CFA ESG - key concepts
Nationally determined contributions (NDCs) are at the heart of the Paris agreement and fall in the
25-30% range of GHG emissions relative to 2005 by 2030
As (in public companies at least) it is not possible for investors to negotiate pay directly with management, shareholders need to rely on
remuneration committees to do so effectively on their behalf, and need to have confidence that the non-executive directors on those committees will do this well and with shareholder interests in mind.
Italy has
single tier structure with a single executive director and an independent chair.
PRI defines ESG integration as
"The systematic and explicit inclusion of material ESG factors into investment analysis and investment decisions."
Analysing environmental risks
A. carbon footprinting and other carbon metrics; B. natural capital approach; and C. climate scenario analysis.
it is possible to organise exclusions across four basic categories:
1. universal; 2. conduct-related; 3. faith-based; and 4. idiosyncratic exclusions.
The longer-term equity rewards usually measure performance over at least three years and are typically paid out in shares which must be held for a further period.
(currently the expected minimum overall period, including the performance period and lock-up thereafter, is five or more years). Performance for these schemes is usually measured by broad brush financial measures, usually a combination of total shareholder return (TSR) and earnings per share (EPS).
Approaches to integrating ESG The endgame for ESG integration at the portfolio level is the combination of top-down analytics and underlying ESG analysis to produce a more complete picture of ESG exposure and risk at the portfolio construction and management levels. PM should embed ESG considerations into:
- At the highest level, asset allocation decisions - Portfolio exposure to non-financial factors - Risk management measures - Performance attribution
Main players in the overlay market (voting advice and direct engagement)
- BMO - Federated Hermes - Robeco - Sustainalytics
Approaches towards decomposing performance attribution
- Brinson attribution - Risk factor attribution
3 recommendations of Cadbury report
- CEO and Chairman separate - Boards should have 3 non exec directors, two of whom should have no financial or personal ties to executives - Each board should have audit committee composed of non exec directors.
on the PM level, ESG integration should be considered in light of two different investment strategies
- Discretionary ESG investment strategies fundamental portfolio approach to complement bottom up strategies - Quantitative investment strategies rules based approaches
CFA INSTITUTE PROPOSED ESG PRODUCT FEATURES (6)
- ESG integration - ESG-related exclusions - Best-in-class - ESG-related thematic focus - Impact objective - Proxy voting, engagement and stewardship
At a company or project level, investors looking to identify and measure a company's environmental impact or materiality would need to analyse both quantitative and qualitative environmental factors in order to make an informed evaluation of the environmental risks embedded within on:
- Energy consumption - Water utilization - Waste utilization
the UK listing regime, class tests are applied if:
- If a transaction affects more than 5% of any of a company's assets, profits, value or capital, there must be additional disclosures (Class 2 transactions); or - if affects more than 25% of any of them then there must be a shareholder vote to approve the deal, based on detailed justifications (Class 1 transactions).
The EU Action Plan on Financing Sustainable Growth, agreed in 2019, requires the following
- Mandatory disclosure of policies in relation to ESG risk (consistent with the PRI's fiduciary duty recommendations) for all firms and financial products. - Comply or explain disclosure of the principal adverse impacts of the investment on sustainability factors (mandatory for firms with more than 500 staff) at firm and product level. - Enhanced disclosure obligations for firms promoting specific environmental or social objectives
Strategic asset allocation models
- Mean Variance Optimization o Produces the minimum standard deviation for the maximum level of expected return o Black Itterman global asset allocation model is a MVO and one of the most promising approaches - Factor Risk Allocation - Total portfolio analysis - Dynamic asset allocation - Liability driven asset allocation o Seems to find the most efficient asset class mix driven by a funds liabilities - Regime switching models
Broadly speaking the PRI recognizes three main approaches for screening
- Negative screeningAvoidance of worst performers: sectors, regions, issuers, business activities and practices, products and services, even security types such as certain commodities - Positive Screening - Norms based screening applies existing normative frameworks in order to screen against issuers against internationally recognized minimum standards of business practice. Screening applies globally recognized frameworks like - UN Global Compact - UN Human Rights Declaration - ILOs declaration of fundamental principles and rights at work - Kyoto protocol - OECD guidelines for multinational enterprises
Under Dodd Frank ...
- a resolution to consider exec. remuneration "say on pay" must be put to shareholders every 3 years. though shareholders also must be offered a vote of they want to have a say more often. most investors favor this to be the case on an annual basis
Financial risk in the traditional sense is generally expressed as a number. This number could assume many different forms:
- a variance; - volatility; or - value-at-risk (VAR).
