I recently had the pleasure of hosting a panel discussion at the Arab Federation of Exchanges, Virtual Saudi Conference 2021. I was joined by four fantastic panellists:
- Elena Tedesco, Director, Co-Portfolio Manager Emerging Markets ESG Strategies at Federated Hermes
- Dr Mahmoud Mohieldin, Executive Director at the International Monetary Fund
- Stephan Pouyat, Global Head of Funds, ETF & Capital Markets Worldwide at Euroclear Group
- Sam Tripuraneni, Vice President and member of the Sustainable Investing team in EMEA at BlackRock
Together we tackled the broad question of how to integrate ESG into core investments. Specifically, we focused on ESG products and product building. Here are five key takeaways we discussed:
1) Differentiate between ESG integration and ESG products
ESG Integration is the consideration of ESG risks into the investment process. ESG risk is financial risk, and so the integration alongside traditional investment techniques can deliver better long-term risk adjusted performance. Ultimately, ESG integration is not about investment philosophy, it's about risk management. The monitoring of ESG risk is part of an investor’s fiduciary duty to their client. Monitoring specific ESG risks will vary between portfolio as materiality differs between various sectors, regions and at the company level.
ESG Products are ‘outcome’ focused. This is about investment philosophy and making sure you are generating a sustainable or socially focused outcome through your investments. The outcome is dependent on the product. I.e., you can be exclusionary, by sector or economic activity; you can benchmark, and select assets which exceed a benchmark such as carbon emissions; you can be aligned to a framework or regulation, such as the IIGCC net zero framework or the EU taxonomy; or you can specify real world impacts to address.
2) Enabling ‘transition’ is key
There are several investments approaches we can take to drive sustainability and social change, with product innovation around ESG being one of them. Yet, such innovation needs to go hand in hand with assisting sustainable transition within mainstream investments products. Economies have been built on the foundation of unsustainable infrastructure, and whilst we require a shift away from these business practices, we can not neglect the foundations on which our economies still rely. Investment to enable transition is critical and thus investment is required in financial infrastructure to provide more access to more opportunities with better alignment to standards and benchmarks. This needs to be guided by regulation and by better alignment of standard setters to avoid fragmentation.
3) Engagement is crucial
Engagement is a key element to enabling unsustainable economic activities to transition, but also for providing scope for pioneering ESG companies to continue to develop best practice. Thankfully, engagement on ESG issues is often readily received by senior corporate leaders as understanding of financial materiality links up with a growing respect for ESG issues in their own right. From the investor point of view, materiality changes from portfolio to portfolio and asset class to asset class, and as macro trends within our economies and societies shift the scope of materiality it is important to remain engaged at the company level to deliver long-term investment value. Rio ESG can help provide a data driven foundation for your engagement strategy.
4) Emerging markets must not be left behind
Emerging markets are often the most in need of ESG-focused initiatives, and of transitioning their economies towards lower ESG risk, and more sustainable and socially sound practices. ESG performance benchmarks are not equivalent between developing and developed markets, meaning that investors and standard setters must be cautious not to exclude emerging market economies from investment when creating new ESG products. For example, the EU Green Taxonomy outlines the net-zero pathway for economic activities against the EU’s 2050 carbon neutral commitment. It is specific to Europe regarding the current levels of carbon emissions by economic activity and thus the transition pathway specified by the taxonomy. Applying European emissions targets and transition pathways to emerging markets risks overlooking regional specific challenges, resources, and ambitions. Ultimately, without consideration, this approach could prove exclusionary and counterproductive to global sustainability efforts.
5) There is plenty more to do!
A lot of time and resources have been spent on developing climate investment products, frameworks, and legislation. This is obviously necessitated by the climate emergency, and great work has been done to move forward. Yet, there are many other components of E, S, and G that deserve attention, not least because of their importance as stand-along societal challenges, but also the opportunity to increase investment value through better understand and tracking of their materiality.
Have more questions about ESG investing or want to discuss how Rio can help you improve your ESG performance? Book a meeting with Dominic, Senior ESG Manager below.
