What is Environmental, Social and Governance investing?
ESG investing is the philosophy that investors should consider the impact that their investment decisions will have on the natural world and on society, as well as any financial gains that they might make.
What is ESG investing?
ESG investing means that investors consider environment, social and governance criteria alongside traditional financial factors. It represents a more holistic approach to investing that takes into account our impact on the natural world and society, as well as any potential financial gains.
Investors often refer to ESG investing interchangeably with other concepts such as ethical investing, socially responsible investing, green investing, sustainable investing and impact investing. All of these terms describe the idea that finance should support the broad long-term objectives of society rather than simply trying to make profits.
However, ESG investing is much broader. It offers both a statement of ambition for the world as it should be and provides objective and rigorous criteria for identifying investments that can help our journey towards these goals.
'$35.3 trillion in assets across five of the world’s major markets'
By 2020, approximately $35.3 trillion in assets across five of the world’s major markets – Australia & New Zealand, Canada, Europe, Japan and the United States – were invested in accordance with ESG principles, according to data from the Global Sustainability Investment Alliance. This represented a 15% increase over the previous two years.
What does ESG stand for?
ESG stands for “Environmental, Social and Governance”. These three areas sum up the key ways in which we can act to protect the natural world, ensure social progress and improve global governance standards. Each area covers a wide range of ESG factors on which the non-financial performance of a company or an investment project can be measured.
- Environmental factors refer to the impact that a company has on the natural environment. This includes issues such as pollution (carbon emissions, toxic chemicals and metals, packaging and other waste), the use of natural resources (water, land, trees) and the consequences for biodiversity (the variety of life on Earth), as well as attempts to minimise our environmental footprint (energy efficiency, sustainable farming, green buildings).
- Social factors are those that affect people – whether employees, customers or society at large. They cover matters such as health and safety for employees or labour and welfare standards for other workers employed in the company’s wider supply chain, as well as product safety for consumers or privacy and data security for its users. Increasingly, investors also want to see that companies are actively committed to overcoming inequality and discrimination, both through fair treatment of employees and ensuring that no social groups are excluded from access to critical products and services.
- Governance factors relate to whether a company manages its business in a responsible way. This takes into account the ethical requirements of being a good corporate citizen, such as anti-corruption policies and tax transparency, as well as traditional corporate governances concerns such as managing conflicts of interest, board diversity and independence, quality of financial disclosures and whether minority shareholders are treated fairly by controlling shareholders.
A brief history of ESG
The ideas that underpin ESG investing go back a long way. Leading thinkers and economists have warned of the dangers of environmental damage or the social ills caused by certain products or business practices for many centuries, including the theologian John Wesley (The Use of Money, 1744) and the economist Adam Smith (The Wealth of Nations, 1776).
The first investment vehicle that explicitly identified itself as a “responsible” investor was the US Pioneer Fund, which launched in 1928. This avoided investing in sectors such as alcohol and tobacco. Public discussion about the damage that unchecked economic growth was causing through pollution and environmental degradation began to grow substantially in the 1960s, 1970s and 1980s.
In particular, the foundation of the interdisciplinary Club of Rome network in 1968 and its inaugural report (The Limits to Growth, 1972) attracted considerable public attention. This was a key step in changing the paradigm of how our economic activities interact with the natural world.
By the 1990s, the idea that companies, organisations and investors should be taking account of environmental and social costs became more widely recognised, with the arrival of the first “socially responsible” stock index, the Domini 400 Social index, and the “triple bottom line” (also known as TBL and 3BL) or “people, planet, profits” accounting framework, under which organisations began to take account of their social and environmental performance in addition to their financial results.
ESG: a new abbreviation for a new century
The formal representation of these issues under the ESG definition began in 2004, when the abbreviation was first used in a report by the United Nations (UN) Environment Programme Finance Initiative (Who Cares Wins, 2004).
Just two years later, the UN launched its “Principles for Responsible Investment”, a framework for incorporating ESG issues into investment. This began with 63 signatories overseeing $6.5 trillion in assets, and had grown to more than 3,000 signatories with more than $100 trillion in assets by 2020.
Multinational support for ESG objectives then took a major step forward in 2015, when the 193 countries of the UN General Assembly adopted the UN Sustainable Development Goals (SDGs). These set out 17 interlinked global goals intended to set the world on a path towards a more sustainable and equal future.
The SDGs cover a wide range of ESG factors, including the environment (such as tackling climate change and reducing waste), social progress (such as education, health and gender equality) and robust governance (such as developing justice and strong institutions).
Achieving the SDGs could potentially create opportunities worth an estimated $12 trillion by 2030, according to the Business and Sustainable Development Commission.
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