Outsourcing is done by almost all investors in the area of voting, where proxy advisers are hired to provide:
- a voting platform and the pipework; and - advice on how to vote.
investors can vote on
- accepting the report and accounts - board appointments - appointment of auditor and perhaps their fees - executive remuneration
in almost every market, investors will be faced to annually with voting decisions on at least the following:
- accepting the report and the accounts - board appointments - the appointment of the auditors perhaps their fee - executive remuneration
Governance - types of issues
- audit practices - board independence and expertise - company strategy success likelihood - dual class share structures - executive pay - related party transactions - shareholder rights - transparency and accounatbility
Engagement can encompass the following issues that affect long term value
- capital structure - corporate governance - operational performance and delivery - risk management - pay - strategy
Environmental megatrends (4)
- climate change and transition risks - mass migration - water scarcity -Pollution and loss and/or degradation of natural resources and ecosystem services
EU Taxonomy Regulation The EU Taxonomy Regulation, published on 22 June 2020, established a framework that states conditions for an economic activity to be considered environmentally sustainable. These include
- contributing substantially to at least one of the environmental objectives; - 'doing no significant harm' to any of the other environmental objectives; and - complying with minimum social and governance safeguards.
regulations generally involve three themes
- corporate disclosure - stewardship (most codes are voluntary except Europe) - asset owners (typically pension funds)
The ICGN's Global Governance Principles set out an unusually complete investor perspective on independence criteria; These suggest that there will be questions about the independence of an individual who:
- had been an executive at the company, a subsidiary or an adviser to the company, and there was not an appropriate gap between their employment and joining the board; - receives, or has received, incentive pay from the company, or receives fees additional to directors' fees; - has close family ties with any of the company's advisers, directors or senior management; - holds cross-directorships or has significant links with other directors through involvement in other companies or bodies; - is a significant shareholder in the company, or is an officer of, or otherwise associated with a significant shareholder, or is a nominee or formal representative of a shareholder or the state; and - has been a director of the company for a long enough period that independence may have become compromised.
quantitative investing can be known as 'systematic investing'. It can include strategies such as:
- high-frequency trading; - use of algorithms based on news or factors and statistical arbitrage; - trend-following; - risk parity; or - use of beta strategies.
The European Parliament and the Council established that for an economic activity to be taxonomy-aligned, the activity should be carried out
- in alignment with the OECD Guidelines for Multinational Enterprises and - UN Guiding Principles on Business and Human Rights, - including the International Labour Organization's ('ILO') declaration on Fundamental Rights and Principles at Work, the eight ILO core conventions and - the International Bill of Human Rights. - Where applicable, more stringent requirements in EU law still apply.
audit and remuneration committees will be populated solely by
- independent non-executive directors while - such directors should form a majority of the nominations committee
Five factor risk model explains how certain risk premia are able to explain the probability distribution of investment returns (Farma and French) risk premia are differential between market returns and a risk free rate (difference between high and low valued companies)
- investment risk - market risk - size risk - profitability risk - value risk
Role of portfolio managers is to weigh security specific convictions against
- macro and micro economic data - portfolio financial and non financial exposure - sensitivity to potential shocks
Brunel Management Accord factors of concern
- persistent failure to adhere to Brunel management process - a change in investment style or investments that do not fit in the expected style - lack of understanding of reasons for any underperformance or reluctance to learn lessons from mistakes - failure to follow investment restrictions - organizational instability or the loss of key personnel
Brunel Management Accord (5) : list of issues that give rise to concerns
- persistent failure to brunels investment principles - change in investment style - lack of understanding of reasons for underperformance - failure to follow investment restrictions - organizational instability or loss of key personnel
EU Paris-Aligned Benchmarks (EU PABs), which must:
- reduce carbon emissions intensity by at least 50% in their starting year; - have a four-to-one ratio of 'green' to 'brown' investments relative to the investable universe; and - not invest in fossil fuels.
EU Climate Transition Benchmarks (EU CTBs), which
- require a 30% intensity reduction in starting year and - at least an equal 'green' to 'brown' ratio, - but permit fossil fuel investments as part of a transition process.
How to address coverage gaps
- rescale scoreable portion - apply Bayesian inference to the coverage ratio
The International Corporate Governance Network's (ICGN) Model Mandate Initiative: Model contract terms between asset owners and managers provides a helpful framework and proposes best practices for ESG-aware investment mandates around:
- the monitoring and use of ESG factors; - the integration of ESG factors into investment decision-making; - adherence to good practice around stewardship; - voting and reporting requirements.
ESG factors can impact credit ratings and affect spreads, leading to short term changes in value. Investors should prioritize engagement based on:
- the size of holdings in the portfolio - lower credit quality issuers - Key themes that are material - Issuers with low ESG scores
broad exclusion implications
- will likely produce high active share and tracking error
McKinsey suggests that there are two fundamental questions that asset owners need to ask in developing their ESG investment philosophy
1. . Are ESG factors more important for risk management or value creation? 2. What ESG factors are material?
