As ESG gains greater acceptance with portfolio managers, differentiation often becomes critical. Going beyond transparency into product customization may be the future of ESG product innovation. About 68 percent of investment managers believe that much of the growth in ESG investments will be fueled by product customization.³⁵

Yet, as mentioned previously, while ESG is a priority for institutional investors, only 23 percent have integrated ESG principles throughout their organizations and 30 percent have separate ESG and investment teams.³⁶ This presents a significant opportunity for investment managers to deliver customized solutions for clients who want ESG to play a larger role in their portfolios but lack an implementation road map. DWS Group and Blackrock were able to provide such guidance to a large European pension fund in By each tailoring a unique ESG strategy based on the pension fund’s philosophy to favor companies with strong corporate governance and to avoid certain industries, the two investment management firms were able to bring two new sustainable ETFs to market, each garnering more than US$ million inflows on their first trading day.³⁷ The success of these launches highlights the acceleration of interest in US retail ESG funds by a diverse set of investors.

Looking deeper at customization, invest-tech firms Open Invest Co. and Ethic Inc. have developed platforms that allow investors to choose among environmental, social, or governance themes.³⁸ Investors can customize their portfolios by adding or removing specific companies through direct indexing.³⁹ Some traditional investment management firms have taken notice and are trying to increase their ESG product offerings by developing their own platforms. John Hancock Personal Financial Services designed a platform known as COIN, which is accessible from any device and provides investors with the opportunity to directly own shares of companies that align with UN Sustainable Development Goals.⁴⁰ The COIN platform may strengthen relationships by putting updates on the portfolio’s ESG performance at the client’s fingertips.

Emerging technologies may provide investment managers the tools to both improve client experience and aid in the quest for alpha. With the forecasted rise in ESG data spending this year, the number of investment management firms that provide their clients ESG performance data is likely to increase. The amount of ESG data is expanding as companies increase disclosures and ESG rating firms incorporate new data points into their metrics. It has become more important for investment management firms to develop their own capabilities for gathering and managing quality data.

The need for credibility expected to lead the next wave of ESG-principled investing

There are likely to be winners and losers in the competition for ESG asset allocations. It could be crucial for investment management firms to recognize the importance of ESG and devote more resources to ESG product development to not fall behind peers. The overwhelming majority (89 percent) of investment managers believe sustainable investing will not dissipate, while the same number indicate their firms will devote more resources to this area in the next two years.⁴¹ Differentiation becomes much more difficult with many firms now preparing to expand ESG investment options.

ESG is a lens into effective risk management and an avenue to optimize performance. It has to be credibly embedded into the investment management business model, all the way through to attracting talent.

—Kristen Sullivan, Americas region Sustainability Services leader, Deloitte & Touche LLP

Success could flow to the investment management firms that can align their brand with ESG principles. The most effective method to gain traction may reside in the level of credibility the investment management firm has achieved from investors as opposed to its menu of ESG products. Today, consumers often reward companies that appropriately match their brand to their actions. An investment management firm may earn credibility with ESG-minded investors by fully embracing the influence of ESG issues across its organization and demonstrating its commitment by detailing actions taken to align with these principles. Investment managers may find it difficult to effectively compete for capital allocations without a client-centric ESG strategy that encompasses credible ESG disclosure practices.

Capitalizing on a socially responsible future

The recent uptick in investor demand for ESG suggests investment management firms should take action today to maximize the ESG opportunity. The future wave of growth in ESG investing will likely not be driven by screening out “sin” stocks but could instead be fueled by managers using high-quality ESG data to increase the opportunity for alpha. A burgeoning ecosystem of customized ESG products and platforms presents investment managers with opportunities to further their value proposition to clients.

Investors are still going to consider performance when selecting an investment manager. However, investment management firms may find that ESG metrics improve the opportunity to find alpha as well as attract new clients. Having sustainable products on the shelf might be a necessary first step, but long-term success will likely reside in the ability to demonstrate to investors that the firm has holistically adopted sustainable practices. The ever-expanding expectations of investors and regulators will likely require a proactive approach. Investment management firms should identify any gaps by reexamining their processes through an ESG-principled lens, with an eye on what matters most to today’s investors. By , half of all professionally managed assets could fall under an ESG mandate. For an investment manager to capture a greater share of growth in assets under management, credibility with investors will likely be critical.

In this episode of the ESG Insider podcast, we explore a key theme emerging at the center of the ESG movement in

Following the unprecedented market and policy momentum behind ESG in , investors, corporate boards, and government leaders have raised expectations for progress on climate pledges in Alongside climate, biodiversity, and other environmental concerns, social issues — like diversity, equity, and inclusion and worker wellbeing — appear poised to remain in the spotlight, particularly as they are increasingly woven into broader ESG discussions.

Rising demands for action will likely increase pressure for more accountability, greater regulatory scrutiny, and credible disclosure backed by better data. Below, S&P Global outlines key ESG trends that we think will drive the conversation in Critically, these trends exhibit overlaps and interactions that will have a direct influence on the prospects for meaningful progress on ESG issues in As the graphic below illustrates, the E, S, and G trends we have identified should not be considered in isolation, but rather we believe they should be understood in relation to each other.

Pressure will grow on corporate boards and government leaders to enhance their ESG skills.

In , corporate boards and government leaders will face rising pressure to demonstrate that they are adequately equipped to understand and oversee ESG issues — from climate change to human rights to social unrest. 

The broadened scope of corporate board responsibilities also requires more focus and time commitment from board members to meet their fiduciary duties. Pressure on boards to shore up their ESG credentials is set to grow as investors demand better accountability from the top and heightened focus on sustainability. 

Shareholder activism in this area increased in , including votes against directors for lack of credible climate action plans. This trend is set to pick up speed during the proxy season. In addition, efforts to diversify boards and create policies that foster meaningful diversity, equity, and inclusion will continue to evolve from a box-ticking approach into a holistic appreciation of how differences in identities, expertise, and leadership styles can drive growth and innovation.

Government and corporate leaders are under pressure to strengthen their ESG skills and integrate sustainability into their policy and planning strategies. In particular, they will add adaptation and resilience measures to their investment plans amid the growing economic impact of climate change. In , the U.S. alone experienced 20 storms with losses exceeding $1 billion each.

New regulations and reporting standards will demand more credible corporate disclosures.   

While many large companies set sustainability goals and published ESG-related data in , investors, regulators, and the broader public are exercising greater scrutiny of corporate sustainability efforts, calling out what they perceive as greenwashing. Much of this skepticism is founded on concerns that companies may be using disclosures and sustainability-related labels on products and services as a marketing tool to appear more proactive on those issues than they truly are.

New global ESG-related standards will continue to evolve in , while global standard-setting bodies such as the newly formed International Sustainability Standards Board can help address what may be the largest obstacle to accountability: the lack of a common baseline for disclosure standards consistent across jurisdictions and industries.

To date, agreement on key metrics and reporting frameworks for environmental factors has crystallized more rapidly than for social factors. But could bring increasing convergence on the data, metrics, and reporting requirements most relevant to social issues — alongside rising pressure to ensure these metrics measure impact, not just inputs.

Governments and companies will face the challenge of turning net zeros pledges into near-term action. 

In , the number of governments and large companies setting goals to reach net zero emissions by grew rapidly. But these commitments often lacked interim emission reduction targets or plans to curb indirect emissions that occur along the supply chain. In , we believe that pressure from shareholders and other stakeholders will rise on those entities to develop concrete, near-term plans and begin to act to address emissions across the full value chain.  

A report from the UN's Intergovernmental Panel on Climate Change found that achieving net zero emissions globally by is critical to avoiding some of the worst effects of climate change. In ,  the IPCC issued a high-profile climate report that the UN Secretary-General dubbed “a code red for humanity.” This year, the IPCC will release new reports that could recalibrate how quickly the world must act to keep from overshooting the target of limiting global warming this century to degrees Celsius relative to pre-industrial levels.  

With stakes this high, investors will likely demand more than simply setting long-term climate commitments. We think governments and companies will have to provide credible, achievable near-term signposts on their path to decarbonization. And beyond the established focus on emission reductions, the spotlight will extend to how entities manage exposure to physical climate risks, including the presence and/or adequacy of adaptation and resiliency planning. These expectations will begin to hold entities accountable to their commitments and help address market perceptions of greenwashing.

Climate transition strategies will increasingly embrace social issues. 

Despite expectations for governments and companies to make meaningful progress on their climate commitments in , they will be doing so in a broader economic and geopolitical climate marked by inflationary trends, higher energy costs, and tightening monetary policy. These shifts will challenge the climate agenda and sharpen attention on managing the social implications of the transition.  

In , a key challenge will be balancing actions taken on the ‘E’ with the ‘S’ when implementing climate transition plans to account for impacts on developing nations and vulnerable domestic populations. In particular, efforts to promote the low-carbon economy may be disrupted in the absence of credible plans to promote economic and social inclusion, access to affordable critical services, and the availability of decent work. Indeed, at COP26 in November , more than 30 countries signed pledges to support workers and communities hurt by the transition to a green economy. In the face of potential economic headwinds, the support provided to emerging economies to balance climate goals with those of economic growth and poverty alleviation will deeply affect social stability and momentum on the global climate agenda.

Climate stress testing will gain prominence in the financial services industry.  

Investor pressure regarding climate change has historically concentrated on nonfinancial corporations, especially the energy sector. However, major financial institutions and policymakers are beginning to acknowledge the associated long-term threat to financial stability. They’re also starting to recognize the vital role that financing will play in facilitating the low-carbon transition and ensuring the climate resiliency of the economy. 

Increasingly, based on the work of the Network for Greening the Financial System (NGFS), central banks are beginning to incorporate climate risk as a stress testing feature for banks and insurers. The European Central Bank’s economy-wide climate stress testing in showed the need for banks to enhance assessment of their exposure to both climate transition risks and physical risks in order to proactively manage them. 

In the U.S., the Federal Reserve is weighing the implications of climate-related risks for financial institutions and the financial system and has called scenario analysis “a potential key analytical tool for that purpose.” China, too, has been examining ways of incorporating climate change risk in its stress testing of financial institutions. Much of the work on climate stress tests is coming from collaborative work globally by central banks, something we see continuing in Insurance regulators are also taking steps to integrate sustainability, and particularly climate risks, into their prudential frameworks. 

We view stress testing as a useful starting point as companies work to measure their climate risk. However, we think there will be continued development of qualitative approaches to supplement these assessments.  

Assessing natural capital and biodiversity risks will continue to rise in importance.

Governments and companies are beginning to make progress on commitments to protect biodiversity and nature in their direct operations. For corporates, assessing and managing across their supply chains where materials and inputs are sourced is even more challenging. Data availability and quality as well as generally agreed measurement methodologies remain key challenges. In addition, most of the corporate world still lacks commitments to stop deforestation despite being more easily measured than other natural capital risks, principally due to poor understanding of how to assess the benefits of preservation. Elsewhere, the benefits of nature-based solutions, such as preserving wetlands, forests, and coastlines, will continue to gain favor as effective strategies to help adapt to the physical impacts of climate change.  

