ESG data emphasizes the urgency to incorporate impact analysis when investing
Despite significant regulatory evolution and increase in financial flows as indicated by the growth in assets, many of the critical environmental and social challenges facing the world have become even more acute and have led to systemic risks emerging. The most mainstream sustainable investment (SI) practice of ESG (environmental, social, and governance) integration has been defined by the CFA Institute as “the explicit and systematic inclusion of environmental, social and governance factors in investment analysis and investment decisions”.
However, the way in which it is being practiced has been deemed insufficient to deliver answers of the right magnitude to the issues at stake. There are numerous interlinked systemic issues that the global community is far from resolving – climate change and wealth inequality being just two examples.
In regards to climate change, human-induced warming reached approximately 1-degree above pre-industrial levels in 2017, increasing at 0.2-degree per decade. An annual reduction of over 7% in greenhouse gas emissions (GHG) is required to stay within the 1.5-degree pathway, set by the Intergovernmental Panel on Climate Change (IPCC) as the upper limit for preventing the worst impacts of climate change. However, global greenhouse gas(GHG) emissions have risen by 1.5% per year over the last decade (2010–2020). Importantly, according to the IPCC, mitigation and adaptation options consistent with 1.5-degrees pathways are associated with multiple synergies across the SDGs.
In regards to income inequality, the US has seen the average income of households in the top fifth of income in relation to the bottom has increased from 10.3 in 1975 to 16.6 times in 2019. More importantly, financial wealth inequality – which affects income inequality through the capital income generated by wealth – is sharper than the income gap and is growing more rapidly. In 2017 the three wealthiest people in the United States owned more wealth than the bottom half of the population combined, while over 19 percent, had zero or negative net worth. Even these figures underestimate wealth concentration, as the growing use of off-shore tax havens, domestic tax loopholes allowing much of this wealth to not be considered “taxable income” unless assets are sold and gains realized, and legal trusts has enabled concealing of assets more than ever before. A similar pattern is repeated throughout Europe, if less pronounced.
These examples are just a small illustration of why investors must now take into account what is known elsewhere as “double materiality” – namely, the financial impact of sustainability issues on a company’s financial performance, as well as the company’s impact on society and the environment (beyond the impact on the company itself) through its operations, products and services. As the sustainable investing market matures, financial institutions are looking beyond risk and opportunity to focus on the real-world outcomes of their investments.