In the USA, private sector retirement plans are subject to the provisions of the Employee Retirement Income Security Act (ERISA). The Act sets standards for fiduciaries of defined benefit and defined contribution plans based on the principle of a prudent person standard. Under ERISA, plan sponsors and other fiduciaries generally must:
1. Act solely in the interest of the plan participants and beneficiaries. 2. Invest with the care, skill and diligence of a prudent person with knowledge of such matters. 3. Diversify plan investments to minimise the risk of large losses. Plan sponsors that breach any of these fiduciary duties may be held personally liable.
UN Global Compact Principles
1. Businesses should support and respect the protection of internationally proclaimed human rights; and 2. make sure that they are not complicit in human rights abuses. 3: Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining; 4: the elimination of all forms of forced and compulsory labour; 5: the effective abolition of child labour; and 6: the elimination of discrimination in respect of employment and occupation Principle 7: Businesses should support a precautionary approach to environmental challenges; 8: undertake initiatives to promote greater environmental responsibility; and 9: encourage the development and diffusion of environmentally friendly technologies. 10: Businesses should work against corruption in all its forms, including extortion and bribery.
The Kyoto Protocol was adopted in 1997 and became effective in 2005. It was the first international convention to set targets for emissions of the main GHGs, namely:
1. CO2 ; 2. methane (CH4 ); 3. nitrous oxide (N2 O); 4. hydrofluorocarbons (HFCs); 5. perfluorocarbons (PFCs); 6. sulphur hexafluoride (SF6 ); 7. nitrogen trifluoride (NF3 ).
Environmental megatrends with social impact
1. Climate change and transition risk 2. Water scarcity 3. Mass migration (150-200 m migrants by 2050) 4.Pollution and loss and/or degradation of natural resources and ecosystem services
US corporate governance is a combination of
1. Common sense corporate governance principles - focus mostly on the inner workings of corporate governance, board effectiveness, and accountability, and also alignment through pay 2. ISG corporate governance principles - relationship with US companies and their shareholders
Potential bias in ratings ESG ratings in the credit area may suffer bias as we observe in other asset classes. There are three key types of bias typically encountered.
1. Company size bias 2. Geographical bias 3. Industry and sector bias
SUMMARY OF MAJOR ESG SERVICE PROVIDERS Products
1. Data 2. Ratings. 3. Screening 4. Voting advisory 5. Benchmark 6. Controversies
Six categories of CFA ESG Disclosure Standards
1. ESG INTEGRATION 2. ESG RELATED EXCLUSIONS 3. BEST-IN CLASS 4. ESG RELATED THEMATIC FOCUS 5 IMPACT OBJECTIVE 6. PROXY VOTING, ENGAGEMENT AND STEWARDSHIP
The Institutional Investors Group on Climate Change (IIGCC) published a practical investor guide, in which to approach climate-related scenario analysis. The guide sets out two objectives of undertaking scenario analysis:
1. Financial impact: the use of scenario analysis enables the assessment and pricing of climate-related risks and opportunities. 2. Alignment: aligning the portfolio(s) with a 2°C (3.6°F) or lower future. This is typically driven by a set of investment beliefs
PRI has outlined a sequence of six steps when investors implement screening as an investment approach (IPI ARM)
1. Identify client priorities 2. Publicize clear screening criteria 3. Introduce oversight: investors should establish an internal control or compliance function that - oversees screening- conducts reviews- Considers any changes in screening criteria 4. Adapt investment process 5 Review portfolio implications 6. Monitoring,reporting and audit
According to a 2016 PRI report on how asset owners can drive responsible investment, investment mandates should require investment managers to:
1. Implement the asset owner's investment beliefs and relevant investment policies 2. integrate ESG issues into their: - investment research; - analysis; - decision-making processes. 3. Invest in a manner consistent with the asset owner's time horizons, understanding the key risks that must be managed to achieve the asset owner's portfolio goal 4. Implement effective stewardship processes, including: » engagement with companies and issuers on ESG issues; and » for listed equities, voting all shareholdings.