Several important new initiatives in should help efforts to prioritize biodiversity. A landmark event in Kunming, China, the next UN Biodiversity Conference, will take place in the late April to early May. At this event, governments will aim to agree on a set of new goals over the next decade as part of the Convention on Biological Diversity, given that the previous targets set for were not met. Against this backdrop, the final text of the new framework will be an important milestone to set priorities and help strengthen ambitions and measure progress — or the lack thereof.

Elsewhere, the newly formed Taskforce on Nature-related Financial Disclosures will propose a disclosure framework for nature-related information, including standards and metrics, as well as data requirements, that will bring biodiversity and nature commitments into greater focus.

Social issues in supply chains will command more attention.  

In , companies became acutely aware of their dependency on — and the fragility of — their supply chains. In , we believe this trend will persist as the global economy continues to recover from the pandemic and as management teams focus on heightened supply chain costs and risk of disruption. 

Beyond the resilience of supply chains, we also think that social issues in supply chains will garner greater attention, particularly as efforts grow to curb human rights abuses and improve labor conditions.  

Existing and proposed legislation will make supply chain traceability and social risk management more important this year. Despite delays in the EU Sustainable Corporate Governance directive in , mandatory human rights due diligence legislation at the national level in member states such as Germany, the Netherlands, and France will move a larger swath of companies to identify and act against human rights violations in their supply chains.

Additionally, continued action in the U.S. and other key markets to restrict imports based on forced labor in supply chains will push companies to evidence credible human rights monitoring efforts up the chain. This will be true beyond Tier 1 suppliers and will include raw materials. 

The debate over divestment versus engagement will heat up. 

In , we saw more large asset owners, asset managers, and banks adopt negative screening strategies — in other words, exclusion or divestment of companies with weak ESG practices or high exposure to ESG risk. This approach was most notably applied to fossil fuel and other high carbon intensity companies as well as entities with a high risk of acute and chronic physical climate risks. In , we anticipate that negative screening will become more widespread — especially to decarbonize investment portfolios and loan books, as financial services companies seek to build Paris-aligned investment and lending portfolios, further raising the importance of ESG to credit. 

Exclusion policies may have immediate effects on the reduction of the carbon footprint of lending or investment portfolios, but this approach has its drawbacks. Advocates of engagement policies note that breaking ties with companies via divestment or exclusion does not encourage change and could result in the sale of those securities to investors who are less attentive to ESG issues. Proponents of engagement therefore prefer to use their investments to influence change by engaging with companies on key ESG themes like the climate transition or working conditions in the supply chain. 

Whether they take an approach of negative screening or engagement, lenders and investors will be under pressure to explain how they arrive at their decisions. They will also face pressure to credibly measure and disclose the concrete outcomes of their chosen approach.  

The integrity of the growing sustainable debt market will be tested. 

In , total sustainable debt issuance reached a record high of about $ billion, according to preliminary estimates from the Environmental Finance Bond Database. This figure includes green, social, and sustainability-linked bonds and represents a 61% increase in just one year. Based on historical trends, there is room for continued growth, if not acceleration in , as companies and governments seek to finance the transition to a net zero economy.  

A key challenge for market participants in the coming year will be to manage this growth in a way that preserves the legitimacy of these financing instruments and combats rising concerns about greenwashing. Indeed, diversification and innovation in sustainable debt instruments are likely to continue, risking greater fragmentation across issuers, instruments, sectors, and standards. For instance, with sustainability-linked instruments, which are poised for strong growth in , market participants should be vigilant to ensure that issuers are setting appropriately ambitious performance targets and maintaining transparency over the life of the instrument through periodic and high-quality disclosure. Efforts to further establish and encourage the uptake of clear standards and frameworks, therefore, will be critical in to guard the integrity of the sustainable debt market as it reaches new heights. 

Thank you to all our ESG colleagues across S&P Global who contributed to this piece. 

Brett Azuma, Steven Bullock, Erin Boeke Burke, Rose Marie Burke, Beth Burks, Alexandra Dimitrijevic, David Henry Doyle, Michael Ferguson, Edoardo Gai, Paul Gruenwald, Manjit Jus, Roman Kramarchuk, Jennifer Laidlaw, Matthew Macfarland, Steve Matthewson, Matthew Mitchell, Gautam Naik, Karl Nietvelt, Bryan Schutt, Dennis Sugrue, Sarah Sullivant, Emmanuel Volland, Esther Whieldon, Nora Wittstruck

For essential intelligence to accelerate your sustainability journey, click here.

By Christopher K. Merker, PhD, CFA

Posted In: Drivers of Value, Economics, Future States, Performance Measurement & Evaluation, Portfolio Management

When I began teaching sustainable finance at Marquette University about a decade ago, environmental, social, and governance (ESG) investing and socially responsible investing (SRI) were backwaters. Of course, that has changed dramatically, particularly over the last four years, and here we are today.

But the increasing adoption and application of these types of investing criteria conceal some underlying challenges.

Despite the rapid growth of ESG funds across several measures, I still see four main obstacles to ESG investing&#;s continuing emergence. Below I outline these challenges, rate them according to their severity, and chart the progress towards potential solutions.

1. Defining Standards and Terminology

Severity: High

Problem: A survey conducted last year by State Street Global Advisors found that over half of those institutional investors already implementing some form of ESG strategy in their portfolios were struggling with clarity around standards and terminology. That shows considerable confusion on the subject. MSCI scores ConocoPhillips an A, the third highest rating available. That&#;s, comparatively speaking, a relatively strong ESG rating. So good, that two of the largest asset managers in the world both hold CononoPhillips in their ESG funds. To include or not to include? Are we avoiding the oil sector altogether or not? Maybe the strong &#;non-GAAP&#;-related performance and transparency demonstrated by energy companies should be embraced? Or maybe not. This issue creates a real conundrum for investors, and there are, of course, many less extreme, if no less challenging, examples to untangle in this context.

Another criticism targets the ESG ratings firms themselves. Their ratings are inconsistent due to significant differences in data collection, analysis, and reporting. Indeed, ratings are rarely the same, or even similar, for a given company. And there are a lot of them. The empirical argument on ESG yielding better risk-adjusted performance is untenable if we can’t point to consistent standards. If our interpretation of the data leads us to use one rating and not another and that trade makes our portfolio worse off, what then? We have a fiduciary obligation to our clients in almost all cases to outperform, and ESG’s most important claim is that doing good will drive better returns. That argument is weakened by inconsistent ratings. As James Mackintosh recently observed, Warren Buffett&#;s Berkshire Hathaway was ranked dead last in the S&P by one ratings firm and in the middle of the pack by another. That&#;s simply too much dispersion.

We should strive for greater consistency, as we see with bond ratings, and for ratings differences among the ratings agencies to become more the exception than the norm. But that consistency needs to be driven by something other than human judgment. Rather, it needs to be tied to both financial and impact results.

Discussion: Standards and reporting are catching up through the good work of such organizations as the Sustainable Accounting Standards Board (SASB). The SASB&#;s complete set of codified standards are due out in Q3 The launch of products such as the Morningstar Sustainability Rating in late and ISS-Ethix were likewise positive developments for fund analysis.

How ESG expresses values needs to be better understood, and the gray area made less gray in relation to SRI principles. Are we investing for better performance, impact, or both? What differentiates one ESG manager from another? Better performance, impact, or both? Standardization of reporting to investors will help.

2. ESG Adoption 

Severity: Medium

Problem: Awareness and understanding of ESG and its role need to improve. We also need to clarify how ESG differs from SRI and even impact investing. Institutional investors are having conversations on these issues, and adoption rates are brisk of late, but few others are jumping in, especially among retail investors.

Discussion: This is not as pressing an issue and is less demand- and more supply-driven. ESG methods should help mitigate risk and drive higher returns on the asset management side of the business. As asset managers increase their understanding of ESG as a core investment process, the notion of an ESG product as distinct from other active or indexed products starts to wither away. ESG will just become the way investing is done and will theoretically be applied to all manner of investing.

At some point, no one will ask whether a security is ESG or not. They may inquire what values are expressed or what constraints are in place, as we see today with SRI. Asset managers are clearly not waiting for buyers. Rather, perhaps too many are claiming to be ESG managers without any standards of practice attached to that.

3. The Quality of ESG Information

Severity: Medium

Problem: We need more and better issuer disclosures as well as more insightful data. Too much of the available ESG information is of poor quality.

Discussion: There are lots of people and organizations working on this problem — the Global Reporting Initiative (GRI), Governance and Accountability Institute (GAI), and SASB, among them — and it should eventually sort itself out.

However, information overload is a Big Data problem that requires better quantitative methods. We’ve been working on this at Marquette. For example, governance factors can run more than variables. How can all that data be distilled down to something useful? Applying statistics in a unique way, we reduce the 17 most important variables to a single index. Not only is that index consistently predictive within a month time frame, but it has very strong R-squared explanatory power across multiple financial variables and impact measures. An investment manager, client, or investment board looking at a report may only be interested in a single index measure. That measure needs to be well-researched and robust to be effective.

It&#;s time for ESG to become more of a science and less of an art. This should help address the consistency problem as well.

4. ESG in Other Investment Markets

Severity: High

Problem: As the Wall Street Journal reported recently, private markets have eclipsed the public markets for the last six years in a row when it comes to new issuances.

We’ve all heard about the incredible shrinking equity market, wherein the number of publicly traded companies is about half what it was two decades ago. The question is how does all this ESG work find its way into an area of investing that is overtaking the more traditional forms.

ESG has a natural home in the public markets, which already have ongoing disclosure requirements. Unfortunately, these requirements are why many companies no longer want to remain public.

But what about other areas, say, municipal bonds? One of the constraints on the growth of ESG municipal exchange-traded funds (ETFs) is the lack of data available to the exchanges. Frankly, governments need to be held to the same standards as public companies, especially in light of the rapid growth in green bonds, recent tax legislation around Opportunity Zones, and the emergence of social impact bonds (SIBs), not to mention the controversies around such major defaults as in Detroit and Puerto Rico, financial and social distress in Dallas, Illinois, and Connecticut, and water quality in Flint, Michigan.

Discussion: The solution needs to be driven by issuers, investors, intermediaries, and standard-setting organizations, just as with the public side of ESG. This will, no doubt, be a long process.

This article is based on remarks presented during a panel discussion at the Barron’s Impact Investing Summit in San Francisco on 21 June

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/ JJPanr

Christopher K. Merker, PhD, CFA

Christopher K. Merker, PhD, CFA, is a director with Private Asset Management at Robert W. Baird & Co. He is also director of the sustainable finance and business program at Marquette University, and executive director of Fund Governance Analytics (FGA). He recently served on the CFA Institute ESG Working Group, responsible for leading the development of global ESG standards. He publishes the blog, Sustainable Finance, and is co-author of the book, The Trustee Governance Guide: The Five Imperatives of 21st Century Investing. Chris received his PhD from Marquette University and MBA from Thunderbird, School of Global Management.

A webinar panel organized by Responsible Investor and Qontigo on November 24 brought together the view on impact investing from experts in academia and financial services. 

