Going Mainstream: Sustainable Investing and ESG Standard Setting
Sustainable investing, specifically as defined by environmental, social, and governance (ESG) factors, has taken off big in many parts of the world, not least in Switzerland and the United States. How does ESG investing work, why do standards matter, are standards reliable, why should investors care about ESG considerations—and will there be enough investors to make ESG criteria a permanent fixture in the world’s capital markets?
By Karina Rollins
ESG Investing: What It Is
Environmental, social, and governance (ESG) criteria are a set of standards that socially conscious investors can use to decide whether to invest in a certain company.
Environmental criteria consider how a company performs as a steward of nature. These criteria may include a company’s energy use, carbon footprint, waste, pollution, natural resource conservation, use of toxic chemicals, and treatment of animals. Investors can also use these criteria to evaluate potential environmental risks a company might face, and how the company is managing those risks: Are there issues related to the company’s ownership of contaminated land, its hazardous-waste disposal, its management of toxic emissions, or its compliance with government environmental regulations?
Social criteria examine a company’s relationships with employees, suppliers, customers, and the communities where it operates. Social criteria examine a company’s business relationships: Do its suppliers hold the same values as it claims to hold? Does it donate a percentage of its profits to the local community or encourage employees to perform volunteer work? Do its working conditions show high regard for employee health and safety? Does it take other stakeholders’ interests into account? Social criteria can even include how a company advocates for the social good beyond its limited sphere of business.
Governance criteria deal with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. Investors may want to confirm that a company uses transparent accounting methods, and that shareholders have an opportunity to vote on important issues. Investors may also want assurances that a company avoids conflicts of interest when choosing board members, doesn’t make political contributions to obtain favorable treatment, and doesn’t engage in any illegal practices.
Racial diversity, LGBTQ+ equality, and inclusion programs and hiring practices are increasingly important issues in social and governance evaluations.
A Short History of ESG Investing. In the West, the seemingly new trend of investing based on moral values has a half-century-old history, and Christian origins: In 1971, two Methodist ministers founded the Pax World fund in order to avoid investing their church’s money in companies that supported the Vietnam War.
In 1986, the U.S. Congress passed the Comprehensive Anti-Apartheid Act, which banned any new investments in South Africa. In 1994, around the time that global warming became a public topic, investors could choose among 26 sustainable funds.
In 2004, the United Nations Global Compact, whose participants include Switzerland and the United States, released its “Who Cares Wins” report, with recommendations on how companies can incorporate ESG issues into their analysis, asset management, and securities brokerage. Today, more than 12,000 companies are Global Compact signatories.
ESG Investing: How It Works
ESG investing means choosing to invest in companies that have high environmental and societal-responsibility ratings as determined by independent third parties. Far from being a fanciful do-gooder approach, ESG investing has promoters among major and real-word-oriented companies.
As UBS’s Andrew Lee explains:
Investors are increasingly factoring in environmental, social and governance (ESG) considerations because they can be financially material and useful in analysis and decision making. We expect the next wave of growth will be driven by investors actively seeking to identify and address sustainability challenges in areas ranging from climate to inequality to healthcare.
Swiss Re CEO Christian Mumenthaler (YL 2003), who considers climate change the world’s biggest challenge, explains his company’s philosophy and real-life application like this:
We are focused on long-term value generation at Swiss Re, not short-term profits, and this sometimes means that we reduce our underwriting activities in a particular sector that we don’t consider sustainable, such as thermal coal, or that we stop investing in companies with poor ESG ratings. At the same time, we see ample opportunities to support our clients through risk-transfer solutions related to sustainability and have chosen an ESG investment approach which yields better risk-adjusted returns. Therefore, sustainability is embedded in everything we do, from our own operations, to underwriting and investing.
Attracting ESG Investors
Will enough people choose ESG investing? Socially responsible investments have had a reputation for requiring tradeoffs by the investor. Because ESG investments limited the pool of companies that were eligible for investment, they also limited the investor’s potential profit.
But more and more investors are starting to see a purely practical purpose in sustainable investing: By following ESG criteria, investors may be able to avoid companies whose practices could signal a risk factor—such as BP’s 2010 oil spill in the Gulf of Mexico which sent the company’s stock price plummeting and resulted in billions of dollars in losses.
Moreover, Credit Suisse’s Dominique Scheck points out that “[t]he data leave little room for doubt: companies that achieve ESG excellence exhibit improved performance and enhanced resilience.”
As more companies adopt ESG-minded business practices, investment firms are increasingly tracking their own performance. Credit Suisse, Nestlé, Swiss Re, UBS, Zurich Insurance Group, JPMorgan Chase, Goldman Sachs, and Wells Fargo, for instance, have published reports that review their ESG approaches and the bottom-line results.
Christian Mumenthaler, for his part, is not worried that Swiss Re won’t be able to attract ESG investors: “We do not need to encourage our clients to think about sustainability—it is already very high on their agenda.” He points out that, “Shareholders are putting pressure on all companies to adopt more sustainable practices; regulators are asking for more disclosure; employees, especially the younger generation, also expect real progress towards a more sustainable future.”