Minimum requirement for PRI implementation
1. Investment policy that overs the firm responsible investment approach, covering >50% of AUMs 2. Internal or external staff is responsible for implementing responsible investment policy 3. Senior level commitment and accountability mechanisms for responsible investment implementation
Strategic Asset allocation models
1. Mean-variance optimisation (MVO) 2. Factor risk allocation 3. Total Portfolio analysis 4. Dynamic asset allocation 5. Liability driven asset allocation 6. Regime switching models
17 SDGs
1. No poverty 2. Zero hunger 3. good health and well being 4. quality education 5. gender equality 6. clean water and sanitation 7. affordable and clean energy 8. decent work and economic growth 9. industry, innovation, infrastructure 10. reduced inequalities 11. sustainable cities and communities 12. responsible consumption and production 13. climate action 14. life below wter 15 life on land 16. piece and justice and strong institutions 17. partnership for the goals
DEVELOPING CLIENT-RELEVANT ESG-AWARE INVESTMENT MANDATES (6) includes:
1. RFP Process 2. Investment Integration 3. Engagement and Voting 4. Outsourcing 5. Collective Action 6. Assessing the quality of engagement and voting
ICGN Model Mandate requests two areas of disclosure that are ESG-specific:
1. The manager's assessment of ESG risks that are embedded in the portfolio. 2. A detailed disclosure of stewardship engagement and voting activity.
The ICGN Model Mandate requests two areas of disclosure that are ESG-specific:
1. The manager's assessment of ESG risks that are embedded in the portfolio. This should include both what these risks are, and what the manager has done to identify, monitor and manage them 2. A detailed disclosure of stewardship engagement and voting activity.
Principles for Responsible Investment Established by UNEP FI and UN Global Compact now applied by more than half of the world's institutional investors. Provides support in four areas:
1. Tools and reports on best practices 2. collaborative engagement platform 3. PRI reviews and analyses and responds to investment related policies and consultations. 4. PRI Academy develops aggregates and disseminates academic studies on responsible investment related themes.
The PRI recommends that investors consider eight potential mechanisms to act as engaged owners in infrastructure
1. Use ESG assessments undertaken during due diligence to prioritise attention to ESG considerations and potential for improving profitability, efficiency and risk management. 2. Include material ESG risks and opportunities identified during due diligence into the post-acquisition plan of each asset or project company and integrate this into asset management activities. 3. Engage with, and encourage, the management of the business to act on the identified ESG risks and opportunities using the mechanisms available. 4. Define and communicate the expectations of ESG operations and maintenance performance to the infrastructure business managers. 5. Ensure ESG factors identified as material during due diligence are explicitly woven into asset-level policies. 6. Advocate a governance framework that clearly articulates who has responsibility for ESG and sustainability. 7. Set performance targets for preserving or improving environmental and social impact, including regular reports to the board and investors. 8. Where possible, make ESG information and expertise available to the asset or project company to help it develop capacity.
6 UN PRI Principles regarding ESG
1. We will incorporate ESG into investment analysis and decision making processes 2. We will be active owners and incorporate ESG into our ownership policies and practices 3. We will seek appropriate disclosure on ESG issues by the entities in which we invest 4. We will promote acceptance of the principles within the investment community 5. We will work together to enhance our effectiveness in implementing the principles 6. We will each report on our activities and progress towards implementing the principles
The PRI developed six principles, which are voluntary, but provide overarching guidance on actions members can take to incorporating ESG issues into investment practice. The six principles are:
1. We will incorporate ESG issues into investment analysis and decision-making processes. 2. We will be active owners and incorporate ESG issues into our ownership policies and practices. 3. We will seek appropriate disclosure on ESG issues by the entities in which we invest. 4. We will promote acceptance and implementation of the principles within the investment industry. 5. We will work together to enhance our effectiveness in implementing the principles. 6. We will each report on our activities and progress towards implementing the principles
Engagement and Voting: There are two crucial bases of assessment for any asset owner:
1. Who does the stewardship work: specifically, is it outsourced, delivered by a specialist stewardship team or is it the portfolio managers (or how do these individuals successfully work together)? 2. The closely connected issue of: how significant are the resources assigned to stewardship?
3 types of product liability
1. businesses being found liable to consumers when a court finds design flaws; 2. manufacturing defects; or 3. a failure to warn consumers of a possible danger
Four pillars of the green loan principle
1. clear green use of loan proceeds 2. sustainability objectives have been clearly communicated to members and evaluated 3. Loan proceeds are strictly managed through project accounts 4. Detailed and strict reporting is mandated
6 Environmental objectives EU taxonomy
1. climate change mitigation 2. climate change adaption 3. sustainable use and protection of water and marine resources 4. transition to circular economy 5. Pollution prevention and control 6. Protection and restoration of biodiversity and ecosystem
Having identified which social factors are relevant for a particular company, analysts will assess the way the company manages the risks and opportunities associated with these social factors, compared to its peers. This includes looking at:
1. corporate strategy; 2. policies in place; 3. processes and measures implemented; 4. performance indicators; and 5. public disclosure.
Bonds differ by (8)
1. credit quality; 2. duration; 3. payment schedules; 4. embedded options; 5. seniority; 6. currencies; 7. collateral; and 8. time horizon.
