Sustainable Finance: Myths and realities

Myths (from the Greek “mythos”) are as old as the human memory can remember. Present in all domains of our lives, even in the fact-based world of finance, they rise and adapt to reality until, one day, they fall into oblivion. New fields come accompanied by beliefs that frequently help us to understand them, or to deny the changes they bring with them.

Alan Watts, famous British writer and speaker, once said: “A myth is an image in terms of which we try to make sense of the world.” How right he was! Myths like the Earth being flat or the centre of our solar system, that the sun is yellow or that Sahara is the biggest desert on the planet have seasoned the collective imagination of humanity for centuries. If we tell you that investors only care about financial matters, would that be a myth to you? 

Our contrasting points of view on the impact of human economic activities and our way of living on our planet has triggered a partisan-like divisive narrative.  To some, climate change is a myth; to others it is an inescapable matter on the global agenda. Whichever your current perspective, the common pressing factor is time, either because we may be having the last chance to save mother Earth or because regulators have defined rules and dates to comply with them. 

With sustainable finance becoming more and more pervasive, the need for debunking myths around it grows. Developing a green society and embracing a viable economy model that can cope with the limits of our planet no longer seem to be myths but keys to our survival.

With the COVID-19 pandemic spreading throughout the world, “sustainability” has taken the spotlight. Calls to favour investments following ESG criteria and the reporting stemming from them have increased. Indeed ESG (Environmental, Social and Governance) is challenging the still recent focus on only maximising short term returns.  

To some, businesses aren’t doing enough to embrace ESG criteria and governments are falling short when it comes to driving the matter. In the asset management industry, investors are pushing the boundaries of ESG implementation into core processes and investment decisions. But are ESGs only concerning the asset management industry? 

There are a few myths related to sustainable finance and ESGs that might raise havoc. In this blog article, we take advantage of the power of infographics to demystify some of these misconceptions that appear to be common. How good is your understanding of these two “little” notions?

Where do we stand with ESG?

To answer this question, we need to take a short trip to 2018, when the European Commission (EC) issued its Action Plan on “Financing Sustainable Growth”. According to our publication Sustainable Finance, a new era for asset managers, the Action Plan aims to:

  • Finance the transition to a more sustainable and inclusive growth by directing investment to sustainable activities;
  • Better manage financial risks stemming from climate change, resource depletion, environmental degradation and social issues;
  • Foster transparency and long-termism in financial decisions.

To fulfill these objectives, the EC identified ten measures including legislative changes that will impact the financial sector in Europe. Among these ten measures, there are three proposed regulations in the areas of taxonomy, disclosure and low carbon benchmarks, and amendments to existing Level 2 measures, like MiFID II, UCITS and AIFMD.

These measures will impact asset managers’ investment decisions and financial product distribution and how they incorporate ESG to their business operations and strategy. Asset managers have been asked to consider and measure both the effect of their products and services on sustainability matters as well as the impact of those matters on their products and services.

Be careful though. Some might believe that these measures concern the asset management industry in particular. Nevertheless, sustainable finance will influence, in one way or another, the vast majority of financial products (if not all) and retail and corporate saving and investing as well. 

In early 2020, the new EU Commission already reiterated the importance of financing the transition to a greener economy (“Green Deal Action Plan”).  In a recent consultation (April 2020) on the renewed sustainable finance strategy, the EU Commission stated that: “As the EU moves towards climate-neutrality and steps up the fight against environmental degradation, the financial and industrial sectors will have to undergo a large-scale transformation, requiring massive investment”. However, the EU commission acknowledges that “the financial system as a whole is not yet transitioning fast enough. Substantial progress still needs to be made to ensure that the financial sector genuinely supports businesses on their transition path towards sustainability, as well as further supporting businesses that are already sustainable […] Progress has already been made, but efforts need to be stepped up. Building on the achievements of the Action Plan on Financing Sustainable Growth, the current context requires a more comprehensive and ambitious strategy.”

What’s troubling investors in 2020?

According to the World Economic Forum Global  Risk Report 2020, environmental issues have taken the front stage. The severe social and economic consequences caused by unprecedented extreme weather in recent years has set off the world’s alarms. From storms and hurricanes to heal waves and wildfires threatening business operations and properties globally, the risks of climate change are undeniably impacting investors and redefining investment decisions criteria.

This is time for sustainable financial instruments innovation, therefore, the need to strengthen the government-financial sector collaboration to make it happen. 

Asset managers are very much aware of ESG criteria’s contribution to the performance growth of their investment portfolio. However, if asset managers engage more proactively with the companies they invest in, they can motivate them to perform better from an ESG standpoint. The successful implementation of ESGs in investment decisions is increasingly reflected in their market price while contributing to better ESG risk management. At the end of the day, that means a better risk return.

To a greater extent, businesses are required to understand and manage ESG risks and performance. ESG risks are related to the mitigation and adaptation of climate change impacts, environmental management practices, safety at the workplace, human rights, anti-bribery and corruption practices, and compliance to relevant laws and regulations.

