ESG within the financial industry is an evolution of a set of beliefs and principles dating back centuries. Now, it remains more relevant than ever
The ethos of sustainable investing has been centuries in the making. From its earliest roots in faith-based investing to a complex yet concerted push for environmental, social and governance (ESG) reporting today, the sector has gone by many names as markets and governments evolved and matured.
Proponents of sustainable finance have borrowed from US Founding Father Benjamin Franklin’s quote, to “do well by doing good”. But can the two tenets truly co-exist, especially in the absence of a common ESG reporting standard today?
As part of our commemorative 1,000th issue — marking nearly two decades covering the financial markets — The Edge Singapore goes way back and takes a look at the evolution of the sector that is transforming the financial industry from within.
In its earliest stages, sustainable investing was informed by religious principles. In fact, faith-based investing can be traced back hundreds of years, says Kyle Rudden of the Sequoia Capital-backed investment research firm Smartkarma.
See: SGX invests in Smartkarma
These fell into two broad categories: Christian and Islamic. By excluding sectors that do not align with religious teachings — mainly alcohol, tobacco, gambling and pornography — faith-based investing meant investors’ consciences were clear. Thus began exclusionary investing, or negative screening.
There were further religion-specific nuances, says Rudden. For example, some believed biblical values frowned on embryonic cloning, while Shariah-compliant investing avoided putting money into companies associated with alcohol, pork or gambling.
Another early example of a negative screen was in the US in 1758, when the Quakers refused to buy slaves, says King & Shaxson Asset Management CEO Wayne Bishop.
The followers of the branch of Protestantism took an abolitionist stance at a time when it was unheard of. “Back then, before mechanisation, manual labour was essential and it was simply commercial suicide not to use slave labour,” says Bishop. “Today, the world thinks very differently and most companies are required to have an anti-slavery policy.”
Over the next century, the Quakers across the Atlantic founded many companies that changed English society, says Bishop, each with a positive ethos that sidestepped common capitalist goals.
The Friends Provident, for example, was founded in 1832 as an early iteration of life insurance and pension for the Quakers. Friends Provident was the first investment house in the UK to offer a fully ethical investment fund: The Stewardship fund. The organisation remained exclusive to its followers until 1915.
An employee walks past the offices of Friends Provident in Dorking, UK, on Jan 21, 2008. (Photo: Bloomberg)
Until 1983, a minimum of five members from its board of directors had to be Quakers. In 2001, Friends Provident broke formal ties with its founding religious organisation and listed on the London Stock Exchange, reportedly accruing revenue of GBP949 million in 2008. A decade later, however, the company went defunct; merging into the Aviva insurance group in 2018.
But there were other success stories that survived the Victorian and postwar eras. Some early examples of socially responsible investing (SRI) were carried out by investors who cared about social impact independent of religion, says Rudden.
The Irish dry stout Guinness’s advertising prowess in the 1930s marketed the beer as “a meal in a glass” for the working class, though this was later debunked. Meanwhile, Cadbury’s milk chocolate bars ceased to be a luxury product by 1930 and were sold as an affordable source of calories.
Some early examples of socially responsible investing (SRI) have survived till today, like chocolatier Cadbury (Photo: Bloomberg)
Outside of consumables, British shoemaker Clarks built its brand on affordability, and the company is in its seventh generation of family ownership today. “They were all founded with a social and economic mission to improve lives,” says Bishop.
The growing secularism of the sector in the final decades of the 20th-century hinted at its foray into mainstream acceptance. “Starting around the 1990s, faith-based investing started morphing into a broader form of ethical investing — still rooted in faith, but no longer beholden to it in a strict way,” says Rudden.
Crisis in the 1990s
A good example is investment advisor Domini, founded in 1990. While not faithbased per se, its founder Amy Domini has strong religious ties, serving on the board of the Church Pension Fund of the Episcopal Church in America.
With her company focused on SRI, she helped create the Domini 400 Social Index, a stock market index selected according to a set of social and environmental standards.
Since its launch in 1990, the Domini 400 has outperformed the S&P 500 on a cumulative basis. “Over time, more and more SRI investors emerged that had no basis in religion whatsoever,” says Rudden. “Their emergence was rooted in environmental and social catalysts.”
These catalysts further separated SRI from faith-based investing and started the “mainstreaming” of ESG that we are seeing today, says Rudden. “We are still in the 1990s here, so ‘ESG’ wasn’t a part of the vernacular yet, but the events and issues were very much so even without that fancy abbreviation.”
