Why is ESG so important?
ESG investing is the consideration of environmental, social and governance (ESG) factors, alongside financial factors, in the investment decision-making process. Traditional finance focuses on company’s relationship with bondholders and shareholders. Nowadays the focus is more broad. A company should not only benefit the investors, but the society as a whole. It should create social returns, or benefits to the whole society. While everyone agrees that companies should benefit the society, the question is how to measure the return and performance? Unlike net profits, dividend yields and interest payments, social return is less tangible and harder to quantify.
Social conscious investors are setting investment criteria on Environmental, Social and Governance (ESG) standards to screen out companies that are doing good and avoid undesirable companies that are harming the society. Following the ESG criteria to select companies for investment, the investors and fund managers can align their portfolios with their mandates, hope to make a positive impact to our environment and encourage more companies to be responsible to the public. Investors ensure their capitals support their missions to fight for a healthy planet, democracy, human equality, data transparency and professional integrity.
What are ESG practices?
ESG criteria consists of Environmental stewardship, Social relationship and Corporate governance. Those criteria are used to address the prevailing problems in climate change, pollution, sustainable natural resources, labour and human rights, diversity inclusion and political spending.
Environmental criteria evaluate companies in areas such as climate change, greenhouse gas emission, water usage, waste management and forestation. The criteria encourage companies to protect our planet by reducing waste, pollution, conserving natural resources and treating animals properly. Lessening water usage, performing contaminants detection of expelled liquid, reducing energy consumption, decreasing carbon emission and limiting waste production are some of the ways to protect our earth. With those disclosures made by the company, investors can evaluate any environmental risk the company might face. Alternatively, investors can identify which companies are pursuing the same interest in conserving natural resources, fighting climate change and deforestation.
Social criteria evaluate companies in areas such as working conditions, support of minorities, health and safety and diversity. Social criteria concern how the company treats its employees, suppliers, customers and local community. Are the employees treated equally without age discrimination, gender discrimination or racism? Does the company provide a safe and healthy working area for employees? Does the company work with suppliers that hold the same values? Has the company coerced any small supplier to act in its favor? Does the company give back to the society and encourage its employees to participate in voluntary work? If the employees are treated fairly and feel happy with their employer, production efficiency will be maintained at a high level and labour turnover rate will remain low. Moreover, when a company gains a good reputation from the market and the community, not only the company but also its employees will be respected by the public.
Governance criteria evaluate companies in areas such as executive pay, bribery and corruption, political donations as well as board diversity and structures. Governance criteria encourage the corporate to follow the ethical practice by paying reasonable but not enormous compensation to senior executives, executing strict internal rules to avoid bogus reports, controlling operational expenses, providing accurate and transparent accounting methods, recruiting board committees from different backgrounds and protecting shareholder rights. By releasing more company’s information and accurate data to the market, the company creates valuable goodwill and widens source of capital raising, improving its financial performance consequently.
Who will be concerned about ESG?
Climate Change / Carbon emissions, Sustainable natural resources / Agriculture and Management risk / Board issues are now the top priorities for fund managers and institutional investors. Many investment managers consider managing risk as their top motivation for pursuing ESG incorporation. Many of them aim to fulfill their ESG mandates and create social or environmental impact as their top motivations.
Furthermore, ESG criteria can help investors avoid companies which might face financial risk or legal charges due to their environmental practices, social behaviors, scandals or fraudulent accounting. ESG investment strategy looks for companies with good management in resources utilization, waste control, business relationship, income equality, human rights and diversity inclusion. ESG investment strategy also prefers companies with discipline to conduct financial integrity, practice prudent procedure, provide ESG data, embrace corporate transparency, comply with law and ally with suppliers who also respect ESG criteria too. The most common alliances are sourcing from renewable energy suppliers, electricity car producers and recycle manufacturers.
As investors are increasingly applying ESG criteria to evaluate companies for their potential investment, many financial institutions, especially the mutual funds and brokerage firms offer ESG products, ESG Exchange Traded Funds (ETF) and ESG research reports.
The Bloomberg Head of ESG and Thematic Investing EMEA Adeline Diab and BI Chief Equity Strategist Gina Martin Adams stated that the global ESG assets will exceed USD 53 trillion by 2025, with 15% annual growth per year . Europe accounts for half of the global ESG assets and the U.S. has the biggest expansion, 40%, in the past two years. The next growth momentum will come from Asia, particularly Japan.
