WASHINGTON — As global markets contracted in response to the COVID-19 pandemic, the growth of environmental, social, and governance, or ESG, investing; sustainable investing; and impact investing appears to have accelerated. But whether that potential shift will result in finally unlocking more capital to finance development remains an open question.
The ESG market is expected to reach $45 trillion in assets under management this year, though Europe and North America account for more than 90% of the market, according to research released by J.P. Morgan earlier this year.
“Over the long run, COVID-19 could prove to be a major turning point for ESG investing, or strategies that consider a company’s environmental, social, and governance performance alongside traditional financial metrics,” Jean-Xavier Hecker and Hugo Dubourg, co-heads of ESG & Sustainability within J.P. Morgan EMEA Equity Research said in a statement earlier this year.
What exactly many of those investments look like or whether they measure environmental or social impact is unclear because many companies create their own definitions for those products and there is a lack of standardization.
“My concern is that actually a lot of ESG investing has not really been, if I'm to be really blunt, about the underlying sustainability and development and finance issues. It's been about adding a value-added wrapper to active management because active management is under huge pressure from passive investing and it's sort of adding a bit of marketing gloss to it,” Peter Sands, the executive director of the Global Fund to Fight AIDS, Tuberculosis and Malaria, told Devex.
“What I hope is it does get more real and tangible and therefore does have more direct impact on the targeting of resources to issues like health that do have a material impact on the long term sort of economic and broader sustainability of societies.”
“Governments are unlikely to take bold steps if they don’t feel there is a general demand for those steps, but big crises can lead to big steps.”— Ronald Cohen, chairman, Global Steering Group for Impact Investment
Stephanie von Friedeburg, interim managing director and executive vice president of the International Finance Corporation, echoed those concerns. Some of what is called ESG or sustainable investing is “just whitewashing,” she told Devex.
Change will “require a rethink of lots of things,” von Friedeburg said, adding that quarterly earnings don’t drive good ESG decisions and there needs to be more adoption of performance standards and measurement of impacts.
There is not necessarily one trigger point but it is important that IMF is now much more focused on health risks than ever before, Sands said, adding that before joining the Global Fund he had tried to persuade IMF to take these issues more seriously and had “singularly failed.”
That’s an important signal because if IMF takes these issues seriously, then governments and rating agencies will too, and that will start to translate into the financial world beginning to think differently, which will change incentives for governments and companies, Sands said.
There are a growing number of efforts at standardization and reporting. The European Union launched a classification for sustainable activities and momentum is growing around requiring climate-related financial disclosures, said Marcos Neto, the director of the United Nations Development Programme’s finance hub.
In September, the big four accounting firms — Ernst & Young, PwC, Deloitte, and KPMG — came together to narrow sustainability metrics to a set of 21 reportable metrics in key areas of governance, people, prosperity, and planet, in an effort to standardize and improve what companies measure and report.
In November UNDP and the Organisation for Economic Co-operation and Development released a sustainable finance framework, at the request of the G-7, which identifies solutions to shift funding to more sustainable and resilient investments, particularly in least developed countries, small island developing states, and developing countries.
UNDP’s SDG Impact has also released a set of standards for private equity funds to help create a common language and best practices for impact management in investment decisions, and is working on standards for bonds and enterprises as well.
There is a question about integrity of ESG or sustainable investments and metrics and standards are necessary so that the money is held accountable to its objectives, Neto said.
“There is an interesting growing demand now and interesting change politically towards a desire for global norms and standards for sustainable finance,” Neto said, adding that the notion that every company creates their own version of ESG will not work.
Even though there may be more standardization, and more funds that target environmental and social outcomes, that doesn’t necessarily translate into more funding for the world’s lowest income countries, Neto said. Most of the funds invested in these areas are staying in higher-income countries and it remains challenging to get that money to the world’s poorest countries, he said.
None of the changes in norms or standards changes sovereign or corporate risk, and risk drives the allocation of assets, so without a change in how risk is calculated it will be difficult to drive funding to low income countries, Neto said. Aid dollars could try and leverage projects, but “the question is, can you leverage a country by reducing its risk profile?” he added.
“More progress on norms, standards, and integrity fundamentally moves a lot of money to the rich issues in rich countries, not the right issues in the right ways to poorer countries,” Neto said.
For Pro subscribers: Ronald Cohen on what's needed to drive impact investment to lower-income countries
Impact investments may soon reach $1 trillion, and there is growing opportunity to mobilize those funds for the SDGs, Ronald Cohen, chair of the Global Steering Group for Impact Investing, tells Devex.
Ronald Cohen, social investment pioneer and chairman of the Global Steering Group for Impact Investment, is a bit more optimistic that current trends could eventually translate into more development funding.
In 1929 during the great depression, generally accepted accounting principles were adopted, and so it is possible and even realistic to believe that this crisis could also be a moment for significant change, Cohen said.
“There is increasing traction among investors to push for this. I think calls are going to be increasingly loud that we have transparency,” he said.
Greater transparency and a new accounting framework could lead to the trillions of dollars in ESG investments achieving some impact, Cohen said. But he added that governments are going to need to start mandating increased transparency about non-financial issues.
Cohen is working to change accounting standards to factor in a company’s social and environmental performance in addition to its financial performance when evaluating its profitability.
The Impact-Weighted Accounting Project at Harvard University has released data evaluating 2,500 companies on their environmental performance, finding that for the 1,694 companies with a positive total profit in 2018, 15% of them would have had their profit wiped out by the environmental damage they caused if it was factored in. Some 543 firms would see profit reduced by 25% or more, the project’s research found.
By mainstreaming this new form of accounting, which factors in social and environmental costs, a much broader range of investments can be pushed to seek impact, in large part through government regulation — something Cohen said he thinks can be done in a couple years, based on conversations he has had with accounting boards and some governments.
“Governments are unlikely to take bold steps if they don’t feel there is a general demand for those steps, but big crises can lead to big steps,” Cohen said, adding that demand from investors, employees, and consumers can push governments in that direction.
The impact accounting system is designed to give an objective view of the impact of a company’s products, employment, and operations on people and the planet, Cohen said. Because the system provides greater transparency, particularly on whether a company’s products help underserved populations, it should boost investment to emerging markets, he said.
Other impact investing tools — including pay for success instruments, development impact bonds, and outcomes funds — will play an important role in improving education and health. An increase in impact investing flows should translate to being able to scale some of those tools, Cohen said.
“We need people to understand that impact is the next frontier of capitalism and society, not a peripheral activity but fundamentally changing the shape of the economic system so it delivers greater equality and sustainability,” Cohen said.
It’s clear that there is momentum in the sector, and some change is possible, but how big of a change is unclear, as is whether there will be more rigor around what is called ESG or sustainable investing, and whether any of those new funds will find their ways to the places or issues that could truly open new development funding streams.