Environmental, Social and Governance (ESG) investing has grown considerably and is fast becoming mainstream. Yet market participants across the board are missing the relevant, comparable ESG data they need to properly inform decisions, manage risks, measure outcomes, and align investments with sustainable, long-term value. OECD’s Greg Medcraft summarises the findings in the 2020 OECD Business and Finance Outlook.
The funds flowing into sustainable investment have grown steadily in recent years, with over USD 30 trillion of assets worldwide incorporating some level environmental, social and governance (ESG) consideration. This growth has been spurred by shifts in demand from across the finance ecosystem, driven both by the pursuit of traditional financial value, and by the pursuit for non-financial, values-driven outcomes.
From a value perspective, asset managers and institutional investors increasingly recognise that non‑financial ESG risks can have a material impact on risk-adjusted returns and long-term value. From a values perspective, we have seen the rise of ‘social investing’ as financial consumers become more attuned with how their savings are invested, with a growing share looking to avoid supporting activities that do not align with their values. More widely, the social license to operate has also moved, with an expectation from some governments and citizens that private finance helps meet global challenges like climate change adaptation and mitigation or delivering on the United Nations Sustainable Development Goals, which may mean reputational risk for investors and institutions that do not keep up.
At the same time, the COVID-19 pandemic has highlighted an urgent need to consider resilience in finance – not just in the financial system itself, but the role of capital and investors in making economic and social systems more dynamic and able to withstand external shocks. Beyond the pandemic, physical and transition risks associated with climate change, including for financial stability, are perhaps the most pressing challenges to resilience.
This year’s Outlook, with its focus on sustainable and resilient finance, comes at a time when ESG considerations are rapidly becoming a part of mainstream finance. And yet, as our analysis shows, there is little common understanding within the market – from retail consumers and asset managers to financial service providers, market regulators and other stakeholders – on what the goals of ESG investing are or should be.
For the vast majority of investors, incorporating ESG factors has the stated objective of enhancing management of material risks to improve long-term risk-adjusted returns. However, as the original research in this Outlook shows, in practice market participants often lack the tools they need, such as consistent data, comparable metrics, and transparent methodologies, to properly inform value-based decision-making through a sustainability risk lens. This is despite a proliferation of ratings, methodologies and metrics on ESG performance.
This lack of comparability of ESG metrics, ratings, and investing approaches makes it difficult for regulators, consumers and fiduciaries to draw the line between managing material ESG risks within their investment mandates, and pursuing ESG outcomes that might require a trade-off in financial performance. It makes it difficult for lenders to carry out appropriate due diligence on the activities they are financing. It makes it difficult to compare infrastructure projects across sustainability metrics. And it makes it difficult for those who are prepared to make a trade-off between returns and social outcomes to do so with the confidence that the outcomes they are investing in are actually being achieved.
The growth and development of ESG and other sustainable finance products is promising, and evolving regulatory frameworks and international principles are beginning to form a more solid foundation. But much more needs to be done for ESG practices to support market efficiency and integrity. We cannot rely on finance to deliver better environmental, social or governance outcomes if investors do not have the tools and information to price related risks and direct investments accordingly.
This Outlook is a call to action for governments and market participants to make ESG investing fairer, more transparent and more efficient. It provides a comprehensive map of fiduciary duties and the extent to which ESG can be incorporated into investment decisions under current legal frameworks, and the challenges in doing so. It sets out priorities for policymakers to help markets deliver the data needed to identify and manage material sustainability risks. It lays out existing areas for governments to drive better ESG approaches, for example as owners of companies and as infrastructure investors, or through existing international policy standards and guidelines.
Critically, this Outlook helps governments take stock of what markets can reasonably deliver in terms of ESG impact, where alignment is – and isn’t – between private and public objectives, what can be left to market forces and what must be taken up by public policy. This is particularly important where markets have difficulty connecting the management of short and medium-term risks with long-term material consequences, such as the eventual impacts of today’s carbon emissions. To this end, governments can usefully help business and investors to better price longer-term ESG risks by providing consistent and reliable forward guidance on the timing, character and extent of forthcoming reforms that will influence the viability of assets, to provide certainty and incentivise the necessary adjustments in investment patterns.
None of these efforts can happen in a vacuum; financial markets are inherently global, and so demand global solutions. Governments and regulators will need to work together internationally to pursue the priorities outlined in these pages and ensure a level playing field. Close engagement with the industry, including institutional investors and lenders, ratings and index providers, and international standard setters, will be critical. Together, we can drive positive change in financial markets towards better sustainability and resilience, and ensure finance meets the needs of investors, our economies and of society now and in the decades to come.