The 6 core principles for responsible investment
The responsible investment framework is an overarching structure that includes multiple points of focus, such as green, social, ethical, or sustainable investing. For example, the green label is aimed at assets that create positive impacts on the environment. The social label relates to the advancement of gender equality or social inclusion or to promote occupational health and safety performance. An ethical label can exclude investments into questionable industries (i.e., tobacco or weapons) or investments into institutions that harm human rights. And the sustainable label is usually linked to the U.N. Sustainable Development Goals (SDGs); it can have a strong focus on assessing the long-term possibilities that can be created or limited by an investment.
While there is value in understanding and promoting the different elements within responsible investment, ESG provides a robust framework that can be used to screen investments by applying criteria outlined across three key evaluation areas:
Environmental criteria comprise investments’ energy use, waste, pollution, and natural resource conservation. These criteria take into consideration the direct impacts created by investment, in addition to impacts created in its supply chain.
Social criteria evaluate issues such as LGBTQ+ equality, racial diversity impacts created by investment and community programming. Social criteria also take into consideration how the investment can indirectly contribute to social well-being.
Governance criteria evaluate the transparency and accuracy of the accounting methods of investments, as well as considerations on how to navigate conflicts of interest and other operational considerations.
How does responsible investment benefit investors and businesses?
As part of their efforts to achieve net-zero carbon and contribute to the SDGs, governments are increasingly incorporating ESG criteria into investment frameworks and regulations. In 2018, the European Commission adopted an action plan on financing sustainable growth—which has since then evolved into multiple agendas to stimulate responsible investment in the region—the EU taxonomy for sustainable activities, the EU green bond standard, the climate and ESG benchmarks, guidance for corporate disclosure of climate-related information, and sustainability-related disclosure in the financial services sector. At a country level, the United Kingdom, for example, published its Green Finance Strategy in 2019, and in the United States, the Securities and Exchange Commission (SEC) announced earlier this year an enforcement task force focused on climate and ESG issues.
Investors are becoming more aware of their role in promoting a more sustainable future, and thus being more diligent in their purchase and investment decisions.
They also recognize the strong links between long-term returns on investments and environmental protection, social stability, and appropriate governance, while also becoming increasingly aware of the importance of adequately pricing social and environmental impacts and risks. Mainstreaming ESG can ultimately allow businesses to create stronger relations with their stakeholders and to secure funding from investors.
The potential non-financial value created by responsible investment is obvious: climate mitigation, biodiversity conservation, gender equality, social inclusion, and job creation, to name a few. However, responsible investment can also translate into financial value creation through reduced risk in the short and long term, lower share price volatility, a more stable shareholder base, and excess returns, as studies suggest ESG drives better financial performance.
Ultimately, responsible investment is a framework that promotes enhanced accountability for the impacts created by investments. It invites investors to actively stimulate sustainability by incorporating ESG screening into investment decisions and gives them an opportunity to contribute towards a better future while potentially improving financial performance in the long term. The framework consequently encourages businesses and investees to keep pace with investor demand through increasingly embedding ESG criteria and also taking ownership of the impacts created by their activities.
What are the next steps for responsible investors?
Investors must be able to navigate the changing regulatory landscape and understand how it might affect their way of doing business. They must also be able to quantify the ESG risks associated with their existing portfolios and future investments and to identify investment opportunities and trends.Businesses, as well, must be prepared to disclose the ESG information required by investors to leverage the opportunities a sustainable transition is bringing.