The debate focused on the challenges of implementing impact strategies, and more specifically how to define and measure this segment of responsible investing that is growing at a fast pace.

_{Source: Responsible Investor}

Saumya Mehrotra, Associate Principal at Qontigo’s Sustainable Investment team, moderated the discussion and began the session by sharing the findings from a recent Qontigo study focused on impact investment¹. The study reviews prominent impact management and measurement frameworks to derive a baseline of what counts as investor impact, and assesses existing impact-branded investment practices vis-à-vis the baseline to gauge the level of alignment between theory and practice. As part of the study, the authors also examine the challenges to integrating impact in investment strategies.

We found there is “rampant confusion in the market about the process of impact creation through investments, which leads to mislabeling and capital misallocation,” Mehrotra told the audience. “One of the major challenges is in developing a comprehensive and holistic view of company-level impact. A second issue is the inconsistency in the underlying metrics to evaluate a company’s performance. The third thing is the lack of data verification and assurance standards.”

The Qontigo whitepaper also explores the United Nations’ Sustainable Development Goals (SDGs) as a practical framework to measure impact, as they provide a comprehensive link between larger systemic goals of society to very granular, ground-level company performance. The potential of SDGS as an impact measurement tool would be brought up at various times throughout the debate.

Measuring impact  

Julian Kölbel, a postdoctoral researcher at the University of Zurich whose studies have focused on sustainable investing’s contribution to societal goals², underscored the importance of measuring companies’ and investor impact amid a flush of capital inflows into impact strategies. The impact market has been valued at USD billion.³

“That must be an essential question we should address: what is the impact of all that money going in?” Kölbel said. “Five years ago, the most important question was, ‘how does (impact investing) perform compared to conventional investments?’ And I think now the question has shifted to ‘what really changes?’ You undertake some sort of activity and you want to know what changed because of that and how does that compare to what the world would look like if it hadn’t been done.”

Carlos Lastra, researcher at Clarity AI, returned to the SDGs and said they can help bridge the measurement gap. Clarity AI’s methodology maps the impact of a company’s operations, products and services to 52 out of SDG targets that have been identified as relevant to investors, measurable and with an actionable timeline. The methodology calculates in monetary value the contribution that companies make to each one of the measurable targets.

“The SDGs provide a framework in which you can bring in a taxonomy of the different impacts that companies create,” said Lastra. The framework allows an assessment and “makes information accessible and comparable across companies and asset classes.”

Drivers of demand

Quyen Tran, Director of Impact Investing and Head of Sustainable Investing Research for Fundamental Equities at BlackRock, brought the asset-management industry’s perspective. Tran explained that demand for impact investing is being fed by three drivers: a new cohort of more active and conscious asset owners, the realization that generating a positive outcome does not mean giving up on returns, and the availability of more choices thanks to innovation and accessibility.

“Demand for impact has been strong and rapidly increasing,” said Tran. “Even before the pandemic, the world already had urgent needs for solutions to fundamental challenges to society as well as the environment. The pandemic has only exacerbated these challenges and urgency to solve them.”

BlackRock’s approach to defining impact, Tran explained, is gauging whether a company is an agent of change or generates ‘additionality’ in terms of societal benefits. In other words, assessing whether its products and services, or its operations, produce a specific positive outcome that would not have occurred but for their existence. 

“We look to see whether the business model is not only different to competitors, providing that additionality, that edge that leads directly to impact, but also whether or not it is reaching the underserved,” Tran explained. 

Fostering impact as investors

And how can investors push companies to generate a positive effect on societies and foster additionality? BlackRock’s Tran said investors can bring innovation to companies and steward them through engagement towards specific actions and practices. On the financial side, she said anchor investors can increase visibility to undervalued companies that have a positive impact, provide capital in primary equity sales, and “create a better marketplace for private companies seeking a responsible exit to go public.”

Netting off positive and negative impact

Clarity AI’s Lastra brought up the challenge of calculating the net impact of companies that may add to certain societal goals while undermining others.

“It may be that, as a company, you create lots of employment but you also pollute a lot; in fact, that may be typical,” Lastra said. “We provide information on each one of the SDGs. We aggregate across different impact types through a measure of the value that is created for society. There’s meaningful comparisons that can be done across SDGs.”

Reasons for optimism

The debate brought an enlightening exchange of ideas around a rapidly-growing segment of responsible investing that is catching the attention of investors, regulators and the business sector. There was a positive take-out shared by most of the panelists: despite confusion and difficulties in settings clear rules for impact investing, there is reason for optimism in the rising awareness from investors, and in innovation in the use of frameworks such as the SDGs to measure real-world impact. 

¹ Bocquet, R., Mehrotra, S., Georgieva, A., Pina, P. Coelho, R., Lastra, C., ‘On the Way to Impact Investment: Mind the Gap Between Theory and Practice,’ August/September
² See also Heeb, F. and Kölbel, J., ‘The Investor’s Guide to Impact,’ University of Zurich.
³ Data from the Global Impact Investing Network (GIIN).

​With the growing focus on social responsibility globally, many investment management companies are including environmental, social, and governance aspects in their decision-making, aided by emerging technologies such as AI and advanced analytics. Not only might this help build credibility with investors, it could also create opportunities for alpha.

The sustainability movement is growing

Social consciousness has spread throughout many facets of life, and many companies are making a concerted effort to align with these principles. This effort has likely contributed to the steady rise in the media coverage afforded to “sustainable” brands over the past two years.¹ Evidence suggests a similar growth in a desire for what are characterized as “sustainable” or “socially responsible” investments. Globally, the percentage of both retail and institutional investors that apply environmental, social, and governance (ESG) principles to at least a quarter of their portfolios jumped from 48 percent in to 75 percent in ² While directing investments based on one’s values has been around for decades, discussions between advisors and their clients about ESG investing have become commonplace.

Despite greater adoption within the investment community, the varying approaches to ESG incorporation by investment management firms, regulators, and investors suggest the full potential has yet to be realized. This will likely happen if investment managers routinely consider ESG metrics in all investment decisions.³ While this scenario seems unlikely in the short term, the Deloitte Center for Financial Services (DCFS) expects client demand to drive ESG-mandated assets to comprise half of all professionally managed investments in the United States by According to the DCFS, investment managers are likely to respond to this demand by potentially launching up to beebs and her money makers hand out record new ESG funds bymore than double the previous three years. Firms may capture a greater share of this growing allocation to ESG by utilizing emerging technologies for incorporating quality ESG data into the investment decision process, developing products with clear ESG objectives, and embracing an ESG-driven culture across the organization to gain credibility with investors.

As runescape money making guide 2022 afk technologies, such as AI, enable better-quality ESG data and the regulatory landscape becomes clearer, institutional, and retail investors are expected to increasingly demand that ESG factors be applied to a greater percentage of their portfolios. In this scenario, ESG assets should continue to grow at a 16 percent compound annual growth rate (CAGR), totaling almost US$35 trillion by (figure 1).

New ESG fund launches to accelerate as demand spreads across geographies and investor types

The largest amount of sustainable investing assets is in Europe, totaling US$ trillion, followed by the United States with US$12 trillion.⁴ While Europeans may hold the highest esg investing the challenges of a growing market of ESG-aligned assets, much of the world’s recent growth in this space may be attributed to investors’ increased interest in the United States. From to the beginning ofassets under management with an ESG mandate held by retail and institutional investors grew at a four-year CAGR of 16 percent in the United States, esg investing the challenges of a growing market, compared with 6 percent in Europe.⁵

Flows into ESG funds in the United States picked up the pace in Barring a dramatic turnaround in the final few months ofequity and bond ESG mutual funds and exchange traded funds (ETFs) are likely to achieve record inflows for the fourth straight year.⁶ Flows into sustainable funds reached US$ billion through the first six months ofesg investing the challenges of a growing market, compared to US$ billion in all of ⁷

The driving force behind ESG at investment management firms is evolving and leading to increased fund launch activity. Client demand from both retail and institutional investors is now the top reason reported by money managers to incorporate ESG factors into investment decisions.⁸ Client demand for ESG mandates has increased over the past three years, supporting the rise in investment management firms’ product portfolios.⁹ DCFS expects a record number of ESG fund launches over the next three years as client demand increases. Investment management firms may benefit from this rise because ESG funds tend toward active management, with 92 percent delivered through actively managed portfolios.¹⁰

The ESG investing regulatory landscape remains fluid globally

While many clients are becoming comfortable with incorporating ESG into their portfolios, there are some concerns about the transparency and quality of ESG disclosures. Some institutional investors petitioned the Securities and Exchange Commission (SEC) in the fall of for rules to harmonize ESG investments.¹¹ Without a consistent framework governing ESG principles, investors are left to navigate through the seemingly ever-changing landscape of definitions. Providing consistent definitions for “environmental,” “social,” and “governance” will likely generate more efficiency in the ESG data value chain and drive more effective investor engagement—including between asset owners and asset managers.

Regulators have recently been demanding more depth and transparency from public firms regarding their environmental impact. Bringing uniformity to the Esg investing the challenges of a growing market taxonomy seems to be the goal of both US and global regulators—although both appear to view ESG investing through different lenses.

Traditionally, US disclosure requirements from the SEC on shareholder resolution votes have provided investors with information concerning a company’s ESG practices. Investment managers have utilized these disclosure rules to influence a corporation’s adoption of ESG principles. Updating disclosure requirements to include language related to ESG has received attention from the Congress, with a proposal that requires companies to include ESG metrics anno 1800 wie geld verdienen their annual SEC disclosures recently passing out of committee.¹² Making more money than your husband proposed bill calls for a committee of industry experts to recommend specific ESG metrics to the SEC for required disclosure.¹³

Apart from disclosure rules, an Executive Order released in April directed the Department of Labor, through its power granted under the Employee Retirement Income Security Act (ERISA), to review all pension fund investments to determine whether the funds’ implementation of ESG principles excluded energy companies and thereby hindered the return of plan assets.¹⁴ In other words, US-based institutional investors, such as pension funds subject to ERISA, must demonstrate that ESG investing benefited the long-term growth of plan assets.

In the European Union (EU), the European Securities and Markets Authority (ESMA) recently clarified questions surrounding ESG investments. ESMA proposed several additions to existing regulations that set out how financial market participants and financial advisors must integrate ESG risks and opportunities in their processes as part of their duty to act in the best interest of clients.¹⁵ The proposed amendments esg investing the challenges of a growing market that advisors must explain why sustainability factors were not considered as part of the process. The necessity of ESG integration in investment decisions might help explain why 97 percent of institutional investors in Europe are interested in ESG investments.¹⁶ EU regulators have also taken the lead in developing a common ESG taxonomy to facilitate sustainable growth financing and quiz to make money The stricter standards now applied to sustainable investments may explain why the percentage of ESG assets to total assets shrank in Europe between and even as interest in sustainable investing increased.¹⁸

In Asia, regulators have determined that increasing disclosure requirements about sustainability practices can encourage foreign investment.¹⁹ Inthe Chinese government, in a bid to increase transparency and investment, esg investing the challenges of a growing market, announced that listed companies and bond issuers will be required to disclose ESG-related risks.²⁰ Singapore was an early adopter of ESG-related standards in Southeastern Asia, which had a positive esg investing the challenges of a growing market on the development of its capital markets. Investor confidence in the quality of ESG data was established in Singapore after sustainability reporting was mandated in ²¹

Globally, while different regulators may have taken different approaches to ESG, similar outcomes for investors may be generated. Ultimately, all investors stand to benefit from greater transparency of ESG factors in the investment process. Frameworks such as those created by the Sustainability Accounting Standards Board (SASB) can help companies report material information related to ESG in a consistent manner. Some companies have recognized that the increased value placed on transparency by investors can benefit them and have begun reporting performance on relevant ESG factors in much more detail than would be otherwise required by regulators. For example, BP p.l.c. disclosed to investors that it is testing blockchain to track natural gas produced using more environmentally friendly methods throughout its supply chain.²² Whether it be from the regulators or companies themselves, the trend of greater ESG data disclosure is likely to only increase.