But while asset managers are well into the green and sustainable journey, other industries in the financial sector such as banking seem less concerned with ESG. Voilà, one of the myths around ESG, that it primarily affects asset management. This couldn’t be further from the truth. The focus on climate risk is mostly driven by the millennial generation, who want to invest in a greener future, avoiding or vetoing organisations that don’t meet their growing demands on sustainability. Regulators around the world are also increasingly concerned about the fact that sustainability risks (including climate change, biodiversity loss, alterations to ecosystems, deterioration of social welfare and health) represent underestimated stability risks for the entire financial sector and are eager to have them better captured, monitored and reported.

According to Harvard’s Institutional Investor Survey 2020,  ESG risks and opportunities played a greater role for investors in 2020 than investing and engaging with companies (86%). Investors might push companies of all sectors to answer how they are managing and responding to these risks and opportunities. Boards and companies should also be ready to face investor scrutiny on how they approach and report on their exposure to ESG-related issues. 

Corporate responsibility is a growing expectation for investors who care, more and more, about how they can do good when investing. The current economic crisis caused by the COVID-19 pandemic will unavoidably twist the rules of the game. It will likely push – if not done already – many investors to reevaluate both short and long-term portfolio strategies, and companies to reevaluate their sustainability priorities. And what about the way the pandemic will affect ESG-related investments?

COVID-19 could shape ESG investing for years to come

The global COVID-19 pandemic is an unparalleled event, as you’re probably very much aware. The economic, financial and social impacts are already of vast proportions and it’s still unclear when “normality” will resume. 

Before the coronavirus hit and spread throughout the world, the growing interest in ESG investment was undeniable. The global pandemic hasn’t changed that. If anything, it probably gave a boost to the ESG “movement”please, allow us to use this euphemismfor it to emerge stronger and more influential than ever before. 

Humans behaviour paved the road to where we are now. The UNEP Frontiers 2016 Report Emerging Issues of Environmental Concern explains that around 60% of all infectious diseases in humans are zoonotic (diseases that can be transmitted from animals to people) as are 75% of all emerging infectious diseases. The dramatic reductions in natural ecosystems and biodiversity and increase of domestic animals, makes the transmission of pathogens that much easier.

So it comes with no surprise when we say the coronavirus crisis had its origin in biodiversity loss, with rapid urbanisation, deforestation and bushmeat markets is now a fact acknowledged by more than environmentalists. Articles like the Funds Europe, the Parliament Magazine, The Guardian, the New York Times are proof that the world is waking up to the magnitude of the problem. These issues might just prompt the change of emphasis from asset managers. Tackling environmental issues climbed higher on the to-do list of governments and companies alike. 

At the same time, COVID-19 strengthens the strategic importance of sustainable and impact investment in emerging markets. Countries in self-isolation, focused on dealing with sanitation issues and remote work challenges might struggle to address this health crisis effectively.

The steady performance of ESG funds during the COVID-19 caught the attention of conventional investors who might have dismissed sustainability as a crucial goal. According to this article, ESG funds in the US dropped an average of 12.2%, while others tumbled over 24%. While during the month of March the financial markets nosedived, ESG funds managed to stay afloat better than others.

From the corporate governance perspective, COVID-19 has increased investor attention to corporate ESG management, particularly when it comes to business operational and strategic resilience, employee health and safety and workforce policies. Responsible corporate governance is on the spotlight.

Sustainable finance: Myths and realities 

Let’s evoke what we stated in the first paragraph of this article: “new fields come accompanied by beliefs that frequently help us to understand them, or to deny the changes they bring with them”. Sustainable finance isn’t the exception. 

There’s room for a few myths to take hold, and with the speedy access we have to information, they can quickly become a reality. The infographic below compiles 11 myths and their corresponding truths.

What happens next for ESG and investment decisions?

As we previously mentioned, the ESG investment has only been growing for the past few years and it seems that it will keep doing so in the time to come. 

There is growing evidence that ESG factors and financial performance are linked. Consequently,  ESG integration in businesseseither when investing, reporting or measuring riskis a crucial approach that can lead to a better risk-returns spectrum on the long-term. 

One way or the other, no matter to which industry we belong, this is what the future will look like. Sustainable business leads to a sustainable society which leads to a greener future. 

The current global pandemic is a trigger that has opened the worlds’ eyes to the harsh reality that we all put in the back of our minds: we’re not only shattering our world, we’re riding a full speed on an unfinished road. How will we take to realise we need to hit the breaks?

What we think

Nathalie Dogniez, Partner at PwC Luxembourg
Nathalie Dogniez, Sustainable Finance Leader at PwC Luxembourg

Whether you like it or not, ESG and sustainable finance are here to stay – it is not a “hype” trend that will vanish in the aftermath of the COVID-19 crisis. First investors increasingly approach their investments through the lens of sustainability – and the past weeks have demonstrated the resilience of ESG investments. As the topic remains on the top priority of the EU, which has reiterated its ambitions to accelerate the transition to a more sustainable financial sector, even the most “ESG skeptics” will have no choice but to comply with the new requirements, starting early in 2021.

Download the our Sustainable Finance: Myths and realities infographic.pdf here! 

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