Four factors that will drive ESG investing in 2021

What do Zen Buddhists in Japan, Millennials, and hedge funds all have in common? They’re all investors who recognize the value and importance of ESG (Environmental, Social, Governance) investing. According to a forecast published by Deutsche Bank, ESG investments are expected to grow further and exceed the $100 trillion mark by 2030. As ESG moves from a buzzword to a mainstay, companies and investors should keep an eye on four key areas in 2021.

1. Climate change

Environmental, the "E" in ESG, is the leading and best-known aspect of the ESG equation. Familiarity with environmental factors has been boosted in part by the Paris Agreement, which seeks to limit the global temperature increase below 2°C (3.6°F) through the reduction of greenhouse gas emissions and climate-resilient development.

To reach this goal, global emissions need to be reduced by at least 9% per year in order to become net-zero by 2050. Yet data from MSCI shows that only 32% of companies committed to an emissions-reduction target have reached their goal.

With an incoming Biden administration that plans to focus on climate protection policies in 2021, the Paris Agreement target will become a priority. Immediate, short-term goals of the administration could include legislation standards for car and truck tailpipe emissions and the reduction of methane. Green bonds, which are intended to encourage sustainability and to support climate-related or other types of special environmental projects, have recently seen growing interest. However, making a massive change will require the collective effort of government, companies, and investors alike. Investors willing to shift capital to zero- and negative-carbon investments could make a substantial impact.

While investors seek alternative, environmentally friendly funding opportunities, companies that prioritize the creation and use of negative-carbon technologies and place a strong emphasis on issues such as biodiversity, water pollution, and ecosystem preservation could experience a rapid inflow of capital.

2. ESG disclosures

Currently, U.S. corporations can choose whether or not to disclose their ESG strategies and progress in their annual reports, via tools like corporate social responsibility (CSR) reports or one of the many existing ESG frameworks. However, under the new Biden administration, companies may be required to disclose information on sustainability metrics in the years ahead. This may prove difficult as a number of ESG metrics are from different indexes and vary by region. Consequently, there exists a major need for the standardization of ESG reporting amidst a sea of inconsistent disclosure practices and lax Securities and Exchange Commission requirements.

In recent years, Congressional Democrats have promoted legislation that would require companies to disclose ESG-related risks. The drafted legislation could, for example, require securities issuers to annually disclose information regarding climate-change related risks. Other disclosures might include strategies to mitigate these risks, information on direct and indirect greenhouse gas emissions, stranded assets, and the true cost of carbon.

3. ESG data & reporting

The number of companies reporting on sustainability efforts has increased as more investors demand detailed ESG reports. According to the Governance & Accountability Institute, 90% of companies in the S&P 500 Index issued sustainability reports in 2019.

ESG data and reporting standards are transitioning from voluntary to mandatory as companies begin to compete for sustainability-focused investment capital. While many companies are likely to boast about the ESG goals they are achieving, clear and uniform reporting standards are still in their infancy as regulations and investor preferences evolve. The 2019 ESG Global Survey published by BNP Paribas found that 66% of asset owners and asset managers cited data and reporting issues as the biggest barrier to greater adoption of ESG across their portfolios.

As the need for data requirements grow, certain reporting standards are beginning to make their way to the top. In 2020, the Task Force on Climate-related Financial Disclosures (TCFD) reporting framework became mandatory for signatories to the UN Principles of Responsible Investing (UNPRI) and is expected to become required in the United Kingdom, New Zealand, and possibly the U.S. in the next few years.

Technologies such as Decentralized Ledger Technology (DLT) and Internet of Things (IoT) may also help investors make better informed decisions as companies discover innovative methods to automate and improve ESG data collection and analysis.

Greater standardization and agreement on reporting requirements will advance the ESG movement and prove easier for corporate reporting requirements.

4. Diversity & inclusion

Social factors also gained the spotlight in 2020. The COVID-19 crisis created significant challenges that heightened social inequalities while stronger mandates for equal rights grew as movements like Black Lives Matter gained momentum. Consequently, awareness of and action around diversity and inclusion has never been more important, especially as economic recovery allows for the re-inclusion of displaced groups.

While companies like Nike, Ben & Jerry’s, and Patagonia have taken a public stand in the fight against racism, there are limits to how companies can address systemic and root causes of inequality. And it’s important to note that inequality extends beyond just race and gender. To understand the broader definition of inequality, many investors are using the UN’s Sustainable Development Goals as a framework for developing their approach to social issues. The UN’s socially targeted goals include addressing global issues such as hunger, health, education, decent work, poverty, access to clean water and sanitation, as well as gender equality and reducing inequalities.

This year could bring greater contributions from businesses and investors into financial products such as social bonds, where the bond’s proceeds fund projects that promote social equality. There has already been an explosion of social bond offerings in the last year, many focused explicitly on health and well-being in the wake of the pandemic. This approach has been appealing to Tokuunin, a Zen Buddhist temple in central Tokyo, that recently bought 40-year social bonds sold by the University of Tokyo.

ESG investing is here to stay

Overall, ESG investing is no longer just a trend; it’s reaching a new maturity and is here to stay. According to MSCI ESG Research, U.S. companies with high ESG rankings in the S&P 500 index have outperformed their counterparts with lower ESG rankings by at least 3% annually for the past 5 years.

Moving forward, businesses, regulators, and investors will need to work together to achieve their ESG goals, a move that will benefit small and large businesses alike, create stronger accountability, and benefit the world at large.

ESG materiality assessments

With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.

An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.

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Ryan Nelson

Ryan Nelson is Conservice's SVP & General Manager, ESG. He has over 20 years in enterprise software and management consulting experience, including supply chain software implementation and process optimization for fortune 50 companies. Since 2009, Ryan has been focused on helping companies amplify their ESG impact with technology.

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