1. Conclusion
All of this demonstrates that sustainability already plays an important role in shaping the future of the financial industry. Indeed, assets under management with an ESG mandate are growing exponentially and most financial market participants accept that this sustainability transition is something they can no longer ignore. It is encouraging to see that discussions are moving away from whether to do sustainable development to which sustainable investments are available to invest in. Sustainable development has become a significant trend in the financial sector. On the other hand, it is crucial to recognize that progress in this area can vary significantly across different geographies and jurisdictions. While some developed countries, like Switzerland, are on track to fully embrace sustainable finance, others are still lagging. In the case of emerging markets, China is one of the most active countries in Asia in green finance (International Organization of Securities Commissions, 2019). As of September 2019, it had the second biggest green bond market in the world, just after the United States (Climate Bonds Initiative, 2019), while none of the other emerging economies are close to this level.
The majority of global assets are managed passively, relying on index-based investment allocations. To significantly shift towards sustainable development, it’s crucial that both equity and debt indices incorporate sustainability considerations. While ESG indices are increasing, index providers are hesitant to make their “standard” indices more ESG-compliant. Mainstream indices continue to include companies involved in controversial weapons, a practice already avoided by many investors. Addressing this is crucial for ESG integration progress. Beyond negative screening and corporate engagement, sustainable investment mandates must aim for a more substantial impact. These strategies often avoid pricing ESG externalities, leading to superficial ESG overlays with limited impact potential. The failure to capture positive and negative externalities in valuation models hinders the alignment of financial performance with social good. Until significant progress is made in this area, there’s a risk of financial performance driving capital towards investments with negative impacts. Market participants should strive for full ESG integration throughout the investment process, including defining an ESG-compliant investment universe, incorporating externalities into financial assessments, and setting measurable ESG KPIs (Environmental, Social, and Governance Key Performance Indicators.). While asset managers often highlight the breadth of their ESG efforts, focusing on the percentage of Assets under Management (AuM) following ESG principles, press releases and sustainability declarations should now emphasize the depth of their strategies. For sustainable development to become mainstream, financial professionals need to develop the necessary skills and understanding of how to integrate ESG considerations into their investment decisions and client advice. Financial institutions offering sustainable investment services should mandate ESG training for relevant staff. This would enable front-office employees to educate clients and raise awareness about sustainable development, while middle and back-office staff could focus on sustainability-related disclosures, reporting, and risk management. The performance of different ESG strategies under various market cycles is a question to consider. While sustainable development has gained traction since the 2008 global financial crisis, it remains to be seen if a recession or new financial crisis would dampen enthusiasm for sustainable finance.
According to some experts, this will be the definitive proof of the sustainability of this new investment approach. The energy transition will also give a significant boost to sustainable investments. It was not long ago that renewable energy could only compete against fossil fuels with attractive feed-in tariffs in place. Today, four out of five coal power plants in the EU are unprofitable, making utilities lose EUR 6.6 billion in 2019 alone. The reason behind the “eye-wateringly low utilization rates” of coal power plants is they cannot compete with the increasingly cost-competitive renewable alternatives (Carbon Tracker, 2019). This is an example of a change in investment paradigms that will adversely affect portfolio valuations if asset managers ignore what Lombard Odier calls the “sustainability revolution”. Indeed, the Author is convinced that sustainable development is the future of finance. Certainly, there is still a lot of progress to be made before it becomes truly mainstream. However, if the key drivers discussed earlier can indeed generate the expected demand, and if there is a willingness from market participants to transform the traditional way of doing finance, it is only a matter of time. It is expected that in 10 years, sustainable development will just be called “development,” as integrating sustainability considerations will have become the new normal.
2. Recommendations and Suggestions:
1. Sustainable environmental stewardship and corporate engagement should be practiced and encouraged so that companies carry out business in a socially responsible manner and are held accountable for their activities. This will protect and achieve long term value and ESG objective of the stakeholders.
2. Investments should be directed towards projects and organizations that work with communities, empower people, create jobs for low-skilled workers, provide primary education, build-up rural infrastructure, and contribute towards such activities and innovations that raise the quality of life of the people.
3. There should be proactive voluntary compliance of ESG factors by the private sector companies so that they can give social returns to the investors from their investments.
4. The companies should start disclosing information on how they have put investors’ money to use, their performance on environmental factors say, carbon footprint and on the returns to society.
5. Companies should produce annual accounts through the Economic Value Added approach thereby advocating and encouraging corporate social responsibility culture.
6. There is need to create a greater level of awareness among the educated investors who are interested in making a positive contribution to the society by investing in ethical and environmental responsible companies and at the same time achieving their long-term financial objectives.
7. Companies should gradually start the process of making ESG related policies, following sustainable investment practices and being socially responsible, instead of an abrupt and sudden reaction if and when government imposes regulatory compliance of ESG practices.
8. Companies should follow strict disclosure norms, set targets and diligently implement those practices and policies which address environmental and societal concerns in a positive manner.