Public awareness of climate and social issues has been growing for some time, and investors have taken notice. Now, the shift toward sustainable business models that are resistant to turbulent environments has hit the gas pedal, with COVID-19 accelerating environmental, social and governance (ESG) trends. What was once considered a niche sector is now the talk of the town, attracting record net inflows of $71 billion in the second quarter of the year. And it’s no wonder: In the first half of 2020, 72 percent of sustainable equity funds have outperformed their conventional index-fund counterparts.
But as with any nascent sector, there is some work to be done. We take a look at what lies ahead for stakeholders and how to mitigate ESG risks with appropriate levels of due diligence to make the most of sustainable investing trends.
The Beginning of the Road
With Morningstar reporting a record-breaking 23 new sustainable funds launching in the first half of 2020, and the same number again already in the pipeline, sustainable investing is gaining momentum to meet growing investor demands. Blackrock, the world’s largest asset manager, wrote in May that “We are on the front end of a profound, long-term structural shift in global investor preferences toward sustainability.” Blackrock further added that “companies that better manage sustainability-related issues will be more resilient over the long-term.”
But for investors and stakeholders there are some hurdles on the road ahead before this sector reaches its full potential. The recent case of Boohoo, a UK-based fast-fashion retailer, is a case in point. Once considered a darling of ESG fund managers, it lost a third of its value after allegations that workers in its UK supply chain were paid below the minimum wage. Prior to this, the company had been given a double A rating for its ESG standards, attracting investment from twenty sustainable investment funds.
For fund managers relying on data from ESG ratings agencies, the true nature of ESG risks may not be visible. Without detailed due diligence at hand, it is impossible to gauge the reliability of information. There is a huge lack of consistency around ESG data and for funds there is a “lack of cohesive guidelines and methodologies for how to measure, report, and enforce their environmental impact.” Change is on the horizon, especially in the EU, with a financial policy framework targeted at mobilizing finance for sustainable growth likely in the year ahead.
Coronavirus has also magnified the issue of company culture like never before as businesses are under intense scrutiny to prove they can conduct business responsibly. But organizations are faced with ESG frameworks that are still evolving, including those published by the Sustainability Accounting Standards Board (SASB) and the GRI. In the EU, only large public-interest companies with more than 500 employees are required to publish regular reports on the social and environmental impacts of their activities. Yet many are concerned with their abilities to compile sustainability reports in light of the pandemic. For those that do report, it’s likely that they will be full of self-reported information — unverified, uncorroborated, and full of unknowns.
Assessing ESG Risks
For investors looking to make the most of sustainable investing trends, assessing ESG risk requires looking beyond sustainability disclosures and the available risk ratings. From issues of poor corporate governance and extended supply chains through to green financial crime, there are a multitude of risks that can cause serious headaches for stakeholders. Early monitoring of ESG threats will help prevent hidden surprises in the future and drive stronger growth. But as it currently stands, the information may not accurately capture the true picture. Verifying claims must go further than the scant data currently available and ensure that businesses are “walking the walk” when it comes to ESG claims.
IntegrityRisk is focusing the risk, compliance, and due diligence lens on the world of sustainable investing with ImpactCheck. Using a systematic, analytically driven and comprehensive approach, we combine due diligence and investigative assets to verify, validate, and authenticate ESG performance. Our integrated impact measurement and accounting framework provides clarity on ESG. We will identify:
- An entity’s non-compliance with environmental standards and regulation;
- Supply chains that are extractive, polluting or heavily resource dependent;
- How an entity treats its employees;
- How an entity interacts within the communities it operates;
- Discrepancies in self-reported/disclosed company operations;
- Potential risks that can materialize into labor law litigation.