Circular economy
1. design out waste and pollution; 2. keep products and materials in use; and 3. regenerate natural systems
OECD guidelines for MNEs (9)
1. employment and industrial relations 2. human rights 3. environment 4. information disclosure 5. combating bribery 6. consumer interests 7. science and technology 8. competition 9. taxation
Labour rights (ILO) 7
1. freedom of association and protection of the rights to organize 2. right to organize and collective bargaining 3. forced labor and abolition of forced labor 4. minimum age 5. worst form of child labor 6. equal remuneration 7. discrimination (employment and occupation)
Social Megatrends (9)
1. globalization 2. automation and AI 3. inequality and wealth creation 4. digital disruption, social media and access to electronic devices 5. changes to work, leisure time and education 6. changes to individual rights and responsibilities and family structures 7. changing demographics, including health and longevity 8. urbanization 9. religion
Corporate Human Rights Benchmark (open benchmark - 6)
1. governance and policy commitments 2. embedding respect and human rights due diligence 3. remedies and grievance mechanisms 4. performance - company human rights practices 5. performance - responses to serious allegations 6. transparency
PLSA disclosure on ESG integration asks for separate disclosure on both:
1. identification of ESG risk; and 2. the management and monitoring of ESG risks and opportunities, with suggested possible disclosures in respect of each.
PLSA published a disclosure guide for public equities setting out some pared down expectations for manager-reporting on both ESG integration and stewardship activities. The disclosure on ESG integration asks for separate disclosure on both:
1. identification of ESG risk; and 2. the management and monitoring of ESG risks and opportunities, with suggested possible disclosures in respect of each.
McKinsey: Investment operations enablers
1. tools and processes (neg, pos screening, pro active engagement) 2. resources and organization 3. performance management 4. public reporting
two principles that are not always present in stewardship codes
1. investors to manage their conflicts of interest reg. stewardship matters 2. escalation of stewardship activity to include a willingness to act collectively with other institutional investors
It is very useful to quantify the potential impact of social factor scenarios and include these in the ratio analysis and financial modelling of the investment. Some scenarios that can be included in the ratio analysis are:
1. occupational health and safety issues (accident and fatalities), which can result in huge fines and liabilities; 2. human capital management issues, which can lead to greater operating costs if new employees need to be trained due to high employee turnover; 3. supply chain issues, which can impact brand reputation and revenues if consumers choose to boycott certain products; 4. local protests that lead to business disruptions at plants or factories; and 5. poor working conditions, which can result in issues with product safety
Tools and elements of ESG integration
1. red flag indicators 2. company questionnaires and management interviews. 3. checks with outside experts 4. watch lists. 5. internal esg research 6. external esg research 7. esg agenda items at investment committee or CIO level meetings
Portfolio risk can be divided into two portions:
1. the isolated risk of the individual asset or individual investment strategy; and 2. the correlation risk that emerges from the combination of all the assets and strategies.
For material ESG risk that has not been managed by a company, there are two types of risk
1. unmanageable risk, which cannot be addressed by company initiatives; and 2. the management gap, which represents risks that could be managed by a company through suitable initiatives but which may not yet be managed.
Example for dark green, medium green, light green and brown
1. wind energy (dark green) 2. bridging technologies such as hybrid busses (medium green) 3. efficiency investments for fossil fuels technologies where clean alternatives are not available (light green) 4. new infrastructure for coal (brown)
The results from Global Canopy's latest annual survey of the 500 most influential companies and financial institutions in forest supply chains shows that
43% do not have deforestation commitments for any of the forest-risk commodities they are exposed to (63% among financial institutions) and US$2.7tn (£1.9tn) of financing into the most influential high-risk companies comes from Forest 500 financial institutions with no deforestation policy.
GHG emissions are assessed to be material for more than
50% of industries in sectors such as extractives and minerals processing and transportation ..but for less than 50% of industries in sectors such as healthcare or technology and communications - where the management of energy, waste and hazardous materials features more prominently
Friede, Busch and Bassen's 2015 study showed in regards to stewardship
57% of equity studies had a positive effect, though the positive share for bond studies was 64%, rising to 71% for real estate.
Audit Materiality ..
75% is typical 50-60% suggests low level of confidence in the company's financial control
According to the OECD Centre for Opportunity and Equality (COPE) 2015 report, the average income of the richest 10% of the population
About nine times that of the poorest 10% across the OECD.
Collaboration Platform of PRI
According to the PRI's statistics, there have been more than 2,500 groups and more that 600 engagements run through the Collaboration Platform, targeting 24,667 companies with the involvement of over 2,000 signatories
CFA Institute recently announced the publication of the Exposure Draft of its ESG Disclosure Standard.
