The way we do business is changing. It is no longer good enough to simply generate a profit and healthy returns for investors. Asset managers are now being mandated by asset owners to broaden their scope, specifically by integrating ESG into their investment approaches with a view of not just risk management but of positive impact delivery.
Each part of the financial system has a role to play in this, and no single financial instrument is likely to solve the challenges we face. In the private markets, while equity affords the greatest level of direct influence – and with it, the ability to engage, drive best practice risk management and positive impact – debt is typically the majority of the financing deployed, and therefore has the most market exposure.
Debt instruments need to be more strategic and planned prior to investment, incorporating desired positive impacts into lender agreements upfront. Listed markets command the lion’s share of managed capital, offering the opportunity to shift economies at scale.
“No single financial instrument is likely to solve the challenges we face”
To achieve this, we need to rethink the benchmarks used, lowering the risk for portfolio managers, and consider going beyond just an engagement model with portfolio companies.
Demand for green bonds has rocketed. The EU issued its inaugural €12 billion green bond in October, making Brussels the world’s biggest sustainable debt investor. Data from Morningstar shows that investors poured $54 billion into ESG bond funds in the first five months of this year, compared with almost $68 billion for all of 2020.
Green light for green finance
We are seeing the same trend occur in the private equity market. According to research from PwC, the value of ESG private assets could hit between €775.7 billion and €1.2 trillion by 2025, up from €253 billion in 2020. This is indicative of a seismic ‘rebooting’ of the industry, as we see a flood of new private market funds strictly focused on ESG investing.
How can investment professionals effectively exploit these instruments for the purpose of furthering global sustainability? They will need to become more sustainability literate and make decisions on sustainability information in the same way they currently use technical, legal and tax information to decide on investments. Thorough due diligence and robust ESG data management are key to warding off accusations of greenwashing. The investment industry must act with integrity, given the relative lack of regulated transparency in place around ESG markets, or we run the risk of leaving a broken world to future generations.
The private sector cannot wait for regulators to formulate the perfect roadmap; there is no perfect roadmap. We need to forge ahead, working with governments and regulators to create the green and circular economies so crucially needed. It won’t be long before ESG and sustainability reporting become as important as financial data and reporting. Recent collaboration developments with global ESG standards setters and the IFRS taking a lead on standardized ESG reporting are driving this agenda forward rapidly.
Younger generations’ demand is there, investor demand is there, political will is growing – and there is no other option.
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