Emerging technologies create opportunities for alpha and ESG product innovation

Some investment professionals have expressed concern that alignment with ESG principles may hinder performance. However, a recent research study demonstrates that ESG metrics may in fact aid the quest for alpha. The study back tested ESG metrics for materiality and found that a strategy that solely based its investment decisions on these metrics outperformed a global composite of stocks, strengthening the case for an active ESG investment strategy.²³ As a result, ESG may provide an opportunity to both meet client demand as well as improve returns.

While back-testing supports the case for finding alpha with ESG data, the challenge remains for investment managers to apply current Esg investing the challenges of a growing market data to their investment process and client reporting. Much ESG data, such as carbon emissions, is provided inconsistently across companies and industries. Almost 80 percent of investment managers agree that they could improve client service by providing performance related to an investment’s ESG impact in addition to financial performance.²⁴ However, only 44 percent of managers share ESG data with institutional clients and even less (30 percent) do so with retail clients.²⁵

This conundrum of wanting to build material ESG data into the investment process and report ESG performance to clients yet finding it difficult to do so is largely due to the inconsistent availability and quality concerns of data. Global investment managers describe inconsistent data across assets as the biggest barrier to integrating ESG into investment processes.²⁶ ESG disclosures tend to be making money from home blog by larger companies with more resources. Skewed disclosure may cause ESG investments to flow toward the largest companies even though smaller firms may have a similar or better impact regarding ESG issues.²⁷ Investment management firms have recognized this disconnect, and as a result, spending on ESG content and indices is expected to rise from levels by 48 percent to US$ million in ²⁸ Larger investment management firms have accelerated their spending on ESG data and tend to supplement it with proprietary metrics.²⁹

With greater standardization undistributed net investment income calculation ESG measures progressing slowly, advanced data analytics has become an essential component of ESG analysis, esg investing the challenges of a growing market. Investment management firms can leverage AI, such as machine learning, as well as alternative data to develop ESG metrics for analyzing investments, making decisions, and informing investors. By aligning advanced analytics tools with sustainability metrics, investment managers may be able to move beyond simple screening methods to actively make the case for alpha (see sidebar, “Innovative firms provide solutions for integrating ESG data into investment analysis”).

AI allows investment managers to uncover additional material data that may not have been disclosed by a company. One investment management firm uses an AI engine to scan unstructured data to identify material ESG data and then prioritize investments with low valuations for the highest expected return.³² This approach may help gain insight into, say, a company’s carbon emissions regardless of whether the company chooses to report them. The AI engine also searches unstructured data such as patent filings to identify companies that may be close to deploying cutting-edge low-carbon technologies. Identifying these types of investments before the companies tout their achievements may be the basis for higher future returns.

ESG ratings firms also utilize alternative data in their ratings processes. MSCI Inc. estimates that only 35 top oil companies to invest in right now of the data inputs used to compile a company’s ESG rating come from voluntary company disclosures.³³ In one case, the firm used satellite imagery to identify material risks to the environment and the safety of workers in a mining company’s operations to fill the gap between company disclosures and material ESG data metrics.³⁴ As a result, the use of alternative data to identify risks and opportunities for ESG investments is expected to accelerate over the next year.

As ESG gains greater acceptance with portfolio managers, differentiation often becomes critical. Going beyond transparency into product customization may be the future of ESG product innovation. About 68 percent of investment managers believe that much of the growth in ESG investments will be fueled by product customization.³⁵

Yet, as mentioned previously, while ESG is a priority for institutional investors, only 23 percent have integrated ESG principles throughout their organizations and 30 percent have separate ESG and investment teams.³⁶ This presents a significant opportunity for investment managers to deliver customized solutions for clients who want ESG to play a larger role in their portfolios but lack an implementation road map. DWS Group and Blackrock were able to provide such guidance to a large European pension fund in By each tailoring a unique ESG strategy based on the pension fund’s philosophy to favor companies with strong corporate governance and to avoid certain industries, the two investment management firms were able to bring two new sustainable ETFs to market, each garnering more than US$ million inflows on their first trading day.³⁷ The success of these launches highlights the acceleration of interest in US retail ESG funds by a diverse set of investors.

Looking deeper at customization, invest-tech firms Open Invest Co. and Ethic Inc. have developed platforms that allow investors to choose among environmental, social, esg investing the challenges of a growing market, or governance themes.³⁸ Investors can customize their portfolios by adding or removing specific companies through direct indexing.³⁹ Some traditional investment management firms have taken notice and are trying to increase their ESG product offerings by developing their own platforms, esg investing the challenges of a growing market. John Hancock Personal Financial Services designed a platform known as COIN, which is accessible from any device and provides investors with the opportunity to directly own shares of companies that align with UN Sustainable Development Goals.⁴⁰ The COIN platform may strengthen relationships by putting updates on the portfolio’s ESG performance at the client’s fingertips.

Emerging technologies may provide investment managers the tools to both improve client experience and aid in the quest for alpha. With the forecasted rise in ESG data spending this year, the number of investment management firms that provide their clients ESG performance data is likely to increase. The amount of ESG data is expanding as companies increase disclosures and ESG rating firms incorporate new data points into their metrics. It has become more important for investment management firms to develop their own capabilities for gathering and managing quality data.

The need for credibility expected to lead the next wave of ESG-principled investing

There are likely to be winners and losers in the competition for ESG asset allocations. It could be crucial for investment management firms to recognize the importance of ESG and devote more resources to ESG product development to not fall behind peers. The overwhelming majority (89 percent) of investment managers believe sustainable investing will not dissipate, while the same number indicate their firms will devote more resources to this area in the next two years.⁴¹ Differentiation becomes much more difficult with many firms now preparing to expand ESG easy ways to make money 2022 options.

ESG is a lens into effective risk management and an avenue to optimize performance. It has to be credibly embedded into the investment management business model, all the way through to attracting talent.

—Kristen Sullivan, Americas region Sustainability Services leader, Deloitte & Touche LLP

Success could flow to the investment management firms that can align their brand with ESG principles. The most effective method to gain traction may reside in the level of credibility the investment management firm has achieved from investors as opposed to its menu of ESG products. Today, esg investing the challenges of a growing market, consumers often reward companies that appropriately match their brand ways to earn money online as a teenager their actions. An investment management firm may earn credibility with ESG-minded investors by fully embracing the influence of ESG issues across its organization and demonstrating its commitment by detailing actions taken to align with these principles. Investment managers may find it difficult to effectively compete for capital allocations without a client-centric ESG strategy that encompasses credible ESG disclosure practices.

Capitalizing on a socially responsible future

The recent uptick in investor demand for ESG suggests investment management firms should take action today to maximize the ESG opportunity. The future wave of growth in ESG investing will likely not be driven by screening out “sin” stocks but could instead be fueled by managers using high-quality ESG data to increase the opportunity for alpha. A burgeoning ecosystem of customized ESG products and platforms presents investment managers with opportunities to further their value proposition to clients.

Investors are still going to consider performance when selecting an investment manager. However, investment management firms may find that ESG metrics improve the opportunity to find alpha as well as attract new clients. Having sustainable products on the shelf might be a necessary first step, but long-term success will likely reside in the ability to demonstrate to investors that the firm has holistically adopted sustainable practices. The ever-expanding expectations of investors and regulators will likely require a proactive approach. Investment management firms should identify any gaps by reexamining their processes through an ESG-principled lens, with an eye on what matters most to today’s investors. Byhalf of all professionally managed assets could fall under an ESG mandate. For an investment manager to capture a greater share of growth in assets under management, credibility with investors will likely be critical.

By Christopher K. Merker, PhD, CFA

Posted In: Drivers of Value, Economics, Future States, Performance Measurement & Evaluation, Portfolio Management

When I began teaching sustainable finance at Marquette University about a decade ago, environmental, social, and governance (ESG) investing and socially responsible investing (SRI) were backwaters. Of course, that has changed dramatically, particularly over the last four years, and here we are today.

But the increasing adoption and application of these types of investing criteria conceal some underlying challenges.

Despite the rapid growth of ESG funds across several measures, I still see four main obstacles to ESG investing&#;s continuing emergence. Below I outline these challenges, rate them according to their severity, and chart the progress towards potential solutions.

1. Defining Standards and Terminology

Severity: High

Problem: A survey conducted last year by State Street Global Advisors found that over half of those institutional investors already implementing some form of ESG strategy in their portfolios were struggling with clarity around standards and terminology. That shows considerable confusion on the subject. MSCI scores ConocoPhillips an A, the third highest rating available. That&#;s, esg investing the challenges of a growing market, comparatively speaking, a relatively strong ESG rating. So good, that two of the largest asset managers in the world both hold CononoPhillips in their ESG funds. To include or not to include? Are we avoiding the oil sector altogether or not? Maybe the strong &#;non-GAAP&#;-related performance and transparency demonstrated by energy companies should be embraced? Or maybe not. This issue creates a real conundrum for investors, and there are, of course, many less extreme, if no less challenging, examples to untangle in this context.

Another criticism targets the ESG ratings firms themselves. Their ratings are inconsistent due to significant differences in data collection, analysis, and reporting. Indeed, ratings are rarely the same, or even similar, for a given company. And there are a lot of them. The empirical argument on ESG yielding better risk-adjusted performance is untenable if we can’t point to consistent standards. If our interpretation of the data leads us to use one rating and not another and that trade makes our portfolio worse off, what then? We have a fiduciary obligation to our clients in almost all cases to outperform, and ESG’s most important claim is that doing good will drive better returns. That argument is weakened by inconsistent ratings. As James Mackintosh recently observed, Warren Buffett&#;s Berkshire Hathaway was ranked dead last in the S&P by one ratings firm and in the middle of the pack by esg investing the challenges of a growing market. That&#;s simply too much dispersion.

We should strive for greater consistency, as we see with bond ratings, and for ratings differences among the ratings esg investing the challenges of a growing market to become more the exception than the norm. But that consistency needs to be driven by something other than human judgment. Rather, it needs to be tied to both financial and impact results.

Discussion: Standards and reporting are catching up through the good work of such organizations as the Sustainable Accounting Standards Board (SASB). The SASB&#;s complete set of codified standards are due out in Q3 The launch of products such as the Morningstar Sustainability Rating in late and ISS-Ethix were likewise positive developments for fund analysis.

