Green finance is having a moment in the sun

The COVID-19 crisis has unveiled the vulnerability in the strategic assessment and planning, not only of the healthcare systems, but also of the global supply chain and financial markets. This has the potential to significantly reshape investor flows and to influence the future of ESG investing.

ESG - for Ethical, Social and Governance investing - before the current global health crisis was rapidly gaining mainstream traction. Research by Morningstar published in February revealed that investors poured a record-shattering $130 billion into sustainable investment options in 2019, with more than a third of the year’s inflows – $52 billion – coming in the final three months of 2019.

Whether to mitigate risk, reduce long-term volatility, identify opportunities, align values or simply beat the market, more investors – institutions and individuals alike – are looking to incorporate environmental, social, and governance factors into their portfolios.

As a result, sustainable funds have shown resilience during the recent market sell-off. The global sustainable fund universe pulled in $45.6 billion in the first quarter of 2020, compared with an outflow of $384.7 billion.

While global sustainable fund assets stood at $841 billion as of end March, down 12 per cent from an all-time high of $960 billion at the close of 2019, assets in the global fund universe suffered more, registering a fall of 18 per cent.

One of the bellwethers for the rise of ESG over the last decade has been the green bond market, which has now grown to encompass social and sustainability debt as well. In 2019, sustainable bond issuance topped $300 billion vs $30 billion only 5 years ago in 2014.

Despite relatively muted activity in March in capital markets, green, social and sustainable bond issuance as of April 2020, reached $120.1 billion led by the increase in COVID-19 themed social bond issuances.

Clear preferences

The health crisis and the ensuing economic downturn underscore how important it is for companies to run resilient operations, manage their ESG risks, have strong supply chains, take care of their employees and have the right health and safety measures in place.

The crisis has turned the financial community upside-down and reinforced the case for a different type of investing. It is a wake-up call that highlights how reliant we are on solid ecosystems that must be able to weather black-swan events like a pandemic.

The growing collective narrative is that the world as we knew it was not sustainable. The current mood around this is further accelerating the need for the business world to have a greater, societal mission.

In the collective psyche, the COVID-19 crisis is also increasingly linked to other systemic risks like climate change. It is possible that governments could decide to step up policies to transition to a low-carbon economy faster.

Standard Chartered Bank is committing at least $1 billion of not-for-profit financing to companies that provide goods and services helping with the fight against COVID-19, and to companies planning to switch into products that are in demand to fight the pandemic. This funding is being provided at preferential rates, and will be in the form of loans, import/export financing, and/or working capital.

Centred on environment

An ESG approach is mostly used to assess the performance of companies on key environmental, social and governance factors that may affect financial performance. Environmental factors include carbon dioxide emissions, the ability to mitigate activities harmful to the environment, the company’s energy consumption, and use of resources.

Social factors can include employee well-being, diversity, inclusion, relationships with suppliers and host communities, human rights, customer protection and anti-corruption initiatives. Governance is related to internal affairs – transparency, relationships with shareholders, board composition, internal control and risk systems.

So how do you go about ESG investing? First, it is important to have a look at what this actually means, since there is often some confusion over what the term stands for. Is “ESG” interchangeable with “impact” investing, “ethical”, or “socially responsible investing” (SRI), “sustainable” investing etc?

Is ESG about assets, a style of investing or adherence to some standards? Some investors use ESG criteria to narrow their investment universe and select particular securities. Others aim to make an impact alongside financial return by choosing investments in companies that contribute positively to society.

Filter the ratings

ESG ratings have emerged as a key method of assessing corporate sustainability. They have become increasingly important, offering significant value to both companies and investors. Increasingly, ESG ratings are being integrated into credit decisions as more asset managers apply ESG data in their investment analysis predominantly through taking those ratings as a starting point to understand the landscape and to benchmark companies against each other.

Although they remain unregulated, an ESG rating from an external, impartial party can give analysts comfort that they are receiving insights that can be meaningfully compared against other companies rated under the same system. Methodologies differ between rating agencies, and it is therefore key for companies to understand what drives a rating, especially as the complexity of these ratings has increased.

Getting there

In the UAE, the world’s first sharia-compliant capital market since 2007, there is clearly an overlap between ESG investing and Sharia law. Dubai Financial Market (DFM) recently updated its Sharia standards as an answer to growing investor interest in sustainability.

The standards cover the issuance of instruments such as green sukuk, shares and green investment funds. A variety of assets can be considered, but beyond equities, it is currently only possible to integrate ESG in a small range of alternatives such as infrastructure, commodities, green bonds or “social” bonds.

In 2018, Dubai ports operator DP World secured a $2 billion green Shariah-compliant loan, which was led by Standard Chartered Bank. The loan had an interest rate linked to the company’s carbon emission intensity and was the first such loan for a corporate in the Middle East.

While COVID-19 has created some headwinds for growth and sustainability efforts, it has also generated strong tailwinds. The United Nations revealed that as of April 2019, more than 2,300 investment management firms, representing $86 trillion in assets under management, have pledged to integrate ESG factors in their investment decisions by becoming signatories to the UN-backed Principles for Responsible Investment – a growth of over 300 percent in assets under management since 2010.

ESG is becoming more mainstream under pressure from the general public, who are increasingly examining the environmental and human rights records of the brands they buy or subscribe to. As health and social issues come to the fore amid the COVID-19 crisis, this movement is likely to accelerate.

- Mohamed Salama is Head of Global Banking, Standard Chartered MENA.