Understanding the Principles of Sustainable Investing

In a year of remarkable political, social and environmental upheaval, it’s unsurprising that Environmental, Social and Corporate Governance (ESG) has come to the fore. This is a new trend that focuses on a variety of social justice initiatives, such as environmentalism. A growing number of investors are pushing for eco-friendly investment practices, which should help mitigate the risk of climate change and other concerns.

How popular has this form of eco-friendly investing become? One study found that nearly 20% of investors would allocate between 21% and 50% of their investment portfolio to ESG investments. This suggests the shift towards sustainable investing is accelerating.

The Birth and Rise of Sustainable Investing

We have previously talked about ethical investing trends, which were taking off in 2020. Investors (irrespective of asset class) have kept a close eye on how companies have responded during a turbulent year marked by a tragic pandemic, widespread social protest and ongoing environmental threats. Last year accelerated an already evident change – the shift towards companies being judged on far more than simply their ability to generate profit. ESG, which was once thought of as a simple box-ticking exercise, is now fundamental to how companies operate.

Yet, for all the recent interest surrounding ESG, it has often been incapable of escaping one particular criticism – it’s far too confusing. It has long been derided as an ‘alphabet soup’, so ESG has always been dogged by a complicated tangle of acronyms and frameworks which often only serve to confuse and alienate investors trying to understand it.

Encouragingly, however, change is underway. The recent announcement that the Sustainability Accounting Standards Board (SASB) and the International Integrated Reporting Council (IIRC) are merging to create the Value Reporting Foundation will create an integrated framework for companies which will introduce a standardized set of disclosure standards.

This move is indicative of a wider trend towards consolidation and standardisation taking place in ESG. As these changes inevitably make ESG easier to understand, companies are going to find themselves communicating with investors and regulators who are much better placed to scrutinise and hold them to account.

So how do companies respond to this change? I’m a strong proponent of companies having a fourth financial statement – a statement which covers non-financial performance. I believe this is a convenient and comprehensive way for organizations to disclose their ESG performance to an increasingly informed audience in the most transparent way possible.

The idea that mandatory reporting on ESG is going to become the standard across the industry has been further strengthened by the increasing appetite among regulators to begin assessing non-financial performance indicators. The decision, for example, to ensure that all UK companies listed on the London Stock Exchange will have to align with the TCFD (‘Task Force on Climate-related Financial Disclosures’) from 2022 onwards, is one of a number of rules imposed by regulators designed to force companies to be transparent when it comes to ESG.

The message is clear. It’s time to get serious about eco-friendly investing. Compliance is non-negotiable and the reality is that a fourth financial statement is going to become a requirement. Investors are belatedly waking up to the promise of ESG. Companies need to be ready for them.