Changi Airport in Singapore, where the government proposes giving grants to companies to help them prepare climate risk disclosures. Photo / Changi Airport Group
OPINION
Incorporating an environmental, social and governance (ESG) lens when considering investments or building a portfolio has rapidly grown in popularity.
But in recent months, it seems the tide is turning.
As ESG investment solutions have proliferated, confusion around labelling and scepticism on quality has grown. The agenda has become politicised and polarising with a focus from regulators worldwide.
We are not surprised.
ESG encompasses a broad set of issues, from a company’s carbon profile, to how it looks after its employees and supply chain.
Corruption prevention, responsible tax management and how a company is governed also fall within the spectrum. And much more.
The challenge is that when you start to look into the detail, ESG becomes complex and nuanced. Everyone has different expectations on outcomes.
In the United States, 10 state attorneys general are using the law to stop a Securities and Exchange Commission climate risk disclosure requirement.
In stark contrast, the Singapore government proposes giving grants to companies to help them prepare climate risk disclosures.
And in early March the European Parliament voted 467-65 to approve a series of rules aimed at protecting consumers from greenwashing, or misleading environmental claims by companies, including requiring companies to submit product marketing claims such as “biodegradable” or “less polluting” for verification before being allowed to use them.
New Zealand’s largest 200 companies and institutions are well under way in preparing their first mandatory climate disclosures under the Aotearoa New Zealand Climate Standards.
Regardless of divergence between various administrations and political entities, it’s clear the transition away from fossil fuels is well under way.
Corporate and government commitments to build more renewable energy and decarbonise economies continue to accelerate worldwide, while in New Zealand the pipeline of renewable energy generation projects expands.
Navigating the transition to a low-carbon economy became increasingly complicated in recent years amid intensifying geopolitical tensions and higher energy prices.
Supply chain pressures, elevated interest rates and input costs, and muted economic growth have added to the challenge for companies to stay strong on their sustainability commitments.
We recognise the pathway can be windy and parts of the economy move at different speeds.
In New Zealand, there are some interesting dynamics at play causing companies to keep sustainability commitments front of mind.
Regulators, consumers, and our large global wholesale customers such as Tesco and Nestle are driving change throughout their circles of influence. More and more companies are assessing potential ESG risks in their supply chains.
Risks can arise from the impact of severe weather events to modern slavery practices by suppliers. And consumers expect the brands they love and buy to produce their products and services in a responsible way.
From an investment perspective, it is not easy to build accurate judgments on how these types of vulnerabilities or the opportunity for managing them well may impact a company, and over what timeframe.
ESG factors are not often visible in audited financial accounts. When it comes to getting a real sense of the true impact of this swath of factors, we turn more to art than science.
Two years ago, we introduced our annual Carbon and ESG (C&ESG) Ratings to assess how New Zealand-listed companies were preparing for a low-carbon, more sustainability-oriented future.
We use this information to better appraise companies and build confidence in the potential of their long-term success.
The ratings are a measure of a company’s competitive positioning on C&ESG, supplement a screen for quality and help identify areas of risk beyond traditional financial analysis that may warrant further investigation.
Following positive feedback from the market, including institutional and private investors, we now frequently track the C&ESG performance of NZ-listed companies.
Increasingly, there is a body of evidence suggesting a company that manages its ESG risks and opportunities well is rewarded with a lower cost of equity.
With this in mind, the New Zealand equities team at Forsyth Barr have moved to incorporate our C&ESG ratings into our cost of equity calculations. Companies with high C&ESG ratings benefit from a reduction in their cost of equity.
In contrast, companies with lower scores receive an increase. This not only helps us to quantify C&ESG issues, it sends a strong signal to companies of how important this agenda is to us as investors.
We have implemented this at a time of heightened focus on sustainability-related disclosures throughout the world, including in New Zealand.
Greenwashing has the attention of regulators. We welcome this attention. The scrutiny is much needed, healthy, and a sign the market is maturing.
While it may seem there is a proliferation of global reporting standards relating to sustainability disclosures, it is a much-needed consolidation that will, in time, lead to more-robust, comparable and credible C&ESG data from companies globally.
Perhaps then we can transition our judgments to be driven more by science than art.
Katie Beith is head of ESG at Forsyth Barr, and Aaron Ibbotson (CFA) is director- senior analyst equities.
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