As always, COP27 arrived in November, bringing with it plenty of headline-grabbing pledges. But, with the dust now settling following the conference and the attention of governments returning to the pressing cost of living concerns and the ongoing conflict in Ukraine, the risk is that the pledges remain just that. Writes Andrew Pitts Tucker, managing director ESG, Apex Group.
After the politicians, journalists and policymakers have left Sharm El Sheikh. However, it’s important that we remain focused on the challenge of climate change – despite the economic and geopolitical headwinds. The financial services sector, in particular, has a big role to play here. While the impact of the sector itself is relatively small, the investment decisions made by financial institutions globally have a huge impact.
The Carbon Disclosure Project, for instance, estimates that the emissions associated with financial portfolios are 700x higher than those of the financial sector itself. This means that the sector has considerable power when it comes to decarbonising the economy, but is it happening?
There is no doubt a huge amount of progress has been made. Environmental, social and governance (“ESG”) aligned investment has gone truly mainstream and has had impressive growth in recent years. This positive trend is likely to continue, too, with PWC, for example, predicting that ESG-focused institutional investment will grow 84% to US$33.9 trillion by 2026, making up 21.5% of all assets under management.
The primary driver for this is the growing consciousness of environmental impacts on the part of consumers and individuals across the world. And, with younger consumers even more environmentally and socially conscious than preceding generations, we can see why the trend is likely to continue. This is good news, but it also requires regulation and structures to avoid the ‘greenwashing’ of investments, whether intentional or accidental.
If 2021 was the year in which ESG became mainstream, 2022 was characterized by a more thorough examination of its application to the financial services industry. Greenwashing refers to investors or businesses making claims about their ESG credentials which may not accurately match the reality of their business practices. Regulators have flexed their muscles this year, issuing fines for those who they deem to be intentionally misleading their investors in order to attract greater investment. In 2022, it has become clear that businesses will be held to account for ESG and preventing them from reaping the benefits without doing the hard work.
“If 2021 was the year in which ESG became mainstream, 2022 was characterized by a more thorough examination of its application to the financial services industry”
The risk with greenwashing is not just environmental and social malpractice but also the potential eroding of consumer and investor confidence in sustainability claims made by fund managers. This goes beyond the cutting of regulatory corners. It represents a betrayal of the trust of customers who are increasingly guided by environmental concerns in the investment decisions they make and the erosion of faith in the entire system of ESG ratings and the progress it represents
Companies have realised, over the last 12 months, that taking shortcuts when it comes to ESG reporting will not cut the mustard or deliver meaningful outcomes. As a result, more investment managers than ever are outsourcing their ESG needs as the complexities of data collection become clear, with many realising that “marking their own homework” in this regard will only invite further scrutiny.
One major obstacle to progress on this at present is the lack of data. We know greenwashing is an issue, and a significant one at that, but getting an estimate of the scale is difficult. Primarily because ESG reporting remains reasonably nascent, and the international frameworks by which we can hold ESG claims to account have yet to be built.
Important work is being done to find international standards. Research from the Centre for Innovation Management Research, for example, has begun the process of determining a baseline when it comes to testing ESG claims against reality, and early research is promising. Likewise, Bloomberg’s ESG Disclosure Score is a useful tool for investors looking to navigate this complex landscape. More needs to be done to facilitate research here, however, and determine best practices.
The forthcoming EU Taxonomy Rules are also a step in the right direction, bringing a degree of international harmony to our understanding of ESG and greenwashing. This is a good example of how policymakers can work across borders and jurisdictions, as they do in other areas of finance, to facilitate ESG-compliant business and make life harder for those who’d seek to greenwash.
Then there is technology. Collecting ESG data can be difficult, especially when dealing with a large multinational business that might have numerous operations and supply chains spread across many different jurisdictions. The process can be onerous, and developing the information-gathering processes required takes time. Technology has an incredible role to play here, however, in terms of streamlining this process and automating large parts of it. This makes it easier for businesses to comply and take charge of their ESG score.
With the ability to direct global capital flows in a way which is aligned with long-term sustainability, the financial sector has a unique role to play when it comes to decarbonising the economy. At the supranational level, COP27 is generating the energy and focus needed to rise to this challenge. Greenwashing however threatens this progress, so it’s incumbent upon the whole sector to build a more transparent ESG framework that makes it easier for businesses and investors alike to comply with ESG and take action needed to match the pledges made at Sharm El Sheikh.
In 2023, we expect managers to graduate from ESG reporting to seeking solutions which help them to drive measurable, positive change. Regulation will continue to move towards harmonization, driving adoption and becoming more mainstream across jurisdictions. Ultimately, as we have seen since the launch of Apex Group’s ESG solutions in 2019, this is an incredibly fast-moving market, as investor expectations on ESG performance and data are only growing while assets are still facing the same challenges. Managers will need the right partners with an evolving and innovative suite of solutions to help them keep up with the ESG agenda.
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