The Gulf War oil spill and well fires in 1991, for example, brought a man-made environmental crisis to the top of many news bulletins. Iraqi forces had allegedly dumped 480,000 cubic metres of oil on its shores to ward off US coalition-led forces, a heated political move that implicated seabirds and marine life along the Persian Gulf.
Medea Benjamin, co-founder of the Code Pink anti-war group (center), leads a demonstration outside the US headquarters of BP in Houston, Texas, on May 24, 2010. (Photo: Bloomberg)
The 1990s also saw anti-sweatshop activists campaigning to improve conditions for workers in developing countries, particularly Indonesia. Activists targeted multinational firms in the textiles, footwear, and apparel sectors and helped spread consumer boycotts throughout college campuses.
According to a 2010 article published in the American Economic Review, the roots of the anti-sweatshop campaign in Indonesia can be traced to a 1989 study commissioned by the United States Agency for International Development.
The study discovered that among all the factories that produced goods for the export sector, plants that manufactured for Nike paid the lowest wages. As a result of activist pressure, multinational firms were induced to sign codes of conduct pledging to raise wages and improve working conditions in factories producing their products.
Nike established its own codes of conduct in 1992 in order to comply with labour standards and establish living wages, but these practices were not fully implemented until 1995.
At the turn of the millennium, a series of corporate governance events turned attention to the boardroom. The most quintessential of which, highlights Rudden, was the Enron accounting scandal in 2001.
As details emerged of willful corporate fraud at the US energy company, Enron’s stock price, which had achieved a high of US$90.75 per share in mid2000, plummeted to 26 US cents on Dec 2, 2001, right before the company declared bankruptcy. Its shareholders lost US$74 billion in the four painful years leading to Enron’s demise.
“All of the above contributed to an increasing awareness of how ESG factors can seriously affect investment returns,” says Rudden.
Former Enron chief executive officer Kenneth Lay (centre) speaking with an activist outside the Bob Casey Federal Courthouse on Mar 6, 2006. As details emerged of willful corporate fraud at the US energy company, Enron’s stock price plummeted to 26 US cents on Dec 2, 2001 — right before the company declared bankruptcy (Photo: Bloomberg)
The 1990s were a seminal decade for sustainable investing, says Stephen Beng, head of ESG strategy of Phillip Capital Management. “Warning signs about weather-related disasters, sea-level rise and the collapse of entire ecosystems have been lit as early as 1992, and climate change is just one indicator.”
Before the financial world dared to take the plunge, governments had begun laying the groundwork for environmental recovery. In June 1992, the Earth Summit in Rio de Janeiro saw 178 countries adopt Agenda 21, a comprehensive plan of action to build a global partnership for sustainable development to improve human lives and protect the environment.
“The investment risks posed by climate change and poor corporate governance played a big part in the push for ESG investing today,” says Beng, “but it did not happen overnight”.
With pundits perhaps roused by both paranoia and optimism around Y2K, we arrive — at last — at the birth of the term.
“Quite literally, ‘ESG’ integration was first recommended in the 2004 UN Global Compact report, Who Cares Wins,” says Beng.
“[The report] was the result of a joint initiative of financial institutions invited by [former Secretary-General of the United Nations] Kofi Annan to develop guidelines and recommendations on how to better integrate ESG issues in asset management, securities brokerage services and associated research,” he adds. Twenty financial institutions from nine countries with total assets under management (AUM) of over US$6 trillion participated.
Funds with a mandate for SRI began appearing in the news, like The Edge Singapore’s feature on Parnassus Investments (Issue 216, May 15, 2006), which highlighted that its “holier-than-thou” approach to the markets had outperformed the S&P 500 that year.
With some US$47 billion ($63.2 billion) in assets, including five mutual funds, the San Francisco-based investment manager — billed “the last big ESG firm” — was acquired just this July by Affiliated Managers Group (AMG).
“Financial markets have invaded the eco-space,” wrote Sunita Sue Leng, the paper’s then associate editor, in her commentary on carbon trading, with an anecdote from 2007.
At the Greener Skies aviation conference that year, the typically mild-mannered Chew Choon Seng, who was then CEO of Singapore Airlines (SIA), reportedly took aim at emissions trading, charging that brokers were profiteering from the then-fledgling field.
“I find it morally objectionable and offensive when trading houses openly advertise that they are targeting emissions trading as their next big profit generator,” he said. “It has allowed polluters to avoid taking action to clean up, by paying others to carry the obligation.”
