There Has To Be A Focus On Assessment And Reporting To Progress ESG

Despite the world being turned upside down by the pandemic, one upshot has been the business and investment community accelerating their adoption of ESG (environmental, social and governance) factors, as retail investors and consumers alike seek a more impactful return for their money. This is a welcome and much needed shift, but how we measure and, therefore, successfully achieve such a change needs more attention.

ESG investing has enjoyed a rapid ascent. In the nine months to September 2020, The Investment Association, which highlights responsible investment funds, saw net flows of £7.1bn,[1] a 275% rise over the same period the year before. The European sustainable fund market showed inflows rising 10% late last year to stand at £800bn,[2] and sustainable ETFs saw $19bn coming in as opposed to $8bn over the same period in the year prior.[3]

However, a multitude of different definitions of ‘ESG’ is holding back progress. How can we be sure such inflows are actually working to address the issues they seek to improve? ESG measurement methodologies and indexes such as the MSCI ESG Ratings, FTSE Russell ESG Ratings, Sustainalytics and RepRisks often skew towards larger firms that have more resources to self-report, and this leaves small and mid-cap firms at a disadvantage. More worryingly, investors looking for ESG credentials in their investments will be passing over this group of companies, which is especially unfortunate since these smaller and mid-sized firms tend to be the innovative, ambitious firms that will drive economic recovery and are in most need of funding support.

“A broader shift in culture is therefore needed to ensure the success of a company, not least with regards to its financial health.”

Not only is it vital therefore, to have a platform that caters to this group, but also one that is transparent, comparable, and easy to follow for investor and companies alike. In September, finnCap aimed to deliver this with a comprehensive ESG handbook and 15-point Scorecard. It measures factors such as water, waste and energy intensity, through to employee turnover rate, tax paying percentage and CEO pay as a multiple of UK median pay, as well as the percentage of women on boards. A survey of small and mid-cap fund managers we carried out showed just how needed such a toolkit was – the majority said they would use ESG factors to make portfolio decisions compared to a minority just three years ago.

FinnCap and London fintech WWG, both strongly aligned in their aims, then collaborated to integrate the scorecard into a digital sustainability reporting tool for SMEs that helps companies not just track these 15 components, but use them more broadly to then see how they measure up against the UN’s core sustainable development goals. This is an important step if we are to arrest environmental catastrophe and make good progress with social and governance concerns.

A platform that helps measure these factors is extremely helpful; but responsibility still lies with companies themselves. Using resources such as the reporting tool, companies need to make the effort to pivot towards more inclusive cultures, for example, and reverse the headlines that still break with alarming frequency over inequality.  Only a few weeks ago, it was announced that more than a third of FTSE 100 firms, for example, do not have at least one director from an ethnic minority.

A broader shift in culture is therefore needed to ensure the success of a company, not least with regards to its financial health. Research from PwC shows that if the UK mirrored the female employment rate to those of Sweden, GDP would swell an incredible 9%.[4] Meanwhile, failure to facilitate progress on the environmental side is leading to write-downs across fossil fuel dependant operations – known as stranded assets. The Energy Monitor puts global stranded assets in the energy industry at $1trn[5].

Activist investors are also creating an increasingly untenable situation for those who are not making strides, regardless of their standing on the economic ladder. HSBC, for example, is under pressure indirectly through pension funds invested in BlackRock – themselves an investment firm focused on sustainable portfolio management – pressuring the firm to demand HSBC slow down its fossil fuel funding.[6]

There is then, a broad consensus that each pillar of ESG needs to be addressed to achieve broader societal benefits and sustain forward looking, resilient business models. But multiple, complex definitions of ESG are hindering progress, potentially causing small and mid cap companies to lose out on funding. It is why sustainability reporting tools are so important, as is a renewed focus on the mid-market – the segment most likely to be at the heart of the UK’s economic recovery.

[1] https://www.ftadviser.com/investments/2020/11/05/esg-inflows-quadruple-in-2020/

[2] https://www.morningstar.co.uk/uk/news/206906/esg-funds-assets-hit-%C2%A3800-billion.aspx

[3] https://www.cnbc.com/2020/09/19/esg-sees-record-inflows-in-2020-top-issuer-talks-staying-power.html

[4] https://www.pwc.co.uk/services/economics/insights/women-in-work-index.html

[5] https://globalenergymonitor.org/wp-content/uploads/2021/02/Pipeline-Bubble-2021.pdf

[6] https://www.ft.com/content/a5d2969b-d198-4357-a061-095fcd7c932e