Applied at the underlying fund or product level rather than at the firm level, the standard provides recommendations and requirements for these elements of a product's strategy: » objectives; » benchmarks; » sources and types of ESG information; » ESG exclusions; » ESG information in financial analysis and valuation; » portfolio-level ESG criteria and characteristics; » process to achieve impact objective; and » stewardship
EU SFDR defines two categories of sustainable financial products
Article 8 products that promote sustainability characteristics, and the more strictly defined Article 9 products that have stringent, primary objectives for positive sustainability
Generally speaking, institutional investors apply two popular approaches towards decomposing performance attribution
Brinson attribution and risk factor attribution.
Brinson attribution
Brinson attribution decomposes performance return based on portfolios active weights. For given time series, this generally represents performance returns attributed to regional, sector and stock-specific exposure. Brinson model emphasizes stock specific attribution, which makes it popular for discretionary managers, risk factor attribution emphasizes both factor and security-specific exposure.
Sarbanes-Oxley Act of 2002
Created Public company accounting oversight board; addressed conflicts of interest, corporate responsibility and fraud, and public disclosure. - audit standard setter establishing a standard for auditor independence and challenge
UNEP FI produced Freshfields report
ESG relevant for financial valuation and fiduciary duty
Global Greenhouse Gas emissions by sector
Energy 73.2% (Energy in Industry 24.2%, buildings 17.5%, transport 16.2%,) Agriculture 18.4% Industry 5,2% Waste 3,2%
MSCI categories
Environment - climate change - natural resources - pollution and waste - opportunities Social - human capital - product liability - stakeholder opposition - social opportunities Governance - Corporate Governance - Corporate Behavior
Factor risk allocation
Factor risk frameworks seek to build a diversified portfolio based on sources of risk. Typically includes factors such as fundamental risks (gross domestic product (GDP), interest rates and inflation) as well as market risks (equity risk premium, illiquidity and volatility)
Like fixed income, there is good evidence of the positive effect of ESG on returns to real estate investments.
Friede, Busch and Bassen's 2015 study showed that - 57% of equity studies had a positive effect, - though the positive share for bond studies was 64%, - rising to 71% for real estate.
Value Reporting Foundation was formed upon merger of
IIRC (Integrated Reporting Standards) and SASB (SASB Standards)
Risk also appears as either idiosyncratic or systematic
Idiosyncratic risk describes firm- or stock-specific risk. In an ESG context, idiosyncratic risk could be posed by a company's staggered board of directors or a mining company that is repeatedly fined for its untreated. In order to reduce or mitigate this kind of idiosyncratic risk, a portfolio manager may diversify the portfolio, diluting the exposure to the mining company. The portfolio manager may instead simply exit the poor-performing company outright, eliminating the risk. Systematic risk represents market risk, such as economic recession, that cannot be resolved through portfolio diversification, alone. .
12 different forms of engagement according to Investor Forum White Paper
Individual 1. Generic letter 2. Tailored letter 3. Housekeeping engagement 4. active private engagement 5. active public engagement Collaborative (institution works with others) 1. Informal discussions 2. Collaborative Campaigns 3. follow on dialogue 4. soliciting support 5. group meeting 6. collective engagement 7. concert party (formal agreement in any form with concrete objectives and agreed steps - e.g. collectively proposing a shareholder resolution or agreeing on how to vote on a specific matter)
The 2010 Stewardship Code had seven principles
Institutional investors should: 1. publicly disclose their policy on how they will discharge their stewardship responsibilities; 2.have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed; 3. monitor their investee companies; 4. establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value; 5. be willing to act collectively with other investors where appropriate; 6. have a clear policy on voting and disclosure of voting activity; and 7. report periodically on their stewardship and voting activities
Liability driven asset allocation
Liability driven investment (LDI) seeks to find the most efficient asset class mix driven by a fund's liabilities. Simultaneously concerned with the return of the assets, the change in value of the liabilities, and how assets and liabilities interact to determine the overall portfolio value
Active share is a measure of the difference between a portfolio's holdings and its benchmark index
Mathematically, it is calculated as the sum of the difference between the weight of each stock in the portfolio and its benchmark weight, divided by two
MVO
Mean-variance analysis allows investors to find the biggest reward at a given level of risk or the least risk at a given level of return. MVO results in the construction of an efficient frontier that represents a mix of assets that produces the minimum standard deviation (as a proxy for risk) for the maximum level of expected return. It is based on defined asset class buckets and longterm expected returns, risks and correlations. The Black-Litterman Global Asset Allocation is a MVO model, using the Markowitz portfolio optimisation model or modern portfolio theory (MPT).
PRI signatories have grown by 30% since 2006 and include
More than 3000 signatories worldwide In April 2021, PRI asset owner signatories numbered 606 and managed aggregate assets of over US$31.2tn (£22.4tn); total number of signatories was 3,811 with assets circa US$110tn (£79.1tn).
