Environmental, Social and Governance (ESG) investing has moved from a niche part of our industry, to being a major disruptive force in recent years.
Businesses are increasingly incorporating ESG considerations into everyday practice, savers are increasingly expecting people and the planet to be considered as part of investing, and financial regulators are on the prowl to make sure that environmental and social factors are scrutinized and disclosed.
Alongside the change in perception is the realisation that responsible investing is complex, its terminology not completely formalised, regulations and investment providers continuing to evolve a part of the changing world
Questions remain whether investing sustainably affects performance and hence the likelihood of meeting financial goals.
Here we are focusing on terminology, where we draw heavily from the framework put together by The Investment Association (IA), the trade body representing UK investment.
The EU is also working on its own ‘Taxonomy’ of environmentally sustainable activities. However, although this will no doubt be very influential in this area globally (in the same way their data protection legislation has been), current EU proposals are still a work in progress.
They focus more on environmental standards rather than social ones and are more technical in nature rather than trying to create an overall framework for describing the different types of socially and environmentally conscious investing.
From what we have seen of their plans it appears their work, when finalised, will be complementary to what we’ve outlined here.
- Responsible Investment
Lots of terms have historically been used for investing that incorporates social, environmental, or ethical considerations along with pure financial considerations.
These terms include ethical, green, socially conscious, ESG, sustainable and socially
responsible investing (SRI). As umbrella terms none of these are quite broad enough to encompass all strategies, and some have unhelpful connotations (for example are you unethical if you don’t invest in an ethical fund?).
In their ‘2019 IA Responsible Investment Framework Final Report’ the IA uses the term Responsible Investment as their catch-all term for all investing that aims to:
- Maximise long-term returns through consideration of pertinent environmental, social and governance (ESG) risks and opportunities
- Achieve particular sustainability outcomes (for example investing in renewable energy)
- Reflect a particular set of values or beliefs
The IA takes the definitions of these components from several well-known external bodies and, as you will see from their definitions below, there is some overlap in these components. The diagram below is helpful in considering how the components broadly relate to each other in terms of impact and generating returns:
1.1. ESG and ESG integration
ESG refers to the Environmental, Social and Governance characteristics of a company or business. These facets of the business contribute to the risks and opportunities it is exposed to now and in future.
Environmental refers to a company’s dependency and impact on ‘natural capital’, the stock of renewable and non-renewable natural resources. This includes how the business impacts (or is impacted by) climate change, what natural resources it produces or uses and whether it contributes to pollution or waste.