Let’s frame a desired global outcome in as uncontroversial manner as possible – greater prosperity for a greater number of people, ideally all people, and improved human wellbeing. What scenarios and behaviours are specifically preventing this outcome, and conversely which ones would enable it, today and in the future?
For all its faults and volatility, capitalism has a résumé for delivering positive outcomes at scale, which is hard to ignore, and trumps any other model in history. The opening up of China’s markets over the past three decades, which has pulled approximately half a billion people out of extreme poverty, is the most recent remarkable example. Open societies that adopt and manage private enterprise at the heart of economic production have created a standard of living for nearly all people within them that far exceeds the living standards experienced by nearly everyone in all of human history.
But we also know that unfettered capitalism has many problems that lead to avoidable negative outcomes. Markets are inefficient, wealth generation is high but the markets cannot be relied upon to distribute outcomes fairly, and economic growth is often seen as an end in itself - and is often attempted through the exploitation of both people and the environment. It is largely the role of regulators to prevent and correct for inefficiencies; redistribution is under the purview of national and international fiscal policy. However, while governments and regulators can do more to ensure the methods used to drive economic outcomes meet the values of a progressive and sustainable society, there is a massive and exciting trend today towards sustainable outcomes. -This trend is driven by the markets rather than simply imposed on them.
Consumers and investors are informed by the largely uncontroversial notion (outside US partisan politics) that climate change is real and caused by humans. It’s also a given that fossil fuels are limited. People also want to see the notions of equal opportunities and equal rights displayed in the staffing and management of companies in much more manifest and overt ways. As a result, there is a growing demand and expectation that private enterprise manages to these ends.
Two further scenarios are developing that coincide to make sustainable finance a critical issue. One, a greater number of people globally are rising from very low-income lifestyles to a level of economic freedom enabling them to save surplus cash and engage in the investment process. Two, notwithstanding the problems of sweeping generalisations, millennials and Gen Z are more overt about their desire to see purpose in the companies they want to work for and invest in, not only see economic returns, compared with previous generations.
Tracking data in a standardised way across companies globally about their Environmental, Social & Governance (ESG) practices becomes a critical starting point for meeting this demand. Over the past few years various fund managers have employed a basic process of negatively screening out companies for investment based on the industry they operate in (arms manufacturing, oil production, etc). This overly simplistic method is giving way to more nuanced and useful ways to look at ESG as an informative tool for driving towards sustainable investment.
To make good use of this data, investors need a layer of analytics on top of the core company data points, including the scoring of companies on each of these metrics. Furthermore, sophisticated institutional investors want to understand time series for these companies to determine the trajectory of improvement and to weight ESG performance based on the speed of improvement.
Indeed, such investors want to establish greater links and analyses between financial performance and ESG performance – e.g. what is the correlation between carbon emissions and revenue growth of a given company? Fund managers, when making selections as to which securities to invest in, want to be able to score and rate their fund overall with ESG analytics. Establishing a methodology for this is also critical – do you score the fund based on a cap-weighted methodology? How does the ESG rating impact and align with existing risk models and ratings that managers apply to their funds? Do you allow for scoring to be weighted more towards Environmental, Social OR Governance based on the primary interests of your investors? Ultimately, the intention is to establish ESG as a mature asset class in which major strategic and portfolio decisions can be made using established and industry defining standards.
Critically, for companies wanting to raise capital, the criteria needed to attract investors are changing. Reporting on your ESG metrics, and understanding how this compares with your competitors and the rest of the market, is no longer a ‘nice to have’ and driven by the social values of the executive team. It is becoming a ‘must have’, dictated by the need to meet basic qualifying criteria for investment by the institutional asset management industry.