The UN’s 17 Sustainable Development Goals provide a common language that investors can readily understand. Alastair O’Dell reports
The 17 United Nations Sustainable Development Goals (SDGs), set in 2015 in response to urgent global environmental, political and economic challenges, are described by the UN as a “shared blueprint for peace and prosperity for people and the planet, now and in the future”. They cover a broad range of issues that affect everyone and are flexible enough to apply to new and evolving situations, such as the pandemic and its impact on poverty, health, and wellbeing.
They can also provide context for environmental, social, and governance (ESG) considerations for financial advisers or wealth managers and a practical framework for client engagement.
For Anthony Cheung, Chartered MCSI, managing director of ESG, Polymer Capital Management, and trustee and convenor of green finance at environmental charity Friends of the Earth (FoE) in Hong Kong, “the SDGs represent the core pillars” of responsible investing.
And for Patrick Thomas, Chartered MCSI, head of ESG portfolio management at Canaccord Genuity in Scotland, the SDGs have reframed the firm’s analysis of ESG “from risk mitigation – protecting the value of assets from risks such as tightening regulation or the possibility of assets becoming stranded – to targeted thematic growth opportunities”.
But it is worth remembering that the original purpose of the SDGs was to create universal targets. “They weren’t designed to be investment goals,” says Michael Strachan, founder and chief executive officer at wealth manager IAM Advisory. “They’ve been co-opted to bring focus to this incredibly complex area.”
A common language
While SDGs are an important way for investors to communicate the positive impacts they’re trying to generate, there are ongoing challenges around how to measure and assign values, says Kate Capocci, Chartered MCSI, associate director and ESG investment lead at Tilney Smith & Williamson. “But it’s useful to have a common language to frame conversations and look at investments. Even if someone isn’t a sustainable investment expert, they tend to know about SDGs.”
Every company has its own method of breaking down revenue streams into SDG targets, says Kate. “But even then – and this is a huge issue – how do you measure the impact? There are lots of different approaches and datasets, but nothing that I would have full confidence in using.”
There are similar inconsistency issues with ESG reporting. While fund managers have proprietary ESG frameworks, each must ultimately rely on company disclosures. Likewise, advisers must rely on fund managers. The financial services sector needs a coherent way to deliver a complex agglomeration of data with adequate oversight (see our Review article that outlines the challenges and developments in responsible investment reporting).
The non-profit World Benchmarking Alliance (WBA) is developing benchmarks and methodologies that measure and compare corporate performance on SDGs. Recent developments have included the Digital Inclusion Benchmark, which, according to its site, measures and ranks “the world’s most influential 150 technology companies on their responsibility to advance a more inclusive digital society”, covering the themes of access, skills, use, and innovation. And the 2022 Financial System Benchmark will “assess 400 leading financial institutions (asset owners, asset managers, banks, insurers) on their readiness to address global sustainability transitions and their contribution to the 2030 Agenda for Sustainable Development".
Anthony, who has collaborated with the WBA since 2019, says the WBA methodology enables investors to meaningfully engage, even with the giant oil and gas companies. “We talk about it with substance, knowledge, and insights, thanks to the benchmarks developed by the WBA.”
SDGs impacting global financial regulation
The SDGs are also entering financial regulation. In the UK, the Chancellor announced in a speech at the 26th Conference of the Parties (COP26), held in Glasgow from 31 October to 12 November 2021, that all listed companies will need to set annually assessed net-zero transition plans and that the UK would become the world’s first net-zero aligned financial centre (Goal 13 – climate action).
COP26 also saw the completion of the technical negotiations in the Paris Agreement rulebook, which fixes the transparency and reporting requirements for all parties to track progress against their emission reduction targets, according to an EU Commission press release.
The EU Sustainable Finance Disclosure Regulation (SFDR), in force since 10 March 2021, sets mandatory disclosure requirements of EU financial market participants. In recognition that many UK firms are subject to SFDR, the FCA is exploring how products already classified under SFDR can map against a UK framework. “It is fair to say that the SFDR regulations definitely act as a catalyst of the change and development of the global regulatory landscape,” says Anthony, who notes that regulators in Hong Kong and Singapore are “very aware” of the need for developments.
