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Devils in the details

President Biden’s moves during his first few days in office hint at good things for ESG investing, but there are still challenges, says Simon Smiles

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President Biden clearly stated in his acceptance speech what he believed the will of the American people, and his mandate, to be. This mirrors almost perfectly the core underpinnings of sustainable investing - the Environment (E), Society (S), and Governance (G) - and has led to numerous positive reports.

"America has called upon us to marshal the forces of decency, the forces of fairness, to marshal the forces of science and forces of hope in the great battles of our time..." This matches G. "...The battle to control the virus. The battle to build prosperity. The battle to secure your family's health care. The battle to achieve racial justice and root out systemic racism in this country..." These are all key goals linked to S. "...And the battle to save our planet by getting climate under control." This is currently the key sustainable investment focus for E. 

But in reality, devils currently exist in the details for investors who wish to help contribute to these goals. 

Governance (G) 

"America has called upon us to marshal the forces of decency, the forces of fairness, to marshal the forces of science and forces of hope in the great battles of our time..." 

Prima facie, this is exactly what sustainable investment aims to do. 

BUT 

Currently, sustainable investing has its own governance problem with numerous frameworks, taxonomies, approaches and conflicting available data. 

Regulations and rules vary wildly across the world when it comes to what information companies need to provide. At a regional level, the EU has led the way with its Non-Financial Reporting Directive, which tells large companies what types of environmental, diversity and other sustainability-related data they should provide. However, even the EU rules are currently being overhauled amid criticism they are not clear enough and do not cover enough companies.

Sustainable investment firms also have starkly different opinions regarding the optimal approach to sustainable investment, and its governance. There is currently no common agreement on sustainable investing definitions, terms, or frameworks. 

As Blackrock's head of investment stewardship, overseeing the group's $7.8trn in assets, said: “If we look at what investors and corporates alike need we need common data and we need it to be comparable and we'd like the definitions to be comparable." Similarly, the PRI stated in a recent EU-focused report: "Many challenges remain, not least the availability of data and potential changes to the detailed taxonomy criteria."

Social (S) 

"... The battle to control the virus. The battle to build prosperity. The battle to secure your family's health care. The battle to achieve racial justice and root out systemic racism in this country..."

COVID vaccinations have just been developed by leading, listed healthcare companies. And there are many broader healthcare investment opportunities currently available, both private and public, and pooled and direct. Sustainable investments also performed well last year, typically outperforming traditional mutual funds and helping grow participants' prosperity. 

BUT 

It is government policy that will determine US families’ healthcare. And sustainable investing does not currently offer realistic ways to help achieve racial justice and equality. 

For example, the ability to even identify racial inequality - a key component of S - using current data on listed companies is extremely limited. A new study by Conference Board shows the percentage of women directors of the 3,000 largest listed companies has risen, albeit very slowly, to 18.5%. But only 10% of boards for S&P 500 companies even disclose directors' ethnicities, and just 20% of those board members are non-white.

Environmental (E) 

"...And the battle to save our planet by getting climate under control." 

This is currently a key sustainable investment focus in E. During 2019, some $257bn of green bonds were issued, a 50% increase from the previous year, according to the Climate Bonds Initiative. By the end of June 2020, the corporate green bond market was worth $468bn (based on the ICE BofAML Green bond index). And research by Bloomberg New Energy Finance released at the start of October showed green bonds worth more than $200bn had been issued so far in 2020 taking the cumulative total since the securities were launched in 2007 to over $1trn.

BUT 

There are limits on the true contributions most available investment options offer. 

Exclusion is still a widely-used investment, but one with no proven positive impact. The market's liquidity and efficiency prevents buying and selling a company's stock for environmental reasons from actually affecting it in any material way, for example. 

And climate change is just one broad contributor to how E is currently measured. The OECD's 2020 ESG Investing report found that there is a positive correlation between some ESG raters' high E scores of corporate issuers and high levels of carbon emissions and waste, suggesting that aspects of the E score other than key environmental metrics, such as climate risk management and governance, have greater weights in the methodologies that determine scores. As a result, the OECD explicitly recommends that "investors should take care not to misinterpret the information content of the E score as being aligned with low emissions, low carbon portfolios or low-carbon transition." 

Overall, the new President's stated mandate is closely aligned to E, S and G, the key focuses of sustainable investment. But the devils are in the details. Investors can help contribute to a number of the elements of President Biden's stated mandate but currently not all of them, despite what recent headlines have been suggesting. 


Simon Smiles retired from his role as Group Managing Director and CIO for Ultra High Net Worth Clients at UBS in 2020. He established and ran the wealth management sustainable and impact investing teams.



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