More research has surfaced since, and attitudes have understandably changed. Chew left SIA in 2010 to serve as chairman of the Singapore Exchange (SGX), which — for years — has been pushing local listed companies along the sustainability journey.
Similarly, a major turning point only arrived the following decade. The two events that kick-started the “full-on mainstreaming” of ESG are the Paris Agreement and the UN Sustainable Development Goals (SDGs), both in 2015, says Rudden.
The Paris Agreement is a legally binding international treaty on climate change, adopted by 196 parties. Its goal is to limit global warming to below 2 degrees Celsius, preferably to 1.5 degrees Celsius.
See: 'All hands on deck approach' to uphold UN SDG progress: Ban Ki-moon
Meanwhile, the UN SDGs had been built on Agenda 21. Billed as “the blueprint to achieve a better and more sustainable future for all”, the 17 goals are set to be achieved by 2030.
The timing of both events brought ESG issues to the surface. Fronted by climate change, both events remained fresh in people’s minds, says Rudden.
“Critically, it is the simultaneity of these events that enabled them to take such a foothold and drive the future direction of sustainable, SRI and ESG investing,” he says. “It was like, ‘Here is the problem’ — the Paris Agreement; and ‘Here is the solution’ — the SDGs.”
As the green agenda picked up steam, so did its star billing on newsstands. A cover story by The Edge Singapore (Issue 393, Oct 26, 2009) titled “Climate change” examined Singapore’s dreams to be a clean energy hub.
A decade later, this paper ran a cover titled “Climate changed” (Issue 878, April 22, 2019), warning of environmental risks that fund managers were ill-prepared for.
Did the financial industry squander 10 whole years? “I believe most corporations do not yet have definite plans [to handle climate change],” said Peggy Mak, former chief investment officer at PhillipCapital, in 2019.
“Like us, they have no clear idea how the climate risk will evolve and how it will hit them.”
What about now?
So much and yet so little has changed in the two years since. With less than a decade to achieve the UN SDGs, governments around the world face another setback in the form of Covid-19.
In April, the UN warned that current trends could delay global progress on the SDGs by a decade to 2040.
The UN’s Financing for Sustainable Development Report 2021 described a “sharply diverging world”, where rich countries employ strong stimulus measures and digitalisation to recover from the pandemic while poor nations fall into a cycle of poverty and debt.
The UN estimates the funding gap to achieve the SDGs by 2030 at between US$2.5 trillion to US$3 trillion annually, with some experts putting the number even higher.
See: There's US$35 trillion invested in sustainability, but US$25 trillion of that isn't doing much
Financial institutions have a big part to play, says Mario Knoepfel, head of sustainable investing advisory, Asia-Pacific at UBS Global Wealth Management, especially when it comes to educating clients about the importance of the SDGs and mobilising their assets toward achieving them.
The Covid-19 pandemic has brought about a sense of urgency and commitment to the sustainability agenda, Knoepfel tells The Edge Singapore. “As the global pandemic forced investors to reassess their portfolios, they are overwhelmingly choosing to add to sustainable investing strategies, reflecting a recognition of the linkages between sustainability issues, the economy and corporate financial performance.”
In essence, investors are beginning to realise that sustainable investing complements traditional financial analysis. It examines other material, yet obscure, factors — core values that may boost, safeguard or hinder a company’s growth in the future.
UBS Global Wealth Management's Knoepfel: Almost seven in 10 Singaporean high net worth investors are more interested in investing sustainably than they were before the pandemic
“Clients realise that sustainable investing can generate equal or superior returns, and are important elements of their business strategies that can impact bottom lines,” says Knoepfel.
“Additionally, sustainable investing helps clients ‘de-risk’ their businesses and meet mounting consumer demand for sustainable solutions.”
According to the Global Sustainable Investment Alliance, sustainable investments reached US$35 trillion at the beginning of last year. “Sustainable investing products have delivered competitive returns, unlocking significant asset growth, thereby debunking misperceptions of compromised returns,” adds Knoepfel.
See: Singapore well-positioned to lead Asia sustainability push: UBS's Kuek
Citing a survey by UBS, Knoepfel says 90% of wealthy investors globally agree that the pandemic has made them want to align their investments with their values.
“Moreover, almost seven in 10 Singaporean high net worth investors are more interested in investing sustainably than they were before the pandemic, higher than the global average of 59%.”