How ESG expresses values needs to be better understood, and the gray area made less gray in relation to SRI principles, esg investing the challenges of a growing market. Are we investing for better performance, impact, or both? What differentiates one ESG manager from another? Better performance, impact, or both? Standardization of reporting to investors will help.

2. ESG Adoption 

Severity: Medium

Problem: Awareness and understanding of ESG and its role need to improve. We also need to clarify how ESG differs from SRI and even impact investing. Institutional investors are having conversations on these issues, and adoption rates are brisk of late, but few others are jumping in, esg investing the challenges of a growing market, especially among retail investors.

Discussion: This is not as pressing an issue and is less demand- and more supply-driven. ESG methods should help mitigate risk and drive higher returns on the asset management side of the business. As asset managers increase their understanding of ESG as a core investment process, the notion of an ESG product as distinct from other active or indexed products starts to wither away. ESG will just become the way investing is done and will theoretically be applied to all manner of investing.

At some point, no one will ask whether a security is ESG or not. They may inquire what values are esg investing the challenges of a growing market or what constraints are in place, as we see today with SRI. Asset managers are clearly not waiting for buyers. Rather, perhaps too many are claiming to be ESG managers without any standards of practice attached to that.

3. The Quality of ESG Information

Severity: Medium

Problem: We need more and better issuer disclosures as well as more insightful data. Too much of the available ESG information is of poor quality.

Discussion: There are lots of people and organizations working on this problem — the Global Reporting Initiative (GRI), Governance and Accountability Institute (GAI), and SASB, among them — and it should eventually sort itself out.

However, information overload is a Big Data problem that requires better quantitative methods. We’ve been working on this at Marquette. For example, governance factors can run more than variables. How can all that data be distilled down to something useful? Applying statistics in a unique way, we reduce the 17 most important variables to a single index. Not only is that index consistently predictive within a month time frame, but it has very strong R-squared explanatory power across multiple financial variables and impact measures. An investment manager, client, or investment board looking at a report may only be interested in a single index measure. That measure needs to be well-researched and robust to be effective.

It&#;s time for ESG to become more of a science and less of an art. This should help address the consistency problem as well.

4. ESG in Other Investment Markets

Severity: High

Problem: As the Wall Street Journal reported recently, private markets have eclipsed the public markets for the last six years in a row when it comes to new issuances.

We’ve all heard about the incredible shrinking equity market, wherein the number of publicly best investment brokerage firms 2022 companies is about half what it was two decades ago. The question is how does all this ESG work find its way into an area of investing that is kurzon inc. had these transactions pertaining to investments in common stock the more traditional forms.

ESG has a natural home in the public markets, which already have ongoing disclosure requirements. Unfortunately, these requirements are why many companies no longer want to remain public.

But what about other areas, say, municipal bonds? One of the constraints on the growth of ESG municipal exchange-traded funds (ETFs) is the lack of data available to the exchanges. Frankly, governments need to be held to the same standards as public companies, especially in light of the rapid growth in green bonds, esg investing the challenges of a growing market, recent tax legislation around Opportunity Zones, and the emergence of social impact bonds (SIBs), not to mention the controversies around such esg investing the challenges of a growing market defaults as in Detroit and Puerto Rico, financial and social distress in Dallas, Illinois, and Connecticut, and water quality in Flint, Michigan.

Discussion: The solution needs to be driven by issuers, investors, intermediaries, and standard-setting organizations, just as with the public side of ESG. This will, no doubt, be a long process.

This article is based on remarks presented during a panel discussion at the Barron’s Impact Investing Summit in San Francisco on 21 June

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images/ JJPanr

Christopher K. Merker, PhD, CFA

Christopher K. Merker, PhD, CFA, is a director with Private Asset Management at Robert W. Baird & Co. He is also director of the sustainable finance and business program at Marquette University, and executive director of Fund Governance Analytics (FGA). He recently served on the CFA Institute ESG Working Group, responsible for leading the development of global ESG standards. He publishes the blog, Sustainable Finance, esg investing the challenges of a growing market, and is co-author of the book, The Trustee Governance Guide: The Five Imperatives of 21st Century Investing. Chris received his PhD from Marquette University and MBA from Thunderbird, School of Global Management.

More recently, governments and companies have committed to the COP 21 agreement, which has the purpose to curb CO2 emissions as a tangible objective towards slowing down the global warming. From an ESG perspective, the agreement stipulates esg investing the challenges of a growing market companies must report mandatory information and estimates of their CO2 emissions, and further, companies in high CO2 emitting industries are expected to report their transition strategies for reaching a lower CO2 emission level. However, the scoring is highly subjective as it is hard to accurately predict the optimal CO2 level or saving potential in a certain industry, not to mention the inability to measure the CO2 impact of the transformation strategies.

In terms of standards applied by companies, an ISO standard regarding GHG (Green House Gas) defines three scopes of emissions as follows:²

• Scope 1: Direct emission from owned and controlled resources.
• Scope 2: Indirect emissions from purchased energy.
• Scope 3: Indirect emissions that occur in the value chain.

How can companies create value from applying ESG metrics?³

A number of benefits can be achieved by applying ESG metrics and setting goals for business practices:

• A better corporate governance leads generally to better employees retention and engagement.
• Reducing the consumption of the resources that are part of the value chain reduces the direct operating costs. However, it might first take an investment in changing the way product or services are produced to achieve this cost reduction.
• Reducing the indirect polluting behavior has a direct effect on the SG&A costs.
• Having weak internal standards can lead to more compliance investigations or audits, naturally coming with a cumulative financial impact.
• Finally, millennials are increasingly interested in the impact of their consumption. In other words, taking an ESG approach can lead to an organic growth of the top line!

Impact investment - why is it hard to agree on a SRI theme?

Socially responsible investment (SRI) refers to investments with a positive impact on society, and we have seen SRI investments related to various social causes flourish in the investment management industry. Yet, what can be defined as a “good” action is not the same to everybody. Socially responsible investments have been numerous, spanning from investing in funds respecting the Catholic principles, over investing in green energy power plants and water technology platforms, to plastic and waste reduction technologies, and gender gap. The list can go on. The choice of SRI theme is indeed a personal preference rather than a matter of scientific approach. The investor has to find a way to align her or his personal interest with the right and relevant investment product.

What are the main trends in ESG investments?

According to Morningstar research, the share of ESG investment in Europe has been growing fast for the last decade. Inthe AUM of ESG funds was around USD billion and it has since gone up to around USD billion in ESG investments are unevenly distributed when it comes to investment style, such that passive investments comprise only one sixth of those of the active style. Nonetheless, esg investing the challenges of a growing market, the recent months have seen a boom in the number of ESG benchmarks and many providers have launched an ESG version of their core investment offerings (See Figure 4).

The total US domiciled AUM using sustainable, responsible, and impact strategies grew from USD trillion at the start of to USD 12 trillion at the start of How valid are these numbers? How scientific is the esg investing the challenges of a growing market methodologies behind these funds? No one can tell.⁶

Beyond AUMs, what has also changed?

ESG integration in daily investment management processes has also implied that certain organizational changes have taken place. According to a survey by the ‘SimCorp ESSEC - Observatory for Investment Management‘⁴, 92% of the respondents confirmed to have an internal team dedicated to defining, implementing, and monitoring their ESG strategy (See Figure 5). This finding indicates that the companies surveyed do not want to fully rely on the available of-the-shelf ESG data. Roughly 50% of the respondents confirmed to be utilizing both internally or externally generated data points.

Sofia Ramos, Professor of finance at ESSEC Business School, confirms the mentioned trends and gives us her personal perspective: “We expect ESG to continue to significantly grow in the future. Key challenges for asset managers will be to cope with large volumes of extra financial data and integrate them in standard valuation models  to make the most informed investment decisions. Adjustment of valuation models and their calibration to the new data is going to be key."

ESG in practice in investment management

The interpretation of the fiduciary duty of an asset manager has and will be evolving. More and more investors are interested either in understanding the impact of their respective investments on the environment, society, or human rights, or in the impact of integrating ESG on their corresponding investment performance.

In both cases, this leads the institutional investors to consider the following:⁵

• Improve the ESG reporting and climate-related risks reporting in relation to their portfolios or funds.
• Align their internal governance according to the adopted principles.
• Adjust the investment strategy workflows and/or enhance the risk management processes.

The latter point would require a series of steps such as:

• Sourcing data internally or externally from various providers.
• Analyzing the coverage of this data.
• Setting a selection strategy depending on the quality of the coverage.
• Integrating the data within the enterprise esg investing the challenges of a growing market management system at the level of the compliance management, portfolio management or reporting.

Data challenges

The need for external data, esg investing the challenges of a growing market, particularly to have a comprehensive coverage, is unavoidable. Asset managers should develop a thorough due diligence process to understand the providers’ methodologies and quality of work. For example, an asset manager should ask whether the data is based on publicly available corporate reports, media sources, or proprietary on-site investigations. A fair share of the information can be hidden in the supply chain especially in countries lacking the appropriate reporting and/or regulatory frameworks.

Furthermore, depending on the investment universe, an asset manager should define the geographies and industries of interest.

Looking forward

The ESG industry has never played a more serious role in the investment management industry than it does today. In this regard, the non-financial data involved should be treated with the same respect as financial data. In particular, because it looks as if the days of non-audited ESG reports are soon over. With the increasing impact of ESG data, the respective reports issued by companies will be verified and audited just as financial reports in the future.

Eventually, the best way an investor can make sure that the ESG goals set by a company are achieved is by exercising the voting rights that he/she is entitled to. Investors have to play a more active role to influence a company’s governance and to create a positive impact. Consequently, the corresponding asset managers should be able to have a holistic view of the underlying ownerships and voting rights in their portfolios, and more importantly, exercise this right.

Regulatory overview

• EU Taxonomy technical working report has been published. The purpose of this regulation is the following:
  1. Create a common European framework for understanding the sustainability topic – in particular the impact of business activities on the climate change - and setting the required standards for a successful adoption.
  2. The report categorizes financing activities to depict those with a positive contribution to the climate change mitigation and/or the climate change adaptation.
  3. The report defines the relevant users of the taxonomy and the relevant use cases, such as the companies required to report sustainability data and financial institutions that are expected to utilize the reports.
  4. The report describes the economic impact of this potential regulation and the costs of transmission.
  5. The report classifies business activities in the categories of Climate Change Mitigation and Climate Change adaptation by creating a mapping from the NACE classification.
  6. The report lists potential relevant data point to report.

• In the EU as well, the Climate Benchmarks and Benchmarks ESG Disclosures working report has been published covering the following:
  1. “The minimum requirements to create a climate benchmark.”
  2. “Technical advice on ESG disclosures, including associated disclosure templates.”
  3. The aim of the EU Paris-Aligned Benchmarklabel is to align the objectives of the climate benchmarks with the COP21 agreement.
  4. The aim of the EU Climate Transition Benchmark label is to monitor and enforce the CO2 intensity reduction by members of a benchmark, having an objective a climate transition strategy.

