Responsible investments:

How to differentiate yourself, generate added value and improve society

Responsible investment is a concept that strives to consider factors other than shareholders’ value as performance indicators. Our market-based economies are relatively efficient at allocating economic resources but this same system also generates additional social inequalities and environmental issues which can, in turn, negatively affect the perception and performance of certain companies. 

Unprecedented environmental and social pressures driven by food and water shortage, pollution, energy security, access to natural resources, climate change, human rights, supply chain labor standards and ageing populations have become material issues for business, the corporate world and their investors.

Investors are becoming increasingly concerned about the impact their financing may have on these issues and there is an increasing concern to invest in companies that already have some policies and strategies aimed at reducing their impact on the environment.

Responsible investment strives to promote investments that explicitly acknowledge the relevance of environmental, social and governance (ESG) factors, and take into consideration the long-term health and stability of the market as a whole. It recognizes that long-term sustainable returns are dependent on stable, well-functioning and well governed social, environmental and economic systems. More and more financial specialists are also convinced that effective research, analysis and evaluation of ESG issues represent a significant part of the value of a company.

Responsible investment allows companies and investors to consider medium and long-term risks and opportunities related to ESG, enabling them to differentiate themselves from others and invest in generating future additional values.

The concept of responsible investment:

  • It is a process which actively considers environmental, social and governance (ESG) issues when investing, be it at a corporate company level, investing in a portfolio or when exercising voting rights;
  • It requires actors of the economy to rethink their priorities, to assess all the risks and opportunities that may influence the performance of their investment. After which investors have the opportunity to allocate their capital in a manner they considers appropriate;
  • It is an investment strategy driven by effective research, analysis and management of ESG issues that represent a fundamental part of the short, medium and long-term value of a company.

Why are responsible investment initiatives developing?

  • It represents a response, an adaptation of the economy to the recent financial crisis, climate changes and other problems our world is facing;
  • The growing demand from regulators, clients and beneficiaries for a more sustainable approach to investment, together with the evidence of the financial materiality of the ESG issues are very challenging issues to be dealt with by companies. Previous years showed that investors, or their portfolios, were perhaps managed with too much focus on short term profit. More and more investors are now asking their investment managers to consider the medium and long-term impact of their financing; 

– Investors’ ESG considerations are made before they invest but also when exercising their rights as shareholders or directors;

  • There is effective value recognition of ESG issues and related strategies. Such value can be positive if ESG considerations are properly addressed but can also be negative if ESG considerations are simply ignored;
  • These initiatives bring new perspectives and new analysis promoting research, which will in turn lead to competitive advantages and global improvement, be it at the level of the employees, the environment or the entire economy;
  • The investment managers are increasingly accepting ESG-related requests from investors and consider respecting these requests as part of their fiduciary duties;
  • Following the recent financial crisis, some investors are more adverse to risk and require long term ESG considerations to be part of a fund’s investment strategies;
  • As regulators are seeking ways to reconcile financial markets with “the real economy” and want to encourage longer-term investment strategies and sustainable growth considerations, the ESG aspects of the company’s activities are seen as a complementary resource to realize that potential;
  • In more and more countries, listed companies now have to publically report on ESG-related strategies and results. These same companies prefer to report that they only work with companies and service providers that also have implemented some responsible investment strategies.

The United Nations Principles for Responsible Investment

The United Nations Principles for Responsible Investment (UNPRI) initiative is an international network of investors that agreed to put the six responsible investing principles into practice. Its goal is to understand the implications of sustainability for investors and incorporate these issues into their investment decision-making and ownership practices.

As of now, there are more than 1,200 asset owners, investment managers and professional service partners who signed up to these Principles for Responsible Investments representing an estimated signatory strength of US$34 trillion.
The six principles that
investors commit to:

  • incorporate ESG issues into investment analysis and decision-making processes;
  • be active owners and incorporate ESG issues into our ownership policies and practices;
  • seek appropriate disclosure on ESG issues by the entities in which we invest;
  • promote acceptance and implementation of the principles within the investment industry;
  • work together to enhance our effectiveness in implementing the principles;
  • report on our activities and progress towards implementing the principles

In addition to these commitments, organizations have to take concrete actions. They have to define their ESG policy, design processes to incorporate ESG policy into investment analysis and decision-making, and report annually via the reporting framework that includes 12 modules.
The ESG environmental considerations – case of the greenhouse gas

Environmental considerations that should be addressed by a company vary from rational use of water to choosing an appropriate location to reduce its carbon footprint.

For the purpose of this article, we will focus on greenhouse gas (GHG) related issues. As the increase of GHG in the atmosphere impacts the climate and generates more extreme climate phenomena. These climate phenomena in turn are having a growing impact on the economy.

The financial impacts of these climate changes risk, in the short term, to be far greater than what it would cost to significantly reduce GHG emissions. As such, climate changes are not only an environmental issue or a topic for a scientist. For an investment manager, these considerations are necessary to safeguard the activities of their companies.

As of this date, a lot of initiatives have already been taken to reduce production of GHG. Such as for instance: Increase of taxes on fossil fuels; incentives to produce “green” electricity; and issuing CO2 certificates for industrial companies who can sell the quotas they do not use or who would have to buy these certificates if they increase their CO2 emissions.

All these measures are likely to increase the energy costs or even financially penalize companies who are not using energy rationally.

In addition to these financial considerations, other considerations have to be made regarding the positioning of the company in the market, its communication system, the requirements of its clients and the development of new products or services that may require less carbon.

The above considerations will have an increasing impact on economies in the future and it is important for each company to correctly position itself in this regard, develop strategies to be able to quantify emissions of GHG, in order to reduce its impact on the climate.

The main steps to implementing a strategy to reduce GHG include:

  • Performing a complete identification of all the elements used by the company that are a direct or indirect source of GHG.
  • Quantifying GHG emissions and its carbon footprint.
  • Establishing strategies that will aim to reduce the carbon footprint reduction on all the GHG sources or only on the most material ones, depending on its strategy.
  • Converting the GHG constraint into strategy and opportunities.

A first step will consist of establishing a hierarchy of its different activities according to their importance as GHG sources. Efforts will have to be focused on these activities. A very obvious way to manage the carbon constraint is to take measures that will reduce GHG emissions by reducing energy consumption and the quantity of raw materials. In consideration of GHG emissions, the entire operating model of a company is likely to be impacted. Such considerations will without a doubt bring new perspectives and will, in some cases, result in a competitive advantage.

Additionally, these considerations will also show the company’s dependence on fossil energies. Reducing GHG emissions will automatically reduce the use of fossil fuels and therefore the dependence of a company on the price of these fuels. Such independence may represent a very significant competitive advantage.

The ESG social and governance considerations

These considerations are broad but it is worth saying that following the recent financial crisis, certain countries implemented new laws requiring companies to report on their governance policies and practices. Investors are increasingly focused on the good governance and implementation of policies safeguarding from certain misconducts or abuses which could ultimately impair the value of their investment.

Main challenges faced when implementing ESG strategies and issuing related reports

Implementing these policies often needs a case-by-case analysis and may vary due to geographical, cultural, political, social, environmental and other specific contexts in which a given company is located.

Disclosing the results of different strategies and evaluating them correctly in financial terms remains a real challenge.

These IPR considerations have the advantage that they are implemented at the company level itself and represent an incentive to the company to differentiate themselves from their competitors.

In doing so, companies will also achieve other common goals and financial markets may reconcile with the “real economy.”