While much of the ESG conversation has happened in the West, Asia is making up for lost time by “going from zero to full speed very quickly”, says Rudden.
“I see Asia as the new global epicentre of ESG… It still trails Europe, and to a lesser extent the US, by absolute measures like AUM; but in relative terms, more is happening in Asia than in the rest of the world,” he asserts.
Asia is also particularly unique in its diversity, as expected of a region with 48 countries. That is being reflected in how it is going about ESG, says Rudden.
“In Japan, for example, it is still very corporate governance-centric with less emphasis on environmental and social [issues], though that is changing. In island or archipelago regions concerned with rising sea levels, environmental issues lead the way into ESG.”
Smartkarma’s Rudden: I see Asia as the new global epicentre of ESG… More is happening in Asia than in the rest of the world
Within the region, Southeast Asia is leading in ESG-mindedness, says Rudden. While some East Asian countries like Hong Kong and Japan have been active lately, Southeast Asian nations have been focused on SRI or ESG for much longer, he adds.
This is particularly so in Singapore, Malaysia and Indonesia, which form a “trifecta of sustainability leaders” in the region.
Rudden points to initiatives by these countries’ financial exchanges. “Stock exchanges in general are uniquely positioned at the critical intersection of capital, companies, governments, and NGOs. That puts them in a unique position to influence the sustainable or ESG investing agenda.”
European and US bourses were late to get involved, and thus gave up some of their sway, says Rudden, but Asian bourses got involved early, and thus are driving the agenda in significant ways.
SGX, for example, mandated an unpopular sustainability reporting requirement, tempered initially by a “comply or explain” rule.
With some prodding, companies are also getting into the groove of sustainability efforts, making “heartening” improvements, notes Singapore Exchange Regulation (SGX RegCo) and the Centre for Governance and at the National University of Singapore Business School in their Sustainability Reporting Review 2021, released in May.
Across the 566 SGX-listed issuers reviewed, the overall compliance score improved to 71.7 points this year from 60.6 points in 2019. Notably, 59.9% of issuers scored at least 70 points, double the 28.9% figure in the 2019 assessment.
At the end of last year, the SGX FIRST initiative was introduced. Unlike other ESG portals, SGX FIRST — which stands for Future in Reshaping Sustainability Together — has followed its launch with non-stop, substantive actions, says Rudden, such as the ESG-REIT Index Futures contract.
See: SGX first Asian exchange to commit 1.5°C-aligned emission reduction targets
It is no surprise, therefore, that half of international ESG bonds in Asia are listed on the SGX today.
More recently, SGX co-founded a carbon exchange in June with partners DBS, Standard Chartered and Temasek, named Climate Impact X (CIX). On the regulatory front, the Monetary Authority of Singapore (MAS) is advancing the sustainable and green finance agenda in numerous ways, adds Rudden.
“Aside from supporting and facilitating other organisations, MAS is ahead of the curve in green finance, notably regarding green, sustainable and social (GSS) bonds.”
MAS’s Sustainable Bond Grant Scheme (SBGS), for example, was expanded last November to include sustainability-linked bonds. First launched in 2017, the enhanced SBGS covers the post-issuance costs of engaging independent service providers to obtain external reviews or reports for bonds under the scheme. It remains open until May 31, 2023.
See: SGX joins Nasdaq to expand availability of green, social and sustainability bond data
Similarly, MAS’s Green and Sustainability-Linked Loan Grant Scheme (GSLS) came into effect on Jan 1 this year. The first of its kind in the world, MAS defrays costs incurred by banks and corporates when engaging independent service providers to validate the sustainability credentials of loans. The GSLS is valid till Dec 31, 2023.
In June, MAS published its inaugural sustainability report, defining its role in facilitating Asia’s transition to a green economy and embedding sustainability considerations across key roles.
PhillipCapital’s Beng says the move acknowledges threats, such as biodiversity loss, and supports countries, companies and investors that commit to climate action.
In preparation for the “greatest economic transformation since the industrial revolution”, MAS will reinforce policies like carbon pricing and tougher environmental and energy standards, he says.
“There is an urgent need to set more ambitious targets within the financial industry in the fight against climate change, biodiversity loss and social injustices,” says Beng. “We also need to continue to strengthen the process of ESG data acquisition, achieve transparency in verification and reporting and monitor commitments.”
With interest and fund flows at an all-time high, one challenge remains for the ESG sector: The global adoption of a unified reporting standard.