ESG ETFs experienced a cumulative inflow of USD 135 billion in the past years. So the total market value of ESG ETF is expected to reach USD 1 trillion and ESG Debt to USD 11 trillion globally in the coming five years. ESG Debts, which present as a new asset class recently, have been gaining significant demand from institutional investors. They made up 50% of total green bonds sales within the last four years.
How can companies benefit from ESG practices?
The recent rapid expansion of invested capital in ESG investment leads many corporations to study the ESG criteria seriously. The business managers and executives realize that having a strong ESG positioning can safeguard the company and create long term success.
Practicing ESG standards will not lower the company’s return. In fact, the companies will gain higher equity returns. According to the research from McKinsey & Company, ESG practice improves the company performance in 5 important ways . First of all, reducing costs. Secondly, increasing employee productivity. Thirdly, minimizing regulatory and legal interventions. Fourth, facilitating top-line growth. Lastly, optimizing investment and capital expenditures.
Strong ESG positioning companies will consume less energy and resources, which will reduce cost and expenses. They will also keep good relationships with their suppliers in order to obtain cheaper supply. Therefore, their cash flows are better and often more stable. Providing a safe and friendly working environment to keep their employees working happily, the company can increase productivity as well as operation efficiency. As employees become more productive, sales revenue will also rise. When a company generates higher profit and compensates its employees fairly, employees feel satisfied and motivated. They will stay in the company longer and work harder, so quality employees are retained. Hiring costs and training costs can be reduced. A virtuous circle can attract more talents to join the company.
Supporting sustainability for the society and donating resources to the community will gain respect from the government and the public. Strong ESG positioning will attract more new social conscious customers and business alliances. The company can access more resources through a bigger network. In addition, the company can avoid any penalty, tariff, enforcement actions or legal charge by regulatory authorities. The company can also earn government support or subsidies with ESG projects, as the government sponsors environmental and social causes.
Corporate’s credibility is built on prudent accounting practice, professional discipline, stakeholder trusts and engagement activities with the community. The company, which has been demonstrating high governance standards, should be respected by investors, bankers, shareholders, peers and the public. Together with their better cash flow, bigger revenue, smaller downside risk and less legal risk, the company will receive a higher credit rating in creditor assessment, thereby obtain a lower borrowing rate and attract more investors to buy their shares for long term investment. A rising stock price will also attract large investment funds to invest. Market capitalization will increase accordingly. As a result, corporate performance, investment return and ESG issues are inextricably linked. Strong ESG positioning correlates with higher equity performance.
How can we benefit from ESG practices?
Environmental, Social and Governance are intertwined. When a company improves our environmental issues, people will benefit and feel pleasant with the company. When the company provides safety working environment and adopts non-discrimination policies, employees will benefit and be pleased with the company. When the company imposes a high level of corporate governance and reduces risk, investors will benefit and regulators will be satisfied too. ESG strategic investment can enhance investment returns by allocating capital to companies with more sustainable opportunities. ESG compliant companies gain higher market valuation from professional investors.
ACH’s ESG mission
Our vision is to protect our planet, maintain a harmonious living environment and sustain our ecosystem continuously. Now, we encourage listed companies and investors to comply with ESG standards.
ACH facilitates clients to adopt agile and creative methods for value creation and reaching a new horizon of success. In the new era for ESG, ACH will launch a series of ESG services and solutions to clients, including ESG Index, ESG calculator, and other ESG solutions to meet the new ESG standards for ESG reportings.
What is ACH-Deepsite ESG index?
ACH-Deepsite ESG index is an equity index which includes a number of listed companies with top performance in ESG ranking. Their data of waste reduction, amount of energy saving, voluntary activities, amount of donation, employee turnover, female to male staff ratio, gender equality, data transparency, auditor turnover ratio, senior management turnover ratio, number of lawsuit and legal charges, etc., will be abstracted from their annual reports and used for ESG performance evaluation. Companies, which have an ESG score in the top quantile, are included in the ESG index. As a result, the ESG index encourages listed companies to release more data on their ESG practices. More data transparency allows investors better access to data on sustainable characteristics to give investors more confidence. Furthermore, the ESG index will offer a clarity that empowers investors to incorporate sustainability into their portfolio. The ESG index will offer a breadth of choices to the socially responsible companies. So investors need not to search stocks from the whole market but focus on the stocks included in the index. Investors will have more time on adequate valuation assessment on companies.
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