The fast-evolving societal landscape driven by climate, demographic and technological changes is making sustainable investing mainstream.
On Monday, BloombergNEF reported that the global sustainable debt market grew 29% to a record $732 billion last year.
It is unavoidable that environmental, social and governance (ESG) considerations will no longer be a “nice to have” attribute or the choice of a limited group of investors but a core factor integrated in every investment decision to deliver returns that are at least on par with relevant benchmarks.
In fact, smart money has already entered the land of new divine coincidence – doing well by doing good. A number of research and surveys have been conducted in recent years, which conclude that the majority of funds geared toward sustainable and impact investing have outperformed conventional funds. The current trend of ESG investing suggests that over the next five to ten years, the choice of investors will not be between ESG or conventional funds but rather which ESG funds to choose.
Investors’ and lenders’ accelerating shift towards sustainable finance will be facilitated through two channels underpinned by powerful changes in social values across the world. One of these channels is market driven, while the other is mandated by policy makers and asset owners.
Look out for a new breed of consumers!
Consumers’ preferences will continue to evolve towards greater sustainability, driven by a replacement of baby-boomers by millennials and Generation Z (born from 1997 to 2012) as the main consumer age cohorts. A recent survey by digital research company First Insight found that 73% of the surveyed Generation Z representatives would pay more for sustainable items, with the majority of them willing to pay a 10% price premium.When purchasing their energy tariff from a utility company, a Generation Z household is more likely to opt for a more expensive wind-generated electricity plan over a natural gas plan than households of older generations. Such changes in consumer behaviour will increase demand for renewable energy and consequently lead to more investments into wind and solar, helping to drive down production costs and price. As a result, to remain competitive, companies have to accommodate growing consumer preference for sustainable living and turn “green” – producing sustainable products and services and demonstrating socially responsible corporate behaviour.
In addition, a deeper immersion of our daily lives into the digital realm means that we need fewer physical belongings, the manufacturing and recycling of which generate greenhouse gases (GHG) emission. The production of software and digital content consumes much less energy than building things. Therefore, companies providing digital services more easily become carbon neutral – achieving net zero carbon dioxide emissions - and receive consumers’ accolades and money.
Hence, the “green” companies favoured by consumers will be more profitable and generate stronger returns for their shareholders and bondholders.
Governments and investors will keep raising the bar on sustainable investing
Growing legislative and regulatory measures and greater willingness of asset owners to make sustainable investments will increase assets allocated to companies and funds with high ESG ratings.
Legislative measures aimed at reducing carbon emission to meet the 2050 net zero target will only intensify in Europe. Carbon taxes, which are levied by carbon dioxide (CO2) emitters, continue to rise across the continent. For example, last Friday, Norway announced its intention to more than triple its national carbon dioxide tax by 2030. Across the Atlantic, the United States will likely initiate new and more ambitious climate policies with the start of the Biden administration. Such developments will elevate the costs for sustainability laggard businesses, eroding their profits and share prices. Conversely, companies with greater ESG focus will become more competitive and profitable. Over the next three to five years, we will witness acceleration of investors’ prioritisation of sustainability considerations. Such a shift will not only be driven by the growing profitability edge of ESG leader firms over ESG laggards, but also due to a transfer of a significant amount of wealth from boomers to younger generations.
Despite this positive outlook, there are also impediments for a faster and broader acceptance of sustainable finance. One of them is the lack of standardisation and comparability of classifications and disclosures of ESG factors. Whilst the principles for climate related disclosures are broadly accepted and are based on the recommendations of Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), reporting of social and governance risks needs more harmonisation. As such, more collaboration is needed between national regulators and the leading organisations developing ESG disclosure standards to achieve a greater alignment of these standards and as a result better comparability of sustainability reports of various companies.