The Hong Kong Securities and Futures Commission (SFC) made two important steps in sustainable finance regulation in 2021. The first was the tightening of disclosure requirements for any fund that claims to be green or focuses on ESG. It has adopted a comply-or-explain model and accepts disclosures made to the EU.
The second area of progress, introduced in August 2021, requires all asset managers in Hong Kong to report their management and disclosure of climate-related risk, according to FAQs published by the SFC. Large asset managers with more than US$1bn assets under management start complying with the requirements when their transitionary period ends in August 2022, while all other managers have until November 2022 to comply. Large asset managers will be required to provide enhanced disclosures from November 2022.
According to the UN Conference on Trade and Development World Investment Report 2021, private investment in SDGs was hampered by the pandemic – by 67% for water and sanitation (Goal 6) and 54% for both infrastructure and health (Goals 3, 7, 9, 11) – but the UN expects momentum to resume and the investment gap to narrow as the global economy continues its recovery.
Patrick says that almost all SDGs are relevant for investment but, rather than singling out specific SDGs, he says what is most important is to make sure the process is concentrated on achieving the targeted outcome. This is to avoid the “spurious connections” he has seen some wealth managers make to some of the SDG goals, which are “clearly an after the fact marketing exercise unrelated to the actual reason they made the investment”.
In response, clients are asking for a clear process in using the SDGs as an investment framework, he adds. He says the traditional top-down geographical approach will not work because of the sectoral biases of each country, explaining that strategies that target a specific SDG are not compatible with an approach that predetermines a geographical split between countries.
For example, he says, if the target is no poverty (Goal 1), it makes the most sense to “scour the world” looking for the most impactful investments irrespective of the country they are based in. “Doing this properly means targeting smaller companies outside the UK with very limited sector diversification. This means greater tracking error and increased volatility. It is important to make sure the fund selection process is even more rigorous, and the portfolio construction is more thoughtful,” says Patrick.
Direct versus indirect investment
For clients who wish to focus on directly investible SDGs with measurable impacts, there are many options in affordable and clean energy, and gender equality (Goal 5) has a proxy in female board-level participation.
A great idea in energy, for example, is hydrogen’s potential to decarbonise many sectors of the global economy and to offer profitable opportunities. It can be blended into natural gas to reduce its emissions and ultimately replace it, as is planned in the Intermountain Power Project in Delta, Utah. Hydrogen can also be used to power zero-emission buses – 20 entered the London UK fleet in July 2021 and the project involves many private companies, including bus manufacturer Wrightbus, Danish engineering firm Nel Hydrogen and industrial gas supplier Air Liquide.
For no poverty, investing could take many forms, but measuring the impact of a specific action on a countrywide basis is complicated. Perhaps the main determinant of poverty reduction is economic growth, so investments weighed to emerging and frontier markets are likely to reduce poverty.
Returns on investment
Asset managers and advisers must primarily focus on investment returns, unless there is an explicit mandate from the investor. “You appreciate very quickly when it’s virtually unattainable from an investment perspective,” says Michael Strachan, referring to SDGs such as no poverty that would require the creation of livelihoods for billions of people.
Anthony says he has a “very different way of looking at impact investing” compared to other investment managers. “I see it as investing in positive change in SDGs. I encourage my portfolio managers and analysts to identify companies through which we would be able to drive positive change for two to three SDGs, in the business or in the countries they operate. ”
Michael adds: “The debate must go beyond SDGs, to almost distancing yourself from the ethical aspect and looking at the opportunistic aspect. I’m convinced it is possible to pursue a diversified set of SDGs and make substantial incremental returns.” This is backed up by a November 2021 report by fintech and corporate services firm Broadridge, ESG and sustainable investment outlook, which finds that assets in dedicated ESG funds could grow from US$8tn in 2021 to US$30tn by 2030.
Exclusions vs engagement
It is easy for advisories to exclude fund managers that do not subscribe to basic ESG standards. UN Principles for Responsible Investment (PRI), with nearly 5,000 signatories with combined assets under management (AUM) of US$121tn (according to the PRI 2021 annual report), and Climate Action 100+ (AUM of US$60tn) provide public lists. Many advisories also set higher in-house standards.
