The Rise of ESG Investing: The Importance, Benefits, and Challenges of Sustainable Investing

Source: The Fintech Times

In recent years, there has been a growing trend among investors to evaluate companies not just on their financial performance, but also on their environmental, social, and governance (ESG) practices. This trend, known as ESG investing, has been driven in part by increasing public awareness of issues like climate change, social justice, and inequality. ESG investing has the potential to drive positive change both within companies and across industries. By incentivising companies to prioritise sustainability and social responsibility, ESG investing can help to reduce risks and promote long-term financial stability. ESG considerations have become increasingly important in the investment world, with sustainable investment assets reaching $35.3 trillion in 2020, according to The Global Sustainable Investment Review 2020.

One of the main ways that ESG investing is changing the landscape of corporate law is through increased shareholder activism. As more investors prioritise ESG issues, they are increasingly using their shareholder power to push for change within companies. For example, a shareholder proposal calling on Amazon to report on the company's progress in reducing its environmental impact received 29.8% support at the company's 2020 annual meeting. This can take many forms, including filing shareholder resolutions, engaging in dialogue with company management, and voting on corporate governance issues.

This increased shareholder activism has also led to legal challenges for companies that fail to meet ESG standards. For example, in 2020, the French and German government introduced new legislation requiring companies to disclose their ESG risks and impacts. Germany has implemented a Supply Chain Due Diligence Act (SDDA) that requires companies with 3,000 employees or more to perform due diligence regarding their own business and direct suppliers. The French Due Diligence Obligation (DoV) is similar but applies to companies with at least 5,000 employees nationally or 10,000 globally. The SDDA also requires companies to take adequate measures to prevent or mitigate human rights and environmental risks, and it adopts a risk-based approach. The SDDA provides for regulatory fines of up to 2% of the annual global turnover in Germany, while the French DoV allows any "interested party" to seek an injunction to order a regulated company to comply with requirements. The article concludes that European Union level legislation for mandatory supply chain due diligence is underway. Failure to comply with these requirements can result in fines and other legal penalties. This highlights the importance of ESG issues for companies not just from a financial perspective, but also from a legal and regulatory standpoint.

Investors use a range of tools to assess companies' ESG performance, including ESG ratings, which consider factors such as carbon emissions, labour standards, and board composition. MSCI's ESG ratings, for example, are designed to be forward-looking, considering a company's exposure to ESG risks and opportunities.

Companies that perform well on ESG metrics may benefit from lower costs of capital, better access to capital, and higher valuations, according to academic research. However, the relationship between ESG and financial performance varies by industry and region.

Despite the potential benefits of ESG investing, there are also challenges and limitations to consider. One of the key challenges is the difficulty of measuring and comparing ESG performance across companies. While there are several ESG ratings and data providers, there is still no standardised methodology for evaluating companies' performance in these areas. This can make it difficult for investors to make informed decisions about which companies to invest in.

To address this challenge, some organisations are developing new ESG reporting frameworks and standards. For example, the Task Force on Climate-related Financial Disclosures (TCFD) has developed a framework for companies to report on their climate risks and opportunities. The TCFD has published its 2022 Status Report, assessing the progress made in climate-related financial disclosures over the past five years. The report shows that although there has been an increase in the number of companies disclosing in line with TCFD recommendations, only 43% have disclosed in line with at least five of the 11 recommended disclosures. The report also highlights steady growth in disclosures on an industry and regional basis, with European companies leading the way. The TCFD has gained support from over 3,900 organisations across 101 countries, with 92 of the 100 largest public companies supporting or reporting in line with TCFD recommendations. The Task Force will prepare another status report in October 2023. Such efforts to standardise ESG reporting can help investors to evaluate companies’ performance more effectively in these areas.

ESG investing is changing the landscape of corporate law by incentivising companies to prioritise sustainability and social responsibility, reducing risks, and promoting long-term financial stability. One of the ways that ESG investing is driving change is through increased shareholder activism. Shareholders are using their power to push for change within companies, including filing shareholder resolutions, engaging in dialogue with company management, and voting on corporate governance issues.

ESG investing has also led to legal challenges for companies that fail to meet ESG standards. For example, in 2020, the French government introduced new legislation requiring companies to disclose their ESG risks and impacts. Failure to comply with these requirements can result in fines and other legal penalties.

Despite the potential benefits of ESG investing, there are also challenges and limitations to consider, including the difficulty of measuring and comparing ESG performance across companies, which can make it difficult for investors to make informed decisions. Efforts to standardise ESG reporting, such as the Task Force on Climate-related Financial Disclosures (TCFD) framework, can help investors to evaluate companies’ performance more effectively in these areas.

Another challenge is the potential for "greenwashing" or other forms of ESG marketing that may not accurately reflect companies' true practices. To address this issue, some organisations are calling for increased transparency and disclosure around ESG practices, as well as greater accountability for companies that make false or misleading claims.

Despite these challenges, ESG investing is likely to continue to grow in importance in the coming years. As more investors prioritise sustainability and social responsibility, companies will be under increasing pressure to improve their ESG practices. This could lead to significant changes in the way that companies operate and could ultimately have a positive impact on both the economy and the environment.

ESG investing is an important trend that is likely to continue to grow in importance in the coming years. As investors continue to prioritise sustainability and social responsibility, companies will be under increasing pressure to improve their ESG practices. This could lead to significant changes in the way that companies operate, ultimately having a positive impact on both the economy and the environment. However, the challenges and limitations of ESG investing must also be considered, and efforts to address them are necessary to fully realise the potential benefits of sustainable investing.

In conclusion, ESG investing is an important trend that is changing the landscape of corporate law. As investors continue to prioritise sustainability and social responsibility, companies will be under increasing pressure to improve their ESG practices. This could lead to significant changes in the way that companies operate and could ultimately have a positive impact on both the economy and the environment. However, there are also challenges and limitations to consider, including the difficulty of measuring and comparing ESG performance across companies, and the potential for greenwashing and other forms of misleading marketing. By working to address these challenges, investors and companies can help to promote more sustainable and responsible business practices.

By

Haley Seow