What is ESG Investing?

What is ESG Investing?

Environmental Social Governance

It is subjective and highly debatable what elements comprise environmental, social or governance factors, yet the investment community has coined the term as they generally acknowledged a broad definition of ESG Investing as non-financial dimensions of a security’s valuation, performance, and risk profile.

Today, ESG is featured much more in almost every company’s key strategic discussion, especially at its highest levels. As the battle over Exxon in 2021 and McDonald’s right now show, these decisions determine the futures of companies.

The majority of the investors trust, that ESG elements may have solid financial relevance, which is indicated by the increasing use of an ESG score to evaluate company value as well as the general increase in ESG funds available on the market.

ESG investing follows traditional financial analysis and tries to find value in companies that may not be immediately apparent.

The environmental (E) element in ESG considers the wide range of environmental and climate risks that threaten the world. While the concerns vary, some of the main areas of apprehension regarding the environment include climate crisis and carbon emissions, air and water pollution, biodiversity, deforestation, energy efficiency, waste management and water scarcity.

The social (S) elements in ESG are inter alia human rights standards, gender and diversity, data protection and privacy, community relations and labor standards. These factors are playing a very important role in the perception of firms by the public.

The governance (G) element in ESG has evolved into the leading area of concern that institutional investors consider when deciding about their investments. Some of the leading governance issues are executive compensation, lobbying, audit structure, and board composition.

ESG factors pose risks to the financial sector and to financial stability. ESG factors may indirectly affect the companies’ results as a consequence of financial impact emanating from non-financial performance and may also affect the performance of investment portfolios. That’s why it is mandatory to consider ESG factors in the structuring of investment portfolios, to contribute in achieving a better performance in the long run.

Sustainable finance includes re-channeling of private capital to more sustainable investments, fostering sustainable economic growth and long-term economic development, ensuring the stability of the financial system, strengthening transparency and managing the risks deriving from environmental and social issues.

The two important political milestones for sustainable investing were the adoption of the UN 2030 agenda and sustainable development goals and the Paris climate agreement. The Paris climate agreement includes references linking the financial services to the transition to an environment-friendly development.

Sustainable finance is one of the top priorities of the EU, under the European Green Deal and the Capital Markets Union. The European Green Deal is the EU’s action plan towards becoming climate neutral by 2050, whereas the Capital Market Union, is an EU initiative aiming to deepen and further integrate the capital markets of EU member states.

Good news is that based on a recent study by Harvard Business Review, Europe is leading the way, with 81% of the $2.7 trillion invested in global exchange-traded ‘sustainable’ funds residing in the region.