Fund managers could exclude assets, but may achieve more by investing in carbon-intensive companies – there are over 5,200 companies that have joined the UN Race to Zero campaign as reported at COP26 – and encouraging them to transition. Divestment would only result in another investor taking ownership of a stake, with an unknowable perspective on decarbonisation. “Stewardship is a core part of our values,” says Anthony. “We see ourselves as the trustees of our clients’ capital, so not only do we want to enhance our returns, but also the non-financial impacts.”
Michael adds: “The point is not merely to make oneself look good – it is to improve the situation. I’m convinced this offers a much bigger financial opportunity.” With this in mind, wealth manager Brewin Dolphin is one of several firms to join stewardship groups, such as the Net Zero Asset Managers (NZAM) initiative, that aim to influence the strategies of the companies they invest in. NZAM has 220 signatories and combined AUM of US$57tn.
McKinsey & Co research published in February 2020 suggests that others agree that they should be looking beyond pure profit. Its report on The ESG Premium finds that C-suite leaders and investment professionals would be willing to pay a 10% median premium to acquire a company with a positive ESG record over one with a negative record.
Social and governance
The governance aspect of ESG (Goal 16 – peace, justice and strong institutions) has always been an essential part of analysis and this has only increased since the financial crisis. “We saw huge movements especially in the UK towards assessing how companies are governed,” says Kate. “Without good G, the E and S really don’t follow.”
But governance failures continue to occur. Among the most high-profile cases in recent years were the Volkswagen emissions test scandal in 2015 and the Facebook–Cambridge Analytica misuse of data scandal in 2018.
There is also a governance threat from the power of social media to expose bad practices and damage reputations. “The perfect example at the moment is Facebook/Meta, which is struggling to entice talented employees who see the brand as toxic,” says Patrick.
Ethics of SDGs
To gauge the ethics of investing in a particular area, Yichen Shi, chair professor and vice director general of the International Institute of Green Finance at the Central University of Finance and Economics (CUFE) in China, suggests looking at the whole picture through the application of ‘life cycle assessment’. For example, electric vehicles do not produce harmful emissions and may reduce society’s reliance on fossil fuels, but they also require special batteries that are manufactured using materials such as lithium and cobalt.
According to a March 2019 report by Amnesty International, “serious human rights violations” have been “linked to the extraction of the minerals used in lithium-ion batteries”.
An investor’s due diligence in the above example would take into consideration the production process of electric vehicle batteries, any applicable human rights issues, plus the “use and recycling process of electric vehicles”, says Yichen.
Investors new to responsible finance may gravitate to ESG ratings, but these require a degree of interpretation. Yichen concedes they have some use but stresses the real work must be done by an investor to ascertain if an investment meets their own standards of responsibility.Governance can be closely related to social considerations, such as management decision-making relating to its supply chain. “You just have to look at what’s happened to Boohoo,” says Michael, referring to the UK online fast fashion brand that faced severe criticism for the working conditions in its supply chain. Boohoo allegedly encouraged competition among factories in its clothing products supply chain in Leicester that necessitated sub-minimum wage payments, resulting in it being brought before the parliamentary Environmental Audit Committee in 2018.
Social factors can affect a company’s financial performance over the short and long term, according to research by S&P Global, What is the S in ESG? For example, workforce problems can manifest in labour strike and consumer boycotts. Covid-19 has also highlighted the treatment of workers throughout global supply chains. “[As a society] we’ve reassessed who are key workers and how they should be remunerated and treated. We also saw how access to healthcare was relevant to the wider problem – healthcare inequality impacts everyone in a global pandemic,” says Kate.
Looking to the future
The world remains extremely far from achieving all the SDGs, but pursuing one SDG too forcefully may have negative implications for another. “You cannot insist on perfection in everything,” says Michael.
While investors need to be mindful of potential conflicts between SDGs, they also need to consider which, if any, of them should be prioritised. Education is key, says Jack Whittaker, Chartered MCSI and associate investment manager at Brewin Dolphin, “to improve the level of knowledge around sustainable investments and increase the opportunities available for people to invest at a range of price points and capital values”.
In a few years, we are going to see a systemic shift in the way that we invest money, says Kate. “It isn’t just about shareholders, but inclusive of all stakeholders. As someone helping investors navigate through this early stage, I am also excited for where we’re going to be in a few years.”
The full article was originally published in the March 2022 edition of The Review.
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