Insights |Risk Management

10th December 2021

Sustainable investment is here to stay

The rise in demand for sustainable investment is driving a reset of the market for responsible investing across Europe.

The vast majority of investors believe that interest in ESG will continue to remain a high priority even when the pandemic has passed.

PwC forecast that ESG assets will make up between 27% and 42% of Europe’s asset base by 2025; a significant increase from 15% in 2020.

The move is being driven by changes in the regulatory landscape within the EU and UK, alongside the creation of the International Sustainability Standards Board (ISSB), set up to deliver a comprehensive baseline of standards that will provide investors (and others) with information about companies’ sustainability-related risks and opportunities to help them make informed decisions.

Interest in ESG will remain high primarily because clients are demanding it. Research suggests that meeting clients’ needs outweighs the need to meet increasing regulatory requirements. Of the 3 elements of ESG, the main focus for consumers is concern for the environment. Investors not only want to see a return on their investment, but they also expect their money to do some good by being invested in a way that protects the environment and does no harm.

New rules are being introduced by the EU, which the UK is set to follow with its own regulatory strategy. The EU has already set its own Sustainable Finance Disclosure Regulations in motion, for the first time requiring investors and asset management companies to provide information about their investments, the ESG risks and their impact on the planet and society. The EU action plan reflects a major shift in the way ESG factors are considered in the investment process.

In October 2021, the UK the government published Greening Finance: A Roadmap to sustainable investing, in which it sets out an ambition to make the UK the best place in the world for green and sustainable investment. The document outlines a vision for a comprehensive approach to ‘greening’ financial systems, mobilising finance for clean, resilient growth and capturing resulting opportunities for UK companies.

The roadmap will come in 3 phases:

  1. Informing – ensuring decision-useful information on sustainability is made available to decision makers.
  2. Acting – to mainstream the information to businesses and financial decisions.
  3. Shifting – financial flows across the economy to align with a net-zero and nature positive policies.

Sustainability Disclosure Requirements (SDR)

The roadmap describes the new regime as bringing together existing sustainability-related disclosure requirements under 1 framework – building on existing and future global standards and best practice. Disclosures will be consumer-focused, with companies selling investment products having to provide consumer-friendly disclosures explaining the impact, risks and opportunities of the businesses they finance on sustainability.

The roadmap flags up that any form of ‘greenwashing’ will not be tolerated. In an effort to minimise the practice within marketing activities, financial organisations will have to substantiate any ESG claims made by their products.

Other proposals include an intention to bring ratings agencies under FCA control to reflect the increase in importance of ESG ratings to investors. The FCA have just published a discussion paper, seeking views on SDR disclosure requirements for asset managers and certain FCA-regulated asset owners as well as the sustainable labelling system. The aim is to build trust in the market and enhance transparency in the interest of consumers and meet the information needs of institutional investors. The input they receive will inform policy proposals to be issued for consultation next year.

The changes announced by the government represent an ambitious and comprehensive package of measures designed to help improve the flow of investment towards financing the transition to a sustainable economy. By encouraging investors to redirect investment towards sustainable technologies and businesses the measures will be instrumental in aligning the financial system with the UK target for a net zero economy by 2050.

International action: COP26 and sustainable investing

Of course, these shifts in mindset and policy aren’t isolated to the UK and EU.

Investing in sustainable industries and commodities was 1 of the main topics of discussion at the World Leaders Summit Action on Forests and Land Use at COP26.

At the summit, more than 30 financial institutions signed a commitment to move away from portfolios that invest in high deforestation-risk supply chains. These institutions include companies with $8.7tn under management, meaning the stakes are high for non-sustainable industries once private finance pours into companies that are aligned with sustainability goals and regulations.

Tuntiak Katan, Coordinator of the Global Alliance of Territorial Communities, representing communities from the rainforests of Africa, Latin America and Indonesia, said:

”We welcome the announcement at COP of the Joint Statement on Advancing Support for Indigenous Peoples and local communities that has raised to an unprecedented level their visibility as a climate solution.

“At the same time, we will be looking for concrete evidence of a transformation in the way funds are invested. If 80% of what is proposed is directed to supporting land rights and the proposals of Indigenous and local communities, we will see a dramatic reversal in the current trend that is destroying our natural resources.”

Sustainable investment due diligence

Katan makes a key point about evidence. When it comes to investing, it is important to see the full picture. Some private companies claim to work sustainably and support ESG goals but are greenwashing. Investors must always screen potential opportunities before committing. Due diligence is a must to ensure you’re investing in a responsible, sustainable business.

Investment managers often use ESG portfolios to inspect the status of a company before they invest. However, definitions of ESG can be subjective, and it’s important to undertake independent research, rather than to always rely on the opinion of an investment manager.

How ESA Risk can help

Due diligence is an area where we possess the expertise and experience to help you and your business.

For advice on private investing or conducting due diligence, please contact Mike Wright, Risk Management and Investigations Consultant at mike.wright@esarisk.com, on +44 (0)843 515 8686 or via our contact form.

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