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How important is environmental, social and governance (ESG) to sustainable finance?

20 December, 2019Ouida Taaffe

Ouida Taaffe looks at the increased importance of environmental, social and governance (ESG) impacts and how that’s reflected in policy and regulation.

Compass on paperThe responsibilities of investment managers used to be relatively clear-cut. Their fiduciary duty required them to act in the best interest of a fund’s beneficiaries. And, as far as many beneficiaries were concerned, that boiled down to one number – the return on equity.

Now, things have changed. Many beneficiaries want to know that their money is having positive environmental, social and governance (ESG) impacts. And policy and regulation is starting to demand that ESG is taken into consideration.

The October 2019 report, Fiduciary Duty in the 21st Century from the UNEP Finance Initiative and the PRI points out there are over 730 hard and soft-law policy revisions globally.

These cover around 500 policy instruments, designed to promote or require the consideration of “long-term value drivers” including ESG.

That means investors who do not consider ESG “are increasingly likely to be subject to legal challenge” for failing in their fiduciary duty.

Sustainable finance is lower risk

The importance of ESG will not be news to the people who attended the WCBI conference run by The London Institute of Banking & Finance in September.

Steve Barnett, Head of Financial Centre Development at Abu Dhabi Global Market (ADGM), talked about how impact investing is a focus for ADGM, which works with The London Institute of Banking & Finance on a sustainable finance programme. 

Barnett highlighted that “through the cycle, sustainable finance should be lower risk than non-sustainable”.

This is one of the reasons why sustainable investing does not necessarily mean leaving returns on the table.

He also pointed out some of the challenges that sustainable finance faces, in particular:

  • properly defining what sustainable finance is “without actually constraining it”
  • and getting to a point where the higher transaction costs of being certifiably green do not place a drag on such assets.

Given that Abu Dhabi is, as Barnett pointed out, “still very clearly a hydrocarbon-based economy”, it might seem counterintuitive for it to aim to be at the forefront of sustainable finance.

However, it may be that its own experience will give it some particularly useful insights – both into what works and how best to fund it that the rest of the world can draw on.

Projects Barnett cited included:

  • cleaning the water used in the production of hydrocarbons to the level where it can be used to water plants in the desert
  • and making the first test flights using plant-based fuel.

“We want to create a network effect,” Barnett said, “to be understood as a place where people can come to get financing for good projects”.

What is sustainable investing?

What, however, is a “good project” in the sense of being sustainable?

The EU put out a Taxonomy Technical Report in June 2019 to try to define what sustainable investing is.

The aim is to help investors channel the approximately €270bn that will have to be invested annually in EU sustainability, to meet the UN’s sustainable energy and climate goals by 2030.

Barnett said that the Abu Dhabi Ministry for Climate Change is developing a UAE-wide taxonomy that will be in line with international standards, such as the green bond and loan principles and the climate bonds initiative standards, and added that one of countries that Abu Dhabi is working with on the taxonomy is China.

“We see a real passion for this,” said Barnett of ADGM’s sustainability work.

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