• In the US, several acts are of relevance to the topic:

1. ESG Disclosure Simplification Act of [DRAFT], H.R. __, th Congress ()
2. Shareholder Protection Act of [DRAFT], H.R. __, th Congress ().
3. Corporate Human Rights Risk Assessment, Prevention, and Mitigation Act of [DRAFT], H.R.__, th Congress ().
4. Climate Risk Disclosure Act of [DRAFT], H. R.th Congress ().

In the latest review, the congress has rejected the proposed standards in point 1. 

• In the UK, the government issued a draft on the Green Finance Strategy to regulate the disclosure of climate-related risks as of

1. www.oldyorkcellars.com

2. FAQ, Greenhouse Gas Protocol,  www.oldyorkcellars.com

3, esg investing the challenges of a growing market. Five Ways that ESG Creates Value, NovemberMckinsey Quarterly, www.oldyorkcellars.com?cid=soc-app

4, esg investing the challenges of a growing market. INVESTISSEMENT SOCIALEMENT RESPONSIBLE (ISR) ET CRITÈRES ESG: PRÉSENTATION DES RÉSULTATS DE L’ÉTUDE, SimCorp – ESSEC « Observatoire de l’Investment Management » -SimCorp Insights

5. OECD - Integrating Climate Change-related Factors in Institutional Investment, Background paper for the 36^th round table on sustainable development February

6. www.oldyorkcellars.com

A webinar panel organized by Responsible Investor and Qontigo on November 24 brought together the view on impact investing from experts in academia and financial services. 

The debate focused on the challenges of implementing impact strategies, and more specifically how to define and measure this segment of responsible investing that is growing at a fast pace.

_{Source: Responsible Investor}

Saumya Mehrotra, Associate Principal at Qontigo’s Sustainable Investment team, moderated the discussion and began the session by sharing the findings from a recent Qontigo study focused on impact investment¹. The study reviews prominent impact management and measurement frameworks to derive a baseline of what counts as investor impact, and assesses existing impact-branded investment practices vis-à-vis the baseline to gauge the level of alignment between theory and practice. As part of the study, the authors also examine the challenges to integrating impact in investment strategies.

We found there is “rampant confusion in the market about the process of impact creation through investments, which leads to mislabeling and capital misallocation,” Mehrotra told the audience. “One of the major challenges is in developing a comprehensive and holistic view of company-level impact, esg investing the challenges of a growing market. A second issue is the inconsistency in the underlying metrics to evaluate a company’s performance. The third thing is the lack of data verification and assurance standards.”

The Qontigo whitepaper also explores the United Nations’ Sustainable Development Goals (SDGs) as a practical framework to measure impact, as they provide a comprehensive link between larger systemic goals of society to very granular, ground-level company performance. The potential of SDGS as an impact measurement tool would be brought up at various times throughout the debate.

Measuring impact  

Julian Kölbel, a postdoctoral researcher at the University of Zurich whose studies have focused on sustainable investing’s contribution to societal goals², underscored the importance of measuring companies’ and investor impact amid a flush of capital inflows esg investing the challenges of a growing market impact strategies. The impact market has been valued at USD billion.³

“That must be an essential question we should address: what is the impact of all that money going in?” Kölbel said. “Five years ago, the most important question was, ‘how does (impact investing) perform compared to conventional investments?’ And I think now the question has shifted to ‘what really changes?’ You undertake some sort of activity and you want to know what changed because of that and how does that compare to what the world would look like if it hadn’t been done.”

Carlos Lastra, researcher at Clarity AI, returned to the SDGs and said they can help bridge the measurement gap. Clarity AI’s methodology maps the impact of a company’s operations, products and services to 52 out of SDG targets that have been identified as relevant to investors, measurable and with an actionable timeline. The methodology calculates in monetary value the contribution that companies make to each one of the measurable targets.

“The SDGs provide a framework in which you can bring in a taxonomy of the different impacts that companies create,” said Lastra. The framework allows an assessment and “makes information accessible and comparable across companies and asset classes.”

Drivers of demand

Quyen Tran, Director of Impact Investing and Head of Sustainable Investing Research for Fundamental Equities at BlackRock, brought the asset-management industry’s perspective. Tran explained that demand for impact investing is being fed by three drivers: a new cohort of more active and conscious asset owners, the realization that generating a positive outcome does not mean giving up on returns, and the availability of more choices thanks to innovation and accessibility.

“Demand for impact has been strong and rapidly increasing,” said Tran. “Even before the pandemic, the world already had urgent needs for solutions to fundamental challenges to society as well as the environment. The pandemic has only exacerbated these challenges and urgency to solve them.”

BlackRock’s approach to defining impact, Tran explained, is gauging whether a company is an agent of change or generates ‘additionality’ in terms of societal benefits. In other words, assessing whether its products and services, or its operations, produce a specific positive outcome that would not have occurred but for their existence. 

“We look to see whether the business model is not only different to competitors, providing that additionality, that edge that leads directly to impact, but also whether or not it is reaching the underserved,” Tran explained. 

Fostering impact as investors

And how can investors push companies to generate a positive effect on societies and foster additionality? BlackRock’s Tran said investors can bring innovation to companies and steward them through engagement towards specific actions and practices. On the financial side, she said anchor investors can increase visibility to undervalued companies that have a positive impact, provide capital in primary equity sales, and “create a better marketplace for private companies seeking a responsible exit to go public.”

Netting off positive and negative impact

Clarity AI’s Lastra brought up esg investing the challenges of a growing market challenge of calculating the net impact of companies that may add to certain societal goals while undermining others.

“It may be that, as a company, you create lots of employment but you also pollute a lot; in fact, that may be typical,” Lastra said. “We provide information on each one of the SDGs. We aggregate across different impact types through a measure of the value that is created for society. There’s meaningful comparisons that can be done across SDGs.”

Reasons for optimism

The debate brought an enlightening exchange of ideas around a rapidly-growing segment of responsible investing that is catching the attention of investors, regulators and the business sector. There was a positive take-out shared by most of the panelists: despite confusion and difficulties in settings clear rules for impact investing, there is reason for optimism in the rising awareness from investors, and in innovation in the use of frameworks such as the SDGs to measure real-world impact. 

¹ Bocquet, R., Mehrotra, S., Georgieva, A., Pina, P, esg investing the challenges of a growing market. Coelho, R., Lastra, C., ‘On the Way to Impact Investment: Mind the Gap Between Theory and Practice,’ August/September
² See also Heeb, F. and Kölbel, J., ‘The Investor’s Guide to Impact,’ University of Zurich.
³ Data from the Global Impact Investing Network (GIIN).

Yesterday, we started a conversation with Georg Kell, considered one of the fathers of environmental, social and governance (ESG) investing. His new book, Sustainable Investing: A Path to a Money making electronic projects Horizon, takes a close look at the historic convergence between corporate sustainability and ESG-lens investing as a force for good that, together,  help drive systemic market changes.

Since his retirement from the United Nations, Kell has been advising executives from diverse industries on questions of business transformation and sustainability. And for four years, he has been chairing the Volkswagen Sustainability Council and working to lead the company out of its crisis following the "dieselgate” scandal in

TriplePundit: What are the main challenges in building a more sustainable financial system and to bring climate risk and resilience into ESG-lens investing and, really, the heart of financial decision making? You note in your book that we’re talking about a massive reallocation of capital, creating unprecedented risks and opportunities, in what you describe as a VUCA (increasingly volatile, uncertain, complex and ambiguous business context). Can you expand on that?

Georg Kell: There are short-term challenges for investors and sustainable investing at large. It's still difficult to get the right tool off the shelf at the right moment. The data world is still not up to speed. There's a lot of inconsistency and incoherence. However, at the same time, there is a lot of innovation happening and I'm quite confident that much better data analytics and capabilities are being brought to the marketplace. This will enable financial institutions to embrace this agenda much faster.

Another challenge is that there's still uncertainty about the bigger framework conditions on the regulatory side.  The new taxonomy being released in Europe, however, will be a major regulatory push for this movement, which the market is watching closely.

Another problem is: How do you change financial institutions from within when the leadership is reluctant to embrace change or give up established practices? Again, COVID, I am convinced, will accelerate that change at the institutional level.

I also think business education needs an overhaul. Business students today are still looking at finance as a black box isolated by and large from societal changes, esg investing the challenges of a growing market. There's a major transformation happening in societies where ESG issues are gaining relevance, and it affects all industry sectors. Getting a handle on that will be increasingly necessary to be successful in the field of business.

3p: What are the main drivers that will determine if we can rise to the challenge of sustainability?

GK: In my mind, there are three forces, and they’re ebest investment securities. They play out across all countries and regions and they're irreversible, at least in the short or medium term. The first is technology. Clearly the pace of innovations has been accelerating. Technology allows transparency. It allows measurement and quantification of externalities. We couldn’t handle that just a few years ago. What's happening right now is nothing short of a revolution, especially in the world of finance where big data, self-learning and AI are now kicking in to make sense out of ESG factors and offering much deeper insights into risks and opportunities. This is helping financial analysts who may not necessarily have the knowledge about ESG issues, but want to apply some off-the-shelf tools.

Secondly, we bitcoin investing canada 55 the concept of the nine planetary boundaries that provide a safe operating space for humanity, as developed by climate scientist Johan Rockström, a contributor to the book. The boundaries include climate change, biodiversity loss and extinction, land-system change, freshwater use, and ocean acidification, esg investing the challenges of a growing market, among others. Crossing these boundaries increases the risk of generating large-scale abrupt or irreversible environmental changes. We are just now realizing that the pace of disruption to the these planetary boundaries is happening much faster than even scientists have predicted, as we see with the wildfires in California now and the ones in Australia earlier this year.

The third force, and this also makes me feel positive, is young people. I have lived in the U.S. for over 30 years, and I am delighted that young people are taking to the streets around social issues. It shows they care about their future and they want to contribute to the public good. This intergenerational change is powerful.

3p: How should company leaders demonstrate to investors that they are serious about ESG in a new financial system with climate resilience at the center?

GK: Businesses have long understood that efficiency is important to reduce costs and reduce potential liabilities. But it is only recently that corporations have started to understand that their emissions and footprint are more than just black keys money maker meaning cost factor in the equation. Many of them did just enough to comply with regulation — a game of compliance optimization. That has changed radically because carbon and emissions are now seen as one of the central pillars for a future license to operate. It goes beyond a fundamental cost aspect esg investing the challenges of a growing market a strategic component. That is also because carbon pricing is bound to increase; negative carbon is bound to become the currency of the future. Corporate executives are starting to understand that regulators over time will be quite tough on these issues, and there's no escaping anymore that consumers and customers increasingly want to know their footprint.

And increasingly investors are aware of the risks of companies being too exposed on the emissions side and then all of a sudden falling into the trap of stranded assets or negative backlash. Investors want to hear from executives: What is your plan to reduce carbon and other emissions? How do you think you can achieve this? What kind of technologies were you betting on? How is your value chain organized and can you carry them with you? What are the bottlenecks? They want to have a compelling narrative. And of course, we want to know if companies can tell us their current footprint. Amazingly, many corporates still don't have a good accounting for their emissions. In today’s world of risk management, that is inexcusable.