To encourage a transition towards renewable energy, Mumenthaler says that Swiss Re is “moving away from providing insurance coverage to the most carbon-intensive oil and gas producers.” Moreover, Swiss Re is “providing risk cover to more than 5,600 wind and solar farms. To achieve our business and net-zero goals, we build and scale on successful partnerships with clients working on this transition.”
Is Sustainable Investing . . . Sustainable?
Making a profit while investing with your heart—is it too good to be true? There seems to be no reason why it should. As Sarah Smith, an editor at Investor Place, points out:
Wall Street has come a long way when it comes to this trend. Once a fringe concept reserved for hippy-dippy investors, ESG strategies are now mainstream. Electric vehicles. Solar power. Plant-based diets. Sustainable retail. All are trends in their own right, and they are booming alongside what some see as an ESG megatrend.
Still, in the long run, even if investors do well from ESG investing, what if investors do even better through non-ESG investing? A reality of life is that the bottom line generally trumps other considerations.
So, making a profit while investing with your heart—can it last? There seems to be no reason why it shouldn’t. ESG stocks and funds have been outperforming others. In 2020, the S&P ESG Index outperformed the general S&P 500 by nearly 20 percent.
In 2019, sustainable investments hit a new high in Switzerland, with a total volume of nearly $1.3 billion. In 2020, U.S. sustainable funds attracted a record $51.1 billion in net flows, more than twice the previous record of 2019. Sustainable investments continued to enjoy double-digit growth in Switzerland in 2020.
Standardizing the Standards
Not all is smooth sailing, of course. One remaining hurdle to permanent and global ESG investing may be the creation of uniform standards. Reporting ESG results while relying on many different standards— has caused much confusion, with investors requesting more, and more accurate, data. There is an ongoing movement to “standardize the standards” on which companies rely for their reported sustainability results.
As a 2019 study by McKinsey & Company explains, “Years of effort by standard-setting groups have produced nearly a dozen major reporting frameworks and standards, which businesses have discretion to apply as they see fit. Investors must therefore reconcile corporate sustainability disclosures as best they can before trying to draw comparisons among companies.”
In January 2021, the World Economic Forum (WEF) announced that 61 global companies agreed to implement the WEF’s common ESG metrics, which looks like a sign that momentum for a single, uniform set of ESG standards is growing fast.
On the other hand, Tim Mohin, former CEO of the Global Reporting Initiative, points out that, “Over the years, there has been more talk than action on reducing confusion and burden in the reporting space.” “To be fair,” he adds, “some of the burden is self-inflicted by companies that insist on publishing 100-plus page sustainability reports.”
Keeping Both Eyes Open
On a darker note, investors must keep the phenomenon of “greenwashing” in mind—where companies mislead potential investors about their commitment to ESG criteria. Tariq Fancy, former chief investment officer of Sustainable Investing at BlackRock, warns that since “claiming to be environmentally responsible is profitable,” greenwashing is widespread on Wall Street: “No matter what they tout as green investing, portfolio managers are legally bound (as well as financially incentivized) to do nothing that compromises profits.”
In March 2021, the U.S. Securities and Exchange Commission announced the creation of a Climate and ESG Task Force “to proactively identify ESG-related misconduct.” The European Union created a framework of rules and regulations to combat greenwashing, though it seems overly burdensome especially for smaller companies. In Switzerland, there are government proposals to curb greenwashing by improving transparency, strengthening risk analysis, and expanding Switzerland’s international engagement on the issue.
Investors, regulators, companies, watch dogs—and consumers—have their work cut out for them.
Sustainability: To Us, it’s More Than Just One Goal, Swiss International Air Lines Blog, September 2021
Reporting Recommendations on Portfolio ESG Transparency, Swiss Sustainable Finance, June 2021
ESG Investing: A Beginner’s Guide, by Alana Benson, NerdWallet, May 2021
The Big Global Greenwashing Crackdown, by Bella Web, Vogue Business, May 2021
Why Bitcoin Is Bad for the Environment, by Elizabeth Colbert, The New Yorker, April 2021
The Economic Case for Net Zero Is Irresistible, by Christian Mumenthaler (YL 2003), Swiss Re, April 2021
Profitable and Sustainable Businesses Exist: Explorer Bertrand Piccard Proves It with 1,000 Examples, by Sofia Lotto Persio, Forbes, April 2021
What Is ESG Investing? by John Rotonti and Alyce Lomax, The Motley Fool, March 2021
Environmental, Social and Governance: What Is ESG Investing? by E. Napoletano and Benjamin Curry, Forbes, March 2021
Can We Finally Standardize ESG Standards? by Tim Mohin, GreenBiz, January 2021
Greenwashing Leaves a Stain the World Must Not Tolerate, by Teresa Ko, Nikkei Asia, October 2020
Tiffany & Co. Will Now Tell You Where Your Diamond Comes from, and Where It Was Crafted, by Lynn Yaeger, Vogue, August 2020 (featuring ASF board member Anisa Kamadoli Costa (YL 2003), Tiffany’s chief sustainability officer)
ASF CONNECT with Nestlé CEO Mark Schneider