ESG rating: a practical tool for giving meaning to investments

2022 01 20 herpe

Sustainable finance is taking off all over the world, and nowhere more so than in Monaco, at the behest of H.S.H. Prince Albert II, who authorised the creation of the first sustainable investment fund, CFM Environnement Développement Durable, back in 2003.

It’s a vibrant field, which can be tricky to navigate today, given the multitude of trends and varying management styles. Here are a few examples: socially responsible investing (SRI) involves systematic consideration of environmental, social and governance (ESG) criteria, in addition to purely financial criteria, when making investment decisions (share or bond purchases, etc.). Other concepts and tools can also be part of sustainable finance, including extra-financial rating, Best in Class, impact funds, thematic funds that invest in water, sustainable food or energy transition issues, etc.
There has been rapid development in the distribution of SRI funds at the global level, with around €2 trillion invested through 3,167 funds as at the end of June 2021 (Source: Quantalys).
The pandemic has not slowed this trend: during the first half of 2021, SRI funds raised €119 billion in Europe, compared with €90 billion raised by non-SRI funds.

However, criticisms of greenwashing are emerging.

What does this really mean? The Scientific Beta Chair at Edhec Business School warns that there is a risk of greenwashing with some ESG index funds and emphasises that within so-called “climate” stock indices, the climate data “represent at best 12% of the factors that determine the weighting of shares in a portfolio.” Unusually for this sector, which is drowning in regulatory requirements, those working in the industry are leading the charge in calling for common standards. Brussels has been working on the issue for several years, and the European Commission recently unveiled new regulations that will address this area, with the Sustainable Finance Disclosure Regulation (SFDR).
 The SFDR creates three classes of investment with different levels of sustainability: “Article 8” funds promote extra-financial features, while the more committed “Article 9” funds target the Sustainable Development Goals (SDGs). “Article 6” funds, on the other hand, do not promote environmental, social or good governance criteria.

Regardless of their classification, all investment funds must now analyse the impact of ESG risks on the companies in which they invest, as well as the impact those companies have on society and the environment. Will this be sufficient to help save our planet by limiting global warming to 1.5 degrees by 2050? Can finance alone save the planet through the issue of green bonds and other ESG funds? Too much focus on sustainable finance could lead the public authorities to absolve themselves of responsibility and perhaps delay some of their action in relation to the financial industry. The example of coal-fired power stations is illuminating here: all banks stopped owning and financing these power stations, but this divestment ended up benefiting cheaper buyers/lenders who are not subject to the SRI rules. The State is the only actor that could intervene to close these coal-fired power stations, but at very high social and political cost...

In the face of these criticisms and limits on the impact of sustainable finance, we can still see shoots of hope.

Over the last 18 months, thematic management has become increasingly “sustainable” within the ESG field, via active management. In 2020, such management accounted for 40% of investment fundraising. Thematic management offers the advantage of a specific approach, by selecting the potential beneficiaries of an attractive economic trend (drinking water requirements, etc.). This is appealing to private clients in particular. The advent of the United Nations’ 17 SDGs also made it possible to establish a framework for action for thematic managers, to help them respond to the increasingly urgent climate emergency. Another development which will undoubtedly have an impact is the ESG rating of client investment portfolios (three grades are given: E, S and G). Available in our bank from late 2021, these ratings will facilitate improved dialogue with our clients on this issue and will help clients to strengthen the meaning that they are seeking to give to their investments.

As the dreadful health crisis that we have recently been through begins to recede, there is cause for optimism. After all, if we have succeeded in saving millions of lives through global solidarity and public – private cooperation to create a new type of vaccine in record time, isn’t that a wonderful message of hope that can mobilise all political and economic stakeholders to save the planet by the end of the century?


Photo credit: @NEWDAYSTUDIO