ESG InvestingJun 16 2022

Why are ESG frameworks important?

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Why are ESG frameworks important?
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As with any investment philosophy and process, it is important to lay the foundations with a clearly defined framework in order to meet the stated investment objective. 

Due to the subjectivity of environmental, social and governance-themed investing, it becomes increasingly important that fund groups ensure clarity and transparency in both their methodology and messaging around this increasingly important subject. 

Therefore ESG frameworks, which are systems for standardising the reporting and disclosure of ESG metrics, are intended to aid investors’ understanding and provide the investment community with consistency.

But with there being a variety of different approaches to the disclosures provided and frameworks implemented, it presents challenges for investors and financial advisers in making sense of it all, which is one of the greatest challenges with ESG today. 

There needs to be clearer guidelines and consensus on what ESG investors should doAlix Lebec, Lebec Consulting

Alix Lebec, founder and chief executive of Lebec Consulting, says the industry lacks a unified language, methodology, and response to disclosure requests. 

“We don’t have a common data set across all of ESG to compare, distil and analyse information that would allow us to make decisions globally. 

“There needs to be clearer guidelines and consensus on what ESG investors should do, what frameworks they should use and what disclosure requests are coming their way.”

There might be some good news on the horizon, with the development of the International Sustainability Standards Board to ensure there is a global baseline to measure and report on ESG, and then there is the UN's Sustainable Development Goals, which also provide a barometer to measure progress on ESG targets. 

“These are global goals that can set a viable roadmap for ESG investments. We are still lacking, however, common, clear disclosures for the ‘S’ that would provide comparable data sets on companies’ social impact performance, and would enable us to assess and mitigate risks,” Lebec adds.

Towards an industry standard

The Financial Conduct Authority's work on labelling will hopefully help develop an industry standard set of terms that can be adopted for consistency. 

Consistent ESG frameworks, labelling and the use of data are essential in removing barriers to integrating responsible investment as standard practice. 

For example, the fact there are no industry-wide definitions is creating all sorts of confusion, increasing the risk of greenwashing and mis-selling, experts warn.

Lebec says it is important to note that while many investors, companies, and managers have historically boiled ESG down to being an environmental construct, it should be recognised that there are three main components to ESG that are interconnected.

In recent times there has been a much greater focus on social and governance issues.

Following some high-profile corporate governance failings – with some companies failing on both pay and working conditions – there is a much sharper focus on these particular issues now. 

E, S and G

Ryan Medlock, senior intermediary development and technical manager at Royal London, says: “You wrap all of this up together and you can see how this is fuelling consumer demand and presenting opportunities to the advice community to engage with clients on these different themes. 

“We recently published some customer and adviser research on ESG and found that only 10 per cent of advisers believe that the rise in client demand for responsible investment is short-lived.”

The increased focus on the ‘S’ and ‘G’ has also been driven by the pandemic, a racial reckoning in the wake of George Floyd’s murder, the ‘great resignation’ and rapidly increasing inequality. 

While addressing climate risks should and will undoubtedly remain a significant concern for investors, these recent events have underscored the urgency of addressing social and governance concerns and the ways in which they are interrelated with environmental ones. 

Lebec cites examples, such as climate change-induced events disproportionately affecting impoverished communities and exacerbating existing educational, gender and health inequalities. 

And as ESG is linked to higher return on investment and reduction in risk, all three components create equal value, which investors must not ignore. 

Claude Brown, partner at Reed Smith, says: "The ‘S’ and ‘G’ are gaining greater attention, but progress and momentum is behind the ‘E’. Additionally, the ‘S’ is fraught with political implications and shareholder challenges."

Fully embracing and measuring the 'S' and 'G' is expected to hold companies more accountable for diversity – from entry level, to the C-suite, to the board – and foster pay equity – including executive pay – improve employee wellbeing and improve overall social impact. 

Lebec adds: “The reality is that equity and inclusion policies have trickle-down effects, which are all very much a part of ESG. 

“That’s why it’s imperative we improve the disclosure and analysis of social impact data to understand the impact companies have on communities and how they treat their employees at headquarters and across their supply chains. 

“If corporations are not given clear guidelines and requirements on reporting social data, they will lose incentive to do it.”

Nigel Green, chief executive and founder of deVere Group, says: “To ensure that the huge inflows of private money are put to work in the correct way, it’s imperative that global regulators work together on an international framework of standards.

“A global regulatory framework for ESG investing would provide greater protections for those investors who are looking for profits with purpose, which will proactively help protect people and the planet for the long term.”