If there is one undeniable trend in finance, it has been the growing interest in green, or sustainable, investing. The focus on environmental, social and governance (ESG) issues is not just transforming managed fund strategies, it is fundamentally reshaping the finance industry. This is the first in a new series, we're going to be running over the coming months, examining the often complex questions raised by sustainable finance.
In the industrial revolution that erupted in northern England more than 250 years ago, the saying “there’s brass in muck” gained currency. The dirtier the industry — whether it be coal or textiles or railroads — the more money there was to be made.
That equation has now been turned on its head. “There’s gold in green” might be the new ethos as dirty old industries make way for renewable energy, public interest in sustainable products and services grows, and industry interest in meeting that need takes off.
On the demand side, an upsurge in public awareness of climate change is driving interest in investment strategies that take account of companies’ carbon emissions and other activities judged as having a wider environmental and social impact.
On the supply side, a managed fund industry that has been squeezed for years by the growth in passive strategies and an associated pressure on fees has seen in ESG a new steady source of business — one that offers a feel-good factor alongside purely pecuniary appeal.
Big numbers, big challenges
Even in a finance industry numbed by big numbers, the dollar signs attached to sustainable investing are making cynics sit up and take notice. In fact, money flowing into ESG is growing at record rates, far eclipsing demand for funds not managed that way.
According to Morningstar, sustainable fund assets grew by 12% globally to $US2.24 trillion in the second quarter of 2021. Europe dominates these flows, accounting for 81%. By comparison, flows into US sustainable funds represented just 14% of the total.
The number of funds globally claiming to have a sustainability objective totalled nearly 5,000 as at the end of June, 2021. And this does not take account of many more that boast of formally considering some combination of environmental, social or governance factors.
It’s against this background that regulators are scrambling to keep up. Amid rising allegations of “greenwashing” (the practice of elevating marketing spin over substance when it comes to sustainability), there are calls for globally agreed standards.
The International Financial Reporting Standards Foundation (set up by the International Accounting Standards Board) is forming a new International Sustainability Standards Board in time for the COP26 UN climate change summit in Scotland in November.
With the US back in the Paris climate agreement, there is also new impetus from governments. In Cornwall in June, leaders of the Group of Seven industrialised nations stressed support for moving towards mandatory climate-related financial disclosures.
Of course, the challenge to act globally and quickly was highlighted most dramatically by the International Panel on Climate Change’s sixth assessment report, which concluded it is now unequivocal that human influence has warmed the planet, that the scale of changes is unprecedented and that deep reductions in emissions will be needed in the coming decades.
An industry transformed
It is in that context that the investing industry is scrambling to exploit the new appetite for green funds that take account of greenhouse gas emissions and other environmental and social variables like biodiversity, water use, factory farming and child labour.
But this is not just about managed funds. The insurance industry — long and painfully aware of the cost of extreme weather events, heatwaves and drought — is changing its own risk assessments. Lloyds of London has said it will stop fossil fuel underwriting by 2030.Prudential regulators are also increasingly taking account of the systemic risks from climate change.
The Basel Committee on Banking Supervision earlier this year published analytical reports examining climate-related risks for the global banking industry. JPMorgan, one of the world’s largest banks, this year pledged $2.5 trillion toward long-term solutions that tackle climate action and contribute to sustainable development.
So that the finance industry is an undergoing a significant transformation in the face of climate change is undeniable. The risks are being measured not only in terms of the threats to the environment, but more immediately, the threat to financial stability itself.
Walking the talk?
Of course, there are any number of ways that all this burst of goodwill could go wrong. One of them will be attempts by some players, already evident in some areas, to simply cash in on the green trend and exploit sustainability as a source of short-term profits.
After all, it is easy for fund managers to they give primacy to environmental sustainability and social justice. In fact, a recent study by London-based non-profit InfluenceMap found just over 70% of funds promising ESG goals fell short.
So while finding “gold in green” may be the new mantra for some in the financial industry, the welfare of consumers, investors and the planet itself will be best served by greater transparency, agreed uniform standards and something more than marketing flair.
You can take that to the bank.