Corporations have to move from compliance optimization to advocate a policy framework for carbon pricing. In other words, they need to see their role as no longer blocking climate action policies but actually supporting them, because if your new business model is to be successful, we need a change in policy frameworks. In the end, there’s just no way around committed leadership. Increasingly, disruptions are ahead of us. It’s becoming the new normal. You need to have clear understanding of the issues. And then you build your processes, your operations, and you retool them. And if you have the ambition, you design the leap esg investing the challenges of a growing market the future.

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Financial markets can support the transition to a more sustainable and fairer economy by influencing firms' funding costs. To explore this mechanism, we study the extent to which investors respond to signals about the environmental or social benefits stemming from given projects or firms. We find evidence of a carbon risk premium: debt from entities with a higher carbon footprint trades at marginally higher yields, all else the same. We also document that investors are willing to pay a social premium – which we refer to as "socium" – when a firm issues a social rather than a conventional bond. The magnitudes of the carbon risk premium and socium are modest but non-negligible in some industrial sectors and market segments. Some obstacles – such as "ESG washing" – stand in the way of further ESG market deepening, limiting contributions to sustainable development. ¹

JEL classification: Q01, Q5

Climate change and rising concerns over social issues have put the spotlight on the environmental costs and social disparities generated by economic activity. While climate-related concerns were first to come to the fore, the Covid pandemic has drawn attention to social considerations.

Financial markets – and in particular the markets for assets with environmental, social and governance (ESG) benefits – can play a key role in mitigating environmental externalities and social disparities. ESG esg investing the challenges of a growing market have the potential to influence the allocation of investing in johannesburg stock exchange resources by adjusting firms' funding costs. For this mechanism to work well, two conditions need to be met, esg investing the challenges of a growing market. First, there needs to be reliable information about the ESG benefits generated by projects and firms. Second, investors need to be responsive to this information.

Given such potential, policymakers have joined the general public in encouraging market participants to support the transition to a sustainable economy. For example, the Network for Greening the Financial System (NGFS) – representing central banks and supervisory authorities – explicitly seeks to "mobilise capital for green and low-carbon investments in the broader context of environmentally sustainable development".

This special feature explores two questions related to financial markets' role in the transition to a more sustainable and fairer economy. Is there evidence that market participants respond to signals about the environmental and social benefits of projects or firms? What are the major roadblocks standing in the way of further ESG market development, and what are some possible solutions?

Our main contribution is novel empirical evidence on whether financial markets reward activity with perceived ESG benefits and penalise actions perceived to be harmful, esg investing the challenges of a growing market. In particular, we add to the fast-growing literature on climate risk in financial esg investing the challenges of a growing market (see Giglio et al () for a review) with evidence on the pricing of this risk in corporate bond markets. We are also among the first to shed light on whether bond markets pay attention to social issues.

We highlight three takeaways. First, we find that bonds issued by "browner" firms – those with higher carbon emissions – tend to trade at marginally higher yields on secondary markets after adjusting for credit risk. This probably reflects the preference of environmentally responsible investors. That said, the magnitude of the impact – the so-called carbon risk premium – is generally quite small and reaches non-negligible levels only for firms in energy-intensive sectors.

Second, we show that social bonds denominated in the US dollar or the euro have been issued at a price premium compared to standard bonds. There is thus a social premium – which we refer to as "socium" – in a market segment that grew more than fivefold between and ² On average, the socium corresponds to a rating upgrade of more than one notch.

Third, we emphasise the importance of reliable information for ensuring that ESG markets rest on robust foundations. We review roadblocks undermining trust in ESG designations and possible solutions, including efforts already under way.

This special feature is organised as follows. We first provide an overview of ESG markets. We then discuss how investors respond to signals about projects' or firms' role in environmental and social issues. We conclude by highlighting the importance of reliable ESG information for ESG market development.

ESG markets: an overview

Awareness of environmental and social issues has been rising in recent years. Overall, the broad ESG topic has become more relevant for investors, with the term "ESG" increasingly mentioned in large companies' earnings calls (Graph 1, left-hand panel).

This partly reflects mounting environmental risks associated with climate change.³ As a result of rising global temperatures, adverse weather events have become more frequent over the past three decades (Graph 1, right-hand panel). In addition to these physical risks, climate change also poses transition risks – which are related to regulatory measures, changes in consumer preferences or technology that may impair the viability of particular sectors.

At the same time, the Covid pandemic has highlighted the pervasiveness of social disparities. For instance, firms receiving public support have come under scrutiny over their labour practices.⁴ More generally, there is evidence that investors are paying increasing attention to social issues in the post-pandemic world.⁵

In parallel, a growing number of private and public initiatives have emerged to foster sustainable finance – investment products and services that intend to support the transition to a more sustainable and fairer economy. Many of these initiatives focus on improving investors' information about the ESG benefits generated by projects and firms (see Box A for examples).⁶ Some manifest themselves as a rising number of entities supporting climate-related risk disclosures: a fivefold increase since (Graph 2, left-hand panel). There are also efforts to mobilise private and public capital in support of broad ESG goals.

Against this backdrop, the markets for ESG assets are booming. The outstanding amount of "labelled" bonds – use-of-proceeds bonds to finance projects with environmental or social benefits – has risen more than tenfold over the past five esg investing the challenges of a growing market, and bitcoin investing 2022 21 stands at more than $2 trillion.⁷ Green bonds account for the lion's share of this amount (Graph 2, centre panel). Assets under management (AUM) in funds that self-identify as having ESG mandates have also grown manyfold over the last five years, and now stand at about $ trillion (right-hand panel). ESG mutual funds hold mostly equities (more than 60% of AUM), followed by bonds (around 20%).

The footprint of retail investors in the ESG fund segment is rising, as indicated by the growing AUM of passive funds (ETFs). Like mutual funds, ESG ETFs also focus primarily on equities.

Market developments also reflect the increased prominence of social issues since the outbreak of the Covid pandemic. Social bond issuance has surged recently, with outstanding amounts growing more than fivefold between and (Graph 2, centre panel). Such securities tend to be issued by supranationals (33% of total amounts outstanding), sovereigns, government agencies and development banks (46%), as well as corporates (21%), esg investing the challenges of a growing market. Most social bonds are issued in either the euro (67%) or the US dollar (15%).

In interpreting these market developments, it is necessary to keep in mind that the term "ESG assets" covers a wide range of investment products, with a universally accepted, standardised esg investing the challenges of a growing market yet to emerge. For instance, the ESG designation can be self-attributed by the very firms issuing securities (eg labelled bonds) or by asset managers marketing their investment products.⁸ Alternatively, the designation may be assigned by a specialised provider of ESG ratings, with firms' voluntary disclosures providing a key input. When it comes to exposures to climate-related transition risks, such providers and investors seem to be converging on disclosed carbon emissions as a reasonable proxy.⁹ But there is no similar metric when social aspects are involved.

ESG preferences and the cost of debt

ESG markets have the potential to reallocate resources to economic activities that generate fewer environmental externalities and social disparities. A precondition for this esg investing the challenges of a growing market to work is that market participants respond to information about the extent to which a given asset is associated with such activities. Part of this response may have to do with the information's relevance for assessing the asset's riskiness, ie if assets yielding such benefits are perceived as less risky, all else equal. In addition, the response may work through a preference channel. Investors committed to supporting sustainability goals might have a preference, all else the same, for assets that they perceive as helping to achieve those goals.¹⁰

We look for empirical evidence that the preference channel matters – over and above any risk considerations – for the costs of debt finance in two ESG market segments. In E space, esg investing the challenges of a growing market, we study the impact of a firm's carbon footprint on its borrowing costs, which we approximate with secondary market bond yields. In S space, we examine how the "social bond" label affects a bond's yield at issuance (primary market).

Michela Scatigna, Dora Xia, esg investing the challenges of a growing market, Anna Zabai and Omar Zulaica

Environmental and social issues are particularly acute in the Asia-Pacific region. The region has experienced about 40% of all global climate disasters over the last three decades. Moreover, it was hard hit by the pandemic, which exacerbated social disparities. Against this backdrop, policy authorities in the region have stepped up their efforts to address environmental and social issues. This box takes stock of recent developments in Asian ESG markets and provides an overview of policy efforts to foster such markets.

The development of ESG markets in the Asia-Pacific region is well under way. The region accounts for about 20% of global outstanding amounts of labelled bonds. The year to date has seen strong issuance, up 66% compared to (Graph A1, left-hand panel). The region is also well represented in the nascent ESG securitisation markets, with a 20% share (centre panel).

Several regional authorities are deploying a wide range of measures to actively foster ESG markets. The People's Bank of China (PBoC) has taken the lead in the development of taxonomies, issuing the Green Bonds Catalogue and joining forces with the EU to standardise taxonomies across different regions. New Zealand has made climate risk disclosures mandatory for banks and insurers. Hong Kong SAR has announced that climate-related disclosures will be mandatory for listed firms and various financial institutions no later than In addition, climate stress tests are under way or have been planned in several jurisdictions, including Australia, China, Hong Kong, Japan and Singapore. The Hong Kong Monetary Authority and the Monetary Authority of Singapore subsidise the issuance costs of green bonds and loans. Central banks in the region are also integrating ESG principles into monetary policy and reserve management operations. Green bonds have become eligible collateral for the PBoC's lending facilities. The PBoC, the Bank of Japan and the Central Bank of Malaysia (BNM) have announced facilities to subsidise loans to commercial banks that either support decarbonisation sectors (PBoC and BNM) or purchase green bonds or bitcoin investment uk us green loans (Bank of Japan).

In addition, regional and multilateral development banks have been playing an especially active role in deepening ESG markets, esg investing the challenges of a growing market, particularly the labelled bonds segments. On the supply side of these markets, the Asian Development Bank (ADB) and various government agencies in Korea and Japan have issued the bulk of esg investing the challenges of a growing market bonds in the region (Graph A1, right-hand panel). Agencies and multilateral development banks are also helping support demand for new ESG assets by mobilising private and public capital. The Asian Infrastructure Investment Bank (AIIB), for example, has provided anchor capital for a fund dedicated to climate bonds. In collaboration with the development financing community, the BIS is establishing an Asian Green Bond Fund, to channel global central bank reserves to green projects in the Asia-Pacific region.

The views expressed in this box a re those of the authors and do not necessarily reflect those of the BIS. Based on data from Bloomberg, as of end-November The ESG structured products segment is still small overall. At about $10 billion, esg investing the challenges of a growing market, ABS backed by green and social bonds correspond to less than 1% of the outstanding stock of the underlying securities. ashe guide the money maker src="www.oldyorkcellars.com" alt="icon"> For a full review, see De la Serve, M-E, D Revelin and K Triki, "Green finance in the Asia-Pacific region: mobilisation spearheaded by central banks and supervisory authorities", Banque de France Bulletins, noarticle 4, September For more details, see S Tiwari, "Greening Asia for the long haul: What can central banks do?", Brookings Institute Future Development Blog, October

The preference channel and the relative cost of debt in E space

Is there a carbon risk premium in corporate bond markets – one of the main sources of firm financing? In other words, do investors demand a higher yield when trading bonds issued by corporations with heavier carbon footprints? To answer this question, we measure a firm's carbon footprint through its carbon emissions¹¹ and use secondary market corporate bond yields to gauge investors' response.¹² We then analyse the relationship between the two while controlling for credit risk and other bond characteristics.

