The consideration of environmental, social and corporate governance factors in addition to traditional financial factors when making investment decisions is commonly called ESG, standing for E – Environmental, S – Social and G – Governance.
ESG considerations have become increasingly important for companies and their shareholders, and have structurally and permanently changed the way that companies define their purpose, strategy and action, and also the way that the company is appraised and evaluated by the community – investors, shareholders, workers and other stakeholders. The inclusion of a corporate governance component in investment analysis has evolved considerably over recent decades. In general, companies are nowbroadly transparent in providing relevant information, and therefore the respective robustness or fragility of the corporate models are clearly perceived by investors. The consideration of social and environmental factors has evolved more slowly. For a long time, these were perceived as qualitative and intangible elements and, as such, difficult to measure. More recently, refinements in their identification and analysis and increased reporting by companies have resulted in greater quantifiable information and the process of incorporating such data into investment decisions is evolving rapidly. The recent acceleration of this new dynamic has decisively benefited from a significant increase in investment products focused on ESG metrics, based on findings that the incorporation of ESG factors translates into better global performance of companies, that will be more sustainable over the medium / long term, and awareness that environmental and social issues can reduce the value of a company (there are various examples of considerable losses suffered by shareholders as a result of environmental accidents, social controversies, or weak corporate models). It is also important to bear in mind the important role played by regulators, both nationally and supranationally (namely by the EU), customers, suppliers, employees and other stakeholders, who are pressuring companies to adopt more ethical, sustainable and value-creating behaviours over the long-term for society in general.
Whereas in the past sustainable investments were sometimes a marginal concern, the incorporation of qualitative and quantitative factors related to environmental, social and corporate governance when assessing the value of companies today constitutes an important component of many investment strategies and is used by the vast majority of asset managers. Their approaches, however, can differ significantly. For some asset managers, the incorporation of these factors continues to be ensured by filtering processes, which at the outset exclude companies that do not meet the defined criteria. Others have sought to identify risks and opportunities arising from ESG factors and determine whether a company is correctly managing its environmental, social and corporate governance resources, in line with its sustainable business model. Over recent years, new products have been launched and increasingly innovative strategies have been developed, whose objective is to identify companies that successfully manage ESG risks and, as such, may benefit from ESG opportunities in their sector.
ESG issues, particularly environmental and social issues, that can have a material impact on a company’s financial performance, vary from sector to sector and even from one company to the next. For example, environmental factors such as CO2 emissions or water consumption are normally significant for electricity suppliers or mining companies, but are relatively immaterial for financial institutions. In general, environmental factors that are considered to be materially relevant include management of natural resources, prevention of pollution, management and use of water, energy efficiency and reduction of emissions. Social factors primarily aim to assess the management of human capital and talent (human rights, development and well-being of people; product development; and, in some cases,the impact on local communities) and the ability to maintain competitive advantages (personnel retention, health and safety at work, training and education, diversity, value chain management).
Finally, governance factors seek to gauge the robustness of the corporate model, including analysis of the shareholder structure, independence of the members of the governing bodies, remuneration policy, shareholder rights and transparency of the reporting model.
Despite significant advances over recent years, ESG metrics are still “taking baby steps” when compared to financial metrics. As such, major challenges lie on the horizon. The first, and perhaps the most important, is to ensure the dissemination of high-quality information, in particular the provision of objective and accurate information, as well as promoting increased transparency and improved reporting. The second is related to the need for greater systematisation and standardisation of information, in order to facilitate comparability, a critical factor in the selection of companies. Finally, it is essential to define a robust classification that clarifies investors about how ESG issues are addressed, in order to ensure that the information transmitted is reliable. In this context a fundamental role is played by initiatives such as the creation of a taxonomy and the independent review of the information. The importance of ESG factors is expected to continue to grow in the future and will shape the strategies of a rising number of companies. Although some companies continue to see this new approach as a mere compliance exercise or an additional risk management tool, many others view it as a critical and integral element of their strategy, allowing them to obtain competitive advantages and access long-term sources of financing on more favourable terms. Regulators, investors and the general public will continue to demand that corporate practices are aligned with universal principles – such as a clean environment, workers’ rights, and good corporate model practices. In addition, there will be an increasing level of demand and scrutiny by the different stakeholders, which should contribute to greater rigour and systematisation in the reporting and dissemination of information.
Finally, but equally important, companies that anticipate ESG legislation and develop differentiation strategies based on ESG factors and sustainable growth, are likely to benefit from competitive advantages (“first-mover advantages”), resulting in the ability to generate more sustainable returns and create greater notoriety and better reputation in the market. They will be perceived as attractive companies and, as such, will attract the interest of long-term investors. The creation of value for stakeholders in the future will necessarily involve the consideration of environmental, social and corporate governance factors as absolutely critical for the life of companies.
Cristina Rios Amorim,
Director
