Environmental, Social and Governance (ESG) gained popularity in recent years, and is used by organisations to help them reduce financial, reputational and operational risks.
The purpose of ESG strategy development is to ensure that companies limit their negative impact and maximise their positive impact on the environment, society and organisation's governance. This in turn helps improve their resilience to future uncertainties and survival in the long-term.
However, ESG is changing.
ESG is set to grow rapidly and shape the corporate sustainability agenda. Here are some of the most crucial and recent developments.
Concentration in the ESG analysis industry
New types of rating agencies that focused on non-financial criteria began to develop in the early 2000s.
Rating processes were developed to help investors conduct in-depth analyses of the companies within their portfolios and how well those companies adhered to ESG criteria, and such agencies incorporated a review of a company’s environmental, social and governance (ESG) performance in addition to their economic performance.
These agencies are commonly called ESG or social and environmental rating agencies, or, extra-financial rating agencies.
Each extra-financial rating agency has its own evaluation grids and criteria, its own methodology. Just as there is a multiplicity of ESG standards and frameworks (GRI, IIRC, SASB, etc.), there are a number of different extra-financial rating agencies, each with their own process and ESG questionnaires.
Nevertheless, ESG rating processes are trending towards homogenisation.
An initial consolidation movement (mergers, acquisitions or alliances) in the 1990s led to the appearance of the currently well-known extra-financial rating agencies operating on an international scope – Vigeo (France), MSCI ESG Research (United States), EIRIS (United Kingdom), Oekom Research (Germany), Inrate (Switzerland), Solaron (India) and Sustainalytics (Netherlands) – and the 2010s have seen continued consolidation, in a market increasingly dominated by American corporations.
Some of the most significant recent developments in the extra-financial rating ecosystem include:
- 2015 - Vigeo merges with Eiris
- 2018 - Oekom Research is acquired by ISS
- 2019 - Vigeo-Eiris is acquired by Moody’s Corporation and becomes V.E.
- 2020 - Sustainalytics is acquired by Morningstar
ESG funds are growing rapidly, indicating huge market demand for application of ESG strategy.
Global ESG fund assets reached about $2.5 trillion at the end of 2022, up from $2.24 trillion at the end of the third quarter of 2022, according to Morningstar.
A BlackRock representative attributes this increase in interest for ESG to more visibly impactful methods of incorporating sustainable investments. Financial experts now view ESG as a “core-type strategy”- and this trend looks like it will only continue in the coming decades.
Data and Tech in ESG evaluations
ESG leaders are still struggling to get a hold on the unwieldy world of ESG data, but the standardisation of ESG reporting and disclosure remains a challenge.
ESG analysts from Forrester suggest that industry regulations will become increasingly specific, detailed, and relevant in coming years. Companies are also reacting to dynamic materiality and the unpredictability of factors like new knowledge, regulations, and global events by adopting and developing new procedures to measure risk.
Shareholder Activism and ESG Proxy Voting Policies
Shareholder activists use their influence, through ownership of company shares, to enact change within a company and/or in that company’s external impact.
As partial owners of the company whose shares they own, shareholder activists can initiate important conversations with the board of directors and enact change.
Tactics for enacting change vary, especially because there are different classes of shares that allow for a range of voting privileges.
Examples of tactics include: a dialogue with managers, formal proposals, social pressure through social media, and lawsuits.
Market reactions to the climate crisis
According to the most recent IPCC climate report, the world has reached an increase of 1.1°C compared with the average in 1850–1900, resulting in extreme weather events across the world, including the devastating 2020 wildfires of Australia.
In order to achieve commitments ratified with the Paris Agreement of 2015 to limit the increase in the global average temperature to well below 2°C above pre-industrial levels and pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels.
MSCI’s Warming Potential estimates that every company in the MSCI ACWI IMI would have to reduce total carbon intensity (Scopes 1, 2 and 3) by an average of 8%-10% per year from 2021 until 2050.
Launched in June 2007, MSCI ACWI Investable Market Index (IMI) captures large, mid and small cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. The index is comprehensive, covering approximately 99% of the global equity investment opportunity set.
The need for steep reductions in emissions in portfolios means that companies would have to find means of decarbonising rapidly, and investors/investment firms are faced with the choices of convincing companies to undergo massive overhaul of procedure, change their portfolio concentration, and/or shift assets.
The need for ESG only seems to be growing as society faces unprecedented times: climate change, protests and social upheaval, increasing technological capabilities, the ongoing COVID-19 pandemic.
The lack of existing data on the situations that we now face makes a clear need for frameworks that can quantify and mitigate unpredictable risks.
ESG strategies can help meet those needs, while providing some guidelines on how to build more resiliency into the corporate universe.
So, what are you waiting for? Start implementing ESG today!
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