Our data set is as follows. We gather data on both direct and indirect carbon emissions from Trucost. Direct emissions refer to emissions from production (also known as "scope 1"). Indirect emissions refer to those coming from the consumption of purchased electricity, heat or steam ("scope 2").¹³ For bond pricing, we use secondary market quotes of option-adjusted spreads, provided by Refinitiv. We assume that estimates of five-year probabilities of default (PD), provided by Bloomberg, capture investors' perceptions of credit risk. We thus use these estimates to abstract from the risk channel and focus on the preference channel. Our analysis focuses on US and EU companies and bonds issued by them. Box B provides further detail on our empirical setup and reports additional results.

Considering firms in all sectors, we find that bonds issued by those with esg investing the challenges of a growing market carbon emissions ("browner" firms) tend to have statistically higher risk-adjusted spreads, even though the difference is economically negligible (Graph 3, left-hand panel). Through the preference channel, a 10% increase in direct carbon emissions would lead to an increase of 2 basis points in corporate bond spreads for US bonds and basis points for EU bonds (Graph 3, left-hand panel). These esg investing the challenges of a growing market are orders of magnitude smaller than the median spread in our sample, at basis points. The impact of indirect emissions is even smaller, at basis points and effectively zero for US and EU bonds, respectively.

That said, zooming in on firms in energy-intensive sectors – which we define as energy, materials and utilities – reveals more material effects through the preference channel. Indeed, the overall results are heavily influenced by other firms, whose carbon emissions do not have a significant impact on their risk-adjusted spreads (Graph 3, centre panel). By contrast, the impact within the set of energy-intensive firms is not only statistically significant but also of non-negligible economic importance (right-hand panel). In the case of US bonds in particular, a 10% increase in direct carbon emissions would translate to a 6 basis point increase in spreads, which corresponds to a rating deterioration of notches.¹⁴ The differentiated impact across industries probably reflects investors' greater scrutiny of firms traditionally viewed as brown.

Taken together, we find some evidence supporting the presence of a preference channel in E space. However, the economic impact is rather small. This could be because the supply-demand imbalances arising from investors' preferences are not large enough to offset arbitrage forces that reflect purely financial considerations.

We employ two panel regressions to examine the role of carbon emissions in corporate bond spreads. The first provides our estimate of the preference channel and the second that of the risk channel.

To gauge the impact via the preference channel, we estimate the following equation:

where OAS_i,j,t is the option-adjusted spread for bond i issued by firm j at month is the natural logarithm of the five-year probability of default (PD) odds ratio for firm j at month are the one-year lagged carbon emissions from firm j (we use scopes 1 and 2 in separate regressions); Z_i,t is a set of contemporaneous bond-level control variables, including: duration, age, coupon rate, logarithm of amount outstanding, bid-ask spread (a proxy for liquidity) and a dummy indicating whether a bond is callable or not; FE represents a vector of time, firm and currency fixed effects. In this specification, the coefficient β_P,carbon corresponds to the impact of carbon emissions through the preference channel.

To assess the impact via the risk channel, we examine how carbon emissions affect estimates while filtering out the impact of other firm characteristics:

where X_j,t is a set of firm-level control variables, including: size of assets, return on assets, debt/asset ratio, retained earnings/asset ratio and capital/asset ratio, and FE represents a vector of time and sector fixed www.oldyorkcellars.com estimating the regressions, we esg investing the challenges of a growing market different sample splits. We estimate the two specifications separately for US and EU firms (and bonds issued by them). In each case, we conduct one estimate with all industrial sectors in the sample and then we split the sample in two by grouping firms in energy, materials and utilities into an "energy-intensive" category and all the other firms into a separate category. Our estimates of β_P,carbon for the preference channel are shown in Graph 3 and discussed in the main text. Our estimates of β_R,carbon for the risk channel are presented in Graph B1.

The results suggest that higher carbon emissions are linked to higher credit risk (Graph B1, left-hand panel). The impact is slightly larger for EU firms and for direct carbon emissions. Furthermore, the risk how much money have you made bitcoin mining effect is not limited to energy-intensive sectors (Graph B1, centre and right-hand panels). Despite the statistical significance of some of the results, the economic significance is very low. For instance, a 10% esg investing the challenges of a growing market in US firms' direct or indirect emissions would lead to a basis point increase in their bond spread. The numbers are comparable for EU firms.

We use option-adjusted spreads to account for the optionality embedded in callable bonds, which account for 60% of our sample. The logit transformation is a standard approach to account for the fact that default probabilities are bounded by 0 and 1 and are likely to depend on firm characteristics in a non-linear fashion. We use default probability estimates generated by Bloomberg, reflecting firm fundamentals (eg financial ratios) and asset prices (eg stock and CDS prices). We lag carbon emissions by one year to reflect Trucost's one-year release lag of carbon emissions data. We choose the bond-level control variables that are standard in the literature; see, for example, S Gilchrist and How to begin investing in cryptocurrency Zakrajšek, "Credit spreads and business cycle fluctuations", American Economic Review, esg investing the challenges of a growing market, volno 4, esg investing the challenges of a growing market, Junepp – We do not include oil prices in our set of control variables. While they influence corporate bond spreads, especially in the energy sector, their impact is absorbed in the time fixed effect. There are also fixed effects at the country level in the case of the European Union. Our carbon emissions data span the period from to Trucost does not cover a comprehensive list of firms before We obtain the impact of carbon emissions on corporate bond spreads through the risk channel by multiplying β_R,carbon and β_PD.

The preference channel and the relative cost of debt in S space

Might investors value the social label enough to pay a premium for holding mginger earn money sms rather than conventional bonds? In other words, is there a socium?

To answer this question, we match social bonds issued by banks and corporates between and with conventional securities that share similar risk characteristics.¹⁵ For each matched pair, we compute the socium as the yield spread between the social and conventional bond at issuance (that is, on primary markets). We carry out the analysis at the security level because there is no equivalent to carbon emissions in S space: market participants have not yet converged on a set of metrics capturing the social benefits generated at the firm level.¹⁶

In matching bonds, we use several criteria in the spirit of Larcker and Watts () and Flammer (). We first try to match the social bond with a conventional bond that is issued by the same firm. Within that firm, we look for a bond with the same rating as and a similar remaining maturity to the social bond at the time of data retrieval. If several such bonds exist, we pick the one whose issuance date is esg investing the challenges of a growing market to the social bond's. Conversely, if no such bond exists, we look for a security that is issued by a firm in the same sector as the social bond issuer and has similar characteristics to the social bond (again, credit rating and maturity).

We find that investors are indeed willing to pay a socium. That is, social bond yields at issuance are systematically lower than the yields on conventional bonds (Graph 4, left-hand panel). The mean socium in the full sample is statistically significant, at approximately 12 basis points, esg investing the challenges of a growing market. To gauge the economic significance of this estimate, we express it in "rating-notch equivalents" following Baker et al ().¹⁷ We find that the average socium corresponds to a rating upgrade of about 1 to notches. The results are in line with market intelligence reporting that social bond issues are oversubscribed (Bloomberg ()) – enough investors have a preference for these assets to affect their issuance price.

We next investigate whether the socium is currency-specific. To date, most corporate social bonds have been issued in euros (41% of amount outstanding), esg investing the challenges of a growing market, followed by US dollars (23%), Japanese yen (16%) and Korean won (10%). Corporate issuance in euros is associated with companies domiciled in the European Union (95%), whereas about a third of dollar-denominated issuance has taken place outside the United States. We split the sample by currency: one subsample includes bonds issued in euros and dollars, the other in yen and won.¹⁸ For the first subsample, we find the same average socium as in the overall sample: 21 basis points (Graph 4, centre panel). By contrast, there is no socium for securities denominated in won or yen (right-hand panel).

Taken together, our results in E and S space suggest that investors do respond to signals stemming from carbon footprint data and bond labels. While some of the effects are extremely small at present, ESG markets hold the potential to influence the allocation of economic resources.

Concluding observations

For ESG markets to support the transition to a more sustainable and fairer economy, it is not enough that investors respond to environmental and social signals. Another prerequisite is that these signals provide esg investing the challenges of a growing market ESG information.

Whether booming ESG markets rest on solid foundations remains an open question, esg investing the challenges of a growing market, not least because of growing concerns about "ESG washing" – that is, a misleading attribution of the ESG designation. These concerns are stoked by the absence of universal taxonomies and standardised, mandatory disclosures. For instance, ESG ratings are provided by a small group of agencies, which disagree as to how to interpret firms' voluntary ESG disclosures (Berg et al ()).¹⁹ This indicates uncertainty about the ESG benefits reaped by retail investors piling into ETFs that rely on specific ESG ratings (Graph 2, right-hand panel). Similar concerns apply to the nascent ESG derivatives market, and in particular its index segment.²⁰

Another issue is that the current ESG designation system might fail to align incentives with broad environmental goals at the level where decisions are made – the firm. This is particularly relevant when the designation is at the level of a security (ie labelled bonds). Green bond labels are a case in point. For these labels to imply emission reductions,²¹ the attendant projects would have to have a radical impact on the activities of the bond issuer. However, issuance of green bonds does not necessarily indicate a material reduction in carbon intensities at the firm level over time (Ehlers et al ()).

Any ESG designation needs to rest esg investing the challenges of a growing market a reliable taxonomy. Accordingly, some jurisdictions, notably China and the European Union, have already developed and adopted sustainable finance taxonomies, while others are taking steps in that direction (eg Canada, the United Kingdom). Classification systems have also emerged from the private sector (eg the Climate Bonds Taxonomy). The emerging consensus (G20 ()) is that, in an effective classification system, ESG assets will be those whose environmental and social benefits are material and consistent with broader sustainability goals (eg as set out in the Paris Agreement or the UN Sustainable Development Goals).

It is also important to standardise ESG taxonomies and make them comparable across countries. This is high on the policy agenda, as indicated by the G20's Sustainable Finance Roadmap and by the priorities of COP Some progress has already been made on this front. The European Commission and the People's Bank of China recently released their Common Ground Taxonomy, which identifies a set of economic activities recognised as environmentally sustainable by both the EU's and China's own classification systems.

Reliable taxonomies rest on reliable and informative metrics, which are still in the making. The metrics employed to quantify ESG benefits should be science-based (for environmental benefits) or fact-based and verifiable (for social and other benefits). While carbon emissions may be a reasonable proxy for the environmental benefits associated with firms, open questions remain concerning carbon accounting for sovereign or supranational issuers. Importantly, investors have not yet agreed on how to quantify social benefits (ADB ()). Given the multifaceted nature of social issues, it is likely that the quantification process will have to rely on a menu of (possibly ad hoc) metrics rather than a single indicator.

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