The significance of ethical investment is growing. On the one hand, new EU requirements will force investors to apply certain standards. On the other, due to events such as the pandemic or the looming climate crisis, instead of solely looking at the short-term profits achieved without regard to the consequences, investors are also more frequently taking into account the wider implications of their investments and their long-term goals.
Pursuant to EU legislation, environmental, social and governance issues (ESG) will have to be included in the reports of banks, insurance companies and listed companies starting from 1 January 2022. The general idea behind ESG criteria is that the value of ethical companies will grow due to the changes in the preferences of investors and financial market participants, who will be increasingly taking into account the companies’ activities relating to the environment, respect of workers’ rights, or their approach to the customers.
The “green” criteria
The reporting of environmental, social and governance issues is a part of the European policy of sustainable development and its goal is to direct investment towards “green” enterprises, which are contributing to climate change mitigation.
Polish financial institutions are already preparing for this. The Polish Chamber of Insurance (Polska Izba Ubezpieczeń), the Polish Bank Association (Związek Banków Polskich), and the Polish Association of Listed Companies (The Polish Association of Listed Companies), in cooperation with the Reporting Standards Foundation (Fundacja Standardów Raportowania) have established a working group, which will be dealing with the issue of sustainable finances. The first task of the working group is an to analyze the requirements of the draft implementing act to Regulation 2019/2088 on sustainability‐related disclosures in the financial services sector, which enters into force on 10 March 2021.
In accordance with the draft, financial institutions will be obliged to report on 32 indicators concerning, among others, their carbon footprint, energy consumption, relationship with the environment, water consumption and discharged wastewater, generated waste,
indicators of pay disparities between women and men, and the applied anti-corruption measures. These indicators will concern the data derived from all the companies in the given investment portfolio. Financial institutions will be obliged to take into account the risks for sustainable development while providing information on their financial products and investment policies.
Ethical investments don’t have to be unprofitable
Although the historical origins of the focus on environmental, social and governance issues can be traced back to the religious bans on usury, gambling, or tobacco production, the first “ethical” investment fund appeared in the 1970s. The popularity of responsible investment grew after the crisis of 2008, when people realized that maximizing profits without any regard to the possible consequences may prove to be a dead end.
Long-term investors are increasingly often recognizing that taking environmental and social issues into account is not only a question of ethics, but also a matter of profitability. This is not driven solely by idealism but is also the result of linking one’s investment activities to the problems faced by the societies: inequalities, climate change, and the over-exploitation of the natural environment. The combination of traditional financial analysis with analysis concerning the environmental, social and governance issues allows the investor to obtain a broader picture of the given company.
Responsible investing is not charity, however, and doesn’t require the investor to abandon the profit maximization motive. The application of environmental, social and governance criteria isn’t supposed to lead to a deterioration of the companies’ financial results. Instead, it is supposed to provide tangible benefits resulting, for example, from the lower cost of capital or the elimination of losses caused by non-compliance with environmental standards.
Besides, the companies with the focus on, for example, new technologies related to environmental protection, are often among the most innovative enterprises in their respective fields and generate large revenues. It is important that the profits of the companies are not detached from the real needs of the people and the challenges facing contemporary society. Such an approach entails a focus on returns achieved in the long-term thanks to a well-prepared base. It is also associated with investing in quality.
It seems that responsible investment will likely turn out to be a lasting trend and not a short-lived fad. More and more investment funds in the world are noticing this new reality. In large companies, special departments are being created, which are tasked with the preparation of proposed changes enabling these businesses to gain higher scores in ESG rankings. This benefits companies involved in the implementation of environmentally friendly technologies. They are likely to be among the entities that will gain the most in light of the growing importance of environmental, social and governance issues. This includes companies dealing with the changes in the acquisition of water and energy, or with new combustion technologies.
In the article entitled “Sustainable investing in asset management” (“Inwestowanie zrównoważone w zarządzaniu majątkiem”), published last year on the Investhink.org website, Karol Matczak, Jakub Wojciechowski and Czesław Martysz reported that according to estimates sustainable investments now represent more than 25 per cent of the overall value of all investment assets in the world. In Western countries values-based investing already accounts for anywhere between 18 to 63 per cent of all investments.
In Poland, environmental, social and governance issues still aren’t treated as seriously as in the West, despite the fact that the WIG-ESG index has been published on the Warsaw Stock Exchange since 2019. The index includes the largest companies listed on the Warsaw Stock Exchange, from the WIG20 and mWIG40 indices, which follow the principles of social responsibility in business. However, according to analysts, the ESG reports have so far been treated by investors as a superfluous addition. This will probably change over time, as global trends usually reach our country with some delay.
The crisis is changing priorities
The preparations for the legal regulation of environmental, social and governance issues in the EU provide an important incentive to treat responsible investing seriously. However, an even more important role could be played by the motivations of investors, whose behaviour may change as a result of the pandemic. Policy makers have started paying more attention to ethical issues, but this may be a temporary response to the crisis caused by the coronavirus, which is perceived as a warning signal.
On the one hand, in many cases people’s behaviors do not fundamentally change after periods of turmoil and they tend to return to their previous habits, despite the initial widespread optimism that the unpleasant experiences would serve as a valuable lesson. On the other hand, the crisis of 2008 ultimately promoted ethical investing, as investors realized that the pursuit of quick profits without regard for the consequences could actually result in losses.
Jean-Xavier Hecker and Hugo Dubourg, the heads of ESG and Sustainability at JP Morgan EMEA Equity Research, look at the future of ESG issues with hope. They believe that in the long run COVID-19 may prove to be a major turning point for ESG investments or investment strategies that – in addition to the traditional financial indicators – also take into account the given company’s commitment to the environmental, social, and governance criteria. In their opinion, pandemics and environmental hazards are seen as similar to each other in terms of their effects, which constitutes an important warning signal for the policy makers.
J.P. Morgan conducted a survey among investors from 50 global institutions in order to examine their views on how COVID-19 would affect the future of ESG investment. About 71 per cent of the surveyed investors considered it “rather likely”, “likely” or “very likely” that the risk of an event such as COVID-19 would increase people’s awareness of the threats associated with climate change and biodiversity loss and that it would stimulate activities undertaken across the world in order to counter these threats.
The public awareness of long-term threats to sustainable development is likely to increase over time as a result of the crisis caused by the pandemic, and this should be a positive catalyst for ESG investment. This opinion is shared by the majority of the respondents (55 per cent). Meanwhile, only about one-quarter (27 per cent) of the surveyed investors expect a negative impact, while 18 per cent believe that it will be neutral for ESG investment.