Principal Adverse Impacts (PAIs) are
PAIs are the negative effects from an investment on sustainability factors. These PAIs go into great detail and consist of 18 indicators for which disclosure is obligatory, and 46 voluntary disclosure indicators.
Temperature alignment tools PACTA
Paris Agreement Capital Transition Assessment (PACTA) is a public tool developed by 2° Investing Initiative, with backing from the UN PRI, which aims to measure the alignment of financial portfolios with climate scenarios
The path towards net zero Initiatives
Paris Aligned Investment Initiative (PAII) Net Zero Asset Owner Alliance Net Zero Asset Managers Initiative Net Zero Company Benchmark
Transition risks:
Policy and legal, technology, market, reputation
Learn the ESG Integration Framework from CFA
Portfolio level - Scenario analysis o Portfolio scenario analysis - Risk Management o Esg and financial risk exposure and limits o Value at Risk analysis - Asset allocation o Tactical o Strategic - Portfolio construction o Portfolio weightings o ESG Profile vs benchmark Security Level - Security valuation equities o Valuation multiples o Valuation model variables o Forecasted financials o Forecasted financial ratios - Security valuation fixed income o Internal credit assessment o Duration analysis o Relative value analysis/spread analysis o Relative ranking o Internal credit assessment - Equities/fixed income o Security sensitivity/scenario analysis Research - Esg integrated research - Materiality framework - Swot analysis - Internal esg research - Watch lists - Red flag indicators - Company questionnaires - Individual collaborative policy engagement - Voting - Esg agenda at committee meetings - Centralized research dashboard
US Audit Standard setter
Public Company Accounting Oversight Board (PCAOB)
Regime switching models
Regime switching approaches model abrupt and persistent changes in financial variables due to shifts in regulations, policies and other secular changes. Captures fat tails, skewness and time-varying correlations
USE OF GREEN BOND AND LOANS PROCEEDS 2020
Renewable Energy 35%, Buildings 27% and Transport 22%
UN SDGs
The 17 goals are all interconnected and particularly aimed at governments. The Paris Agreement, though negotiated in parallel to the SDGs, became one of its goals. Despite the goals and subsequent targets not being directly applicable to businesses and investors, the SDGs have become a powerful framework for these groups, with some investors already reporting against their impact on the SDGs and allocating capital to contribute to their achievement.
The UN Environment Programme Finance Initiative (UNEP FI) produced what?
The Freshfields Report, which showed that ESG issues are relevant for financial valuation and thus, fiduciary duty. These two reports (Who cares Wins and Freshfields) formed the backbone for the launch of the Principles for Responsible Investment (PRI) at the New York Stock Exchange in 2006 and the launch of the Sustainable Stock Exchange Initiative (SSEI) the following year
Paris Aligned Investment Initiative (PAII)
The Paris Aligned Investment Initiative (PAII) was established in May 2019 by the Institutional Investors Group on Climate Change (IIGCC). As of March 2021, the initiative has grown into a global collaboration supported by four regional investor networks - AIGCC (Asia), Ceres (North America), IIGCC (Europe) and IGCC (Australasia).
ESG index providers
The likes of FTSE Russell and MSCI provide ESG index benchmarks. These indices can be custom built to an investor's preferences 1. The index typically relies upon rules-based criteria assessed on underlying ESG scores or metrics. 2. These then go into a formula to tilt company weightings or exclude entire companies based on ESG scores and hurdles. 3. These scores may be sourced by other ESG service providers. For instance, Sustainalytics started providing FTSE Russell with underlying data from 2019 (and had provided Morningstar with data before this)
Materiality assessments are included in what stage
The research stage typically contains a materiality assessment to identify the ESG issues that are likely to have an impact on the company's financial performance. Materiality is typically measured both in terms of the likelihood and magnitude of impact.
Access to Medicine Index.
The tool analyses how 20 of the world's largest pharmaceutical companies are addressing access to medicine in 106 low- to middle-income countries for 82 diseases, conditions and pathogens, evaluating them in areas where they have the biggest potential and responsibility to make change, such as research and development (R&D) and pricing.
Corporate Governance Codes timeline
The world's first formal Corporate Governance Code emerged in the UK in 1992. The Cadbury Committee had been brought together in May 1991 by the Financial Reporting Council In the UK, shocks around pay levels at newly-privatised utilities led to the Greenbury report, which revised the corporate governance code in 1995
Transition risks
These are the risks represented by legal, regulatory, policy, technology and market change in the transition to a low carbon economy. Stranded asset risk, for example, would qualify as a transition risk for a portfolio.
pre-emption rights
These rights ensure that an investor has the ability to maintain its position in the company. Fundamental in many markets' company laws (excluding USA, for example) is that a company should not issue shares without giving existing shareholders the right to buy a sufficient amount in order to maintain their existing shareholding.