“Transparent measurement and disclosure of sustainability performance is now considered to be a fundamental part of effective business management, and essential for preserving trust in business as a force for good. Yet, the complexity surrounding sustainability disclosure has made it difficult to develop the comprehensive solution for corporate reporting that is urgently needed,” reads a statement from five international framework-setting institutions last September.
As the momentum for sustainable investing continues to grow, the need to filter out funds and investors that are built on greenwashing will continue to increase. It seems sustainability as a buzzword has preceded a common regulatory framework — one necessary to ensure its own sustainability.
The global pursuit of a common standard is encouraging, but could there be too many cooks in the kitchen?
The past decade has introduced the likes of the Carbon Disclosure Project (CDP) in 2010, the International Integrated Reporting Council (IIRC) approach in 2015, the UN Sustainable Development Goals (SDG) in 2016, the Task Force on Climate-related Financial Disclosures (TCFD) in 2017, last year’s Sustainability Accounting Standards Board (SASB) standards and this year’s Climate Disclosure Standards Board (CDSB), just to name a few.
Some, like chief sustainability officer Esther An of City Developments (CDL), have tried their hand at synthesising the ever-growing list of frameworks and standards. The real estate company began reporting its sustainability practices in 2008.
See: Sustainability reporting key to mobilise global capital, accelerate climate action: CDL
“It is a real challenge to design a ‘onesize-fits-all’ reporting standard that is applicable to corporations from diverse geographic locations, industries, market caps, business focus, cultures and more,” An tells The Edge Singapore.
However, it is highly possible for a company to customise a “harmonised framework”, says An, by blending various sustainability reporting standards as they are developed and brought to the fore.
CDL’s An: It is a real challenge to design a “onesize-fits-all” reporting standard that is applicable to corporations from diverse geographic locations, industries, market caps, business focus, cultures and more
Her late boss, CDL’s deputy chairman Kwek Leng Joo, understood the limitations faced by executives and auditors. In a feature on The Edge Singapore (Issue 544, Oct 8, 2012), Kwek said the green economy was still “in its infancy”.
“The majority of companies, investors and bosses here still perceive corporate social responsibility (CSR) as helping society, with no tangible benefit to their firms’ bottom lines,” Kwek added then.
So, what next?
Looking ahead, proponents of ESG investing are waiting on the Taskforce on Nature-related Financial Disclosures (TNFD), which is expected to launch its framework of environmental risks in 2023.
However, while the TNFD aims to build upon the success of the TCFD in assessing climate-related risks; on its own, it will only cover one-third of the ESG trio.
Instead of biding their time, they can start by taking stock of their current portfolio, says Joanne Lee, sustainable finance specialist at WWF International.
“Without understanding their current impact and footprints, investors can’t set targets to reduce negative impacts and increase positive impacts through their investment.”
See: Climate scientists reach 'unequivocal' consensus on human-made warming in landmark report
See also: Beware of risk from nature loss: WWF
A pioneering report by the World Wide Fund for Nature (WWF) in June identifies seven instruments to help portfolio managers assess the real-world impact of their financial portfolios.
“Where most ESG tools focus on the impacts that ESG-related issues have on financial performance, these tools take the opposite approach, and focus on the real-world impact that financial portfolios and investment decision-making have on biodiversity, the environment or delivery on the UN SDGs,” says Lee.
Currently, data for measuring biodiversity variables “range from good to non-existent”, says WWF, and disclosure mandates are highly limited in most cases.
As more forms of reporting are made mandatory by governments and bourses, assessing portfolios’ actual impact — and not just for their investment returns — could be a moment of reckoning for the sustainable investing sector, one that places the feel-good mantra of “doing well by doing good” under a stress test like never before.
Because while countless working groups can be formed and endless treatises can be written to dissect the three letters in ESG investing, the sector is still beholden to the financial industry it rests within.
Money talks, and in the absence of a reputable common standard, portfolios will still be measured by the numbers.
“The gist of it is that I view sustainable, socially responsible, ESG investing, or whatever you want to call it, as first and foremost, investing,” Rudden says. “My alpha-centric approach isn’t because I am a coldblooded capitalist, but rather because I view ESG-generated alpha as a prerequisite to sustainable impact.”
“Without positive financial performance, no company is sustainable. More importantly, whatever greater good that company is doing — whether it’s CSR initiatives or the positive impacts of its business, like that of a solar company — dies with it.”
Header photo: Bloomberg