One of the megatrends shaping the asset management industry today is the growing popularity of ESG (environmental, social, governance) investing. The core of ESG is the idea that investors should weigh factors such as climate change or diversity when considering investment assets, with the aim of improving corporate behaviour and potentially raise returns.
However, a lack of clear guidelines around ESG metrics or even a unified taxonomy has led to a rise in the practice of “greenwashing” with fund managers and companies overstating their commitment to sustainability while making only token gestures to meet such needs.
To combat these concerns and promote greater ESG investing, the European Union announced it will introduce landmark regulations to standardise ESG benchmarks, transparency and reporting for investment funds in March.
The regulations will require all asset managers, not just ESG-focused funds, to disclose how they manage sustainability risks. In addition, impact investors as well as fund houses that claim to adhere to sustainability principles would need to provide evidence of their efforts. Impact investors place equal emphasis on both ESG principles and financial expectations when investing.
The new rules are likely to expand the use of ESG investing in Europe and potentially further afield, and they could create further disincentives for some of the world's largest energy producers and commodities companies, which are by their nature high emitters of carbon.
AsianInvestor asked leading investment professionals what ramifications these more stringent guidelines will have on the appeal of energy- and carbon-intensive stocks, and whether it signals a major reduction in the valuation of such companies and their inclusion in portfolios.
The following contributions have been edited for clarity and brevity.
Helena Fung, Asia Pacific head of sustainable investment
The adoption of well-established and industry leading standards, such as TCFD [Task Force on Climate-related Financial Disclosures], serve to increase transparency for investors. Ripple effects from the SFDR [Sustainable Finance Disclosure Regulation] will impact the whole investment value chain, with asset owners testing the ability of asset managers to provide the recommended ESG data points.
As an index administrator, we are already receiving requests from these asset managers who are trying to understand whether we can provide them with all those SFDR data points with regard to their passive investment strategies.
The Asia region is particularly exposed to both the physical and transition risks related to climate change. Governments across the region are making net-zero pledges and coupled with the need for global capital inflows to bolster investment in renewables and low-carbon technologies, the focus on ESG brings investment opportunities as well as risks.
There is clear demand from investors globally to allocate towards companies that are better managing ESG risks and scaling the technologies and services that will be needed in the low-carbon transition. Companies that manage this well stand to benefit from this.
With regulators in Asia also looking to promote consistent reporting metrics on climate related risks, this will lead to greater transparency for investors to inform their strategies, as well as to further scrutiny of companies.
Cathrine de Coninck-Lopez, global head of ESG
The new EU regulation sets a new minimum bar for disclosure of ESG integration practices in investments. This raises the standard globally including in Asia.
The impact of this regulation takes many forms as it is intended to be a systemic inclusion of ESG principles across the financial system. There will be a more systematic integration of ESG considerations into core investment processes than ever before. Companies that lack disclosure or have significant ESG risks could see valuation impacted more directly than before by ESG issues, due to this greater awareness of ESG across the market.
The regulation is not about divestment, and it would be unlikely to lead to a mass exodus from higher-energy and carbon-intensive Asian companies. There is, however, going to be greater requirements on companies to proactively discuss their strategy for mitigating ESG risks and the financial impact with investors.
Jennifer Wu, global head of sustainable investing
JP Morgan Asset Management
As leading global nations pursue a green recovery, there will naturally be a fall in the appeal of carbon intensive stocks regardless of sector. There will of course be a greater focus on the energy sector and there will be winners and losers, particularly as demand for fossil fuels levels off and eventually goes into reverse.
But, as with other long-term challenges, we expect that the adoption of sustainable technology will both lead to new innovation and increase efficiency. In the energy sector, the winners will be companies who embrace the transition to a low carbon economy and adjust their business models accordingly.
The impact of Covid-19 has exacerbated this trend and awareness from investors as ESG has been thrust into the risk management processes of managers across the world. This will ultimately reduce the appeal of carbon-intensive stocks in the long-term.
Generally speaking, one would expect the valuation of companies not prepared for a transition to a low-carbon economy to fall. However, the extent of any change in stock specific valuation could depend on who bears the cost of the transition. The structure of the transition is a critical factor.
Carlo Funk, Emea head of ESG investment strategy
State Street Global Advisors
The new EU landmark regulation asks for a sustainable investment to, amongst other things, promote economic activities that contribute to an environmental objective, as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy and its greenhouse gas emissions. The ambition is twofold: direct private capital accordingly and put-pressure on carbon intensive companies.
By definition, some sectors will be more carbon intense than others in absolute terms. Hence, rather than penalising high climate impact sectors with a broad brush, the transition to a low carbon economy is about re-allocating capital within high-emitting sectors to companies that are both more efficient and effective in making this transition.
The companies that are better and more ready for the transition will likely also be the winners of the future.