Platform Living Wage Financials
They: 1. measure their performance on living wage; 2. discuss the assessment results; and 3. support innovative pilots.
Temperature alignment
This seeks to compare the climate profiles of companies, sectors or portfolios against a benchmark of global temperature
In the 1950s, approximately 30% of the world population lived in an urban environment. This is expected to increase to
To 68% by 2050
Escalation of engagement
Under principle 11, a ladder of additional steps to raise the stakes in engagement: - holding additional meetings with management specifically to discuss concerns; - expressing concerns through the company's advisers; - meeting with the chair or other board members; - intervening jointly with other institutions on particular issues; - making a public statement in advance of general meetings; - submitting resolutions and speaking at general meetings; and - requesting a general meeting, in some cases proposing to change board membership. - writing a formal letter - seeking dialogue with other stakeholders - formally requesting a special audit - talking concerns public - seeking governance improvements - formally addign company to inclusion list
ESG approach in Sovereign debt
Usually screening or an ESG tilt in the investment process rather than engagement.
The International Finance Corporation's (IFC) Equator Principles, which are based on IFC's Performance Standards have become what
a globally recognised risk management framework, for determining, assessing and managing environmental and social risk in project finance. They set out performance standards that address environmental factors (such as resource efficiency, biodiversity and land resettlement) as well as other social-oriented standards.
Green New Deal
a plan to make the EU economy climate-neutral by 2050 by boosting the efficient use of resources, restoring biodiversity and cutting pollution. - to reorient capital flows by • a classification system (EU taxonomy) for sustainable activities, and • standards and labels for green bonds, benchmarks and other financial products; and • increasing EU funding for sustainable projects. - to mainstream sustainability into risk management - to foster transparency and long term thinking by strengthening disclosure requirements.
A low Active Share score is said to indicate that
a portfolio manager is closely replicating the target index and engaging in a passive investment strategy.
Steps to designing and executing a good mandate
a. Clarifying client needs: defining the ESG investment strategy b. Fully aligning investment with client beliefs c. Delevoping client-relevant ESG aware investment mandates d. Tailoring ESG investment approach to client expectations e. Holding managers to account
Consumer protection includes
a. enforcing product safety; b. distributing consumer-related information; and c. preventing deceptive marketing
Under Dodd Frank ...
access to the proxy standard permits shareholders that fulfill certain criteria
Physical risk
acute, chronic
Board appraisals
are required under many corporate governance codes and can help boards to become more effective
Often, moving an engagement from the private sphere into the public is seen
as one of the most important ways to bolster influence.
Brydon Review
assess, assure and inform
The key concern active shareholders usually have about a company's strategy is
capital allocation
Under NFRD (non financial reporting directive)
companies, including corporates, insurers and banks, are expected to report on the policies they have in relation to environmental protection and a range of other social and governance factors. The original Directive is currently under review. In 2019, it was supplemented by guidelines on climate reporting which introduce the concept of 'double materiality', i.e. the two-way impacts between companies and climate chang
WEIGHTED-AVERAGE CARBON INTENSITY AT THE PORTFOLIO LEVEL
current value of investment / current portfolio value multplied issuers scope 1 and 2 emissions / issuers revenue
calculating TOTAL CARBON EMISSIONS
current value of investment / issuer's market capitalisation multiplied × issuer ' s Scope 1 and 2 emissions
Attribution models serve to quantify and demonstrate the effects of asset allocation and selection decisions on investment returns. Brinson attribution...
decomposes performance returns based on a portfolio's active weights
Investment approaches can be characterized as
discretionary or quantitative. ESG integration in discretionary approaches is process oriented while quantitative approaches whether active or passive are rules based or factor oriented.
EU guidelines under the Non-Financial Reporting Directive (NFRD) which introduced the concept of
double materiality
According to statistics maintained by the Global Sustainable Investment Alliance (GSIA),
exclusions-based approaches remain the largest portion of dedicated, ESG-screened assets under management (AUM).
Securities law is regulated on a federal level in the US. SEC sets law requirements...
for the independence and skills of members of the audit committee of companies . standards were set by SOX
A high Active Share score is said to indicate that a fund's holdings diverge from the target index and that the portfolio manager is outperforming it.
fund's holdings diverge from the target index and that the portfolio manager is outperforming it.
In an ESG context, tail risks are
generally long-term in nature and describe a significant change or move by several standard deviations in the risk profile of an asset. Depending on the position size in a portfolio, the potential volatility of such an asset may carry significant implications for the portfolio's overall risk profile and to its potential risk-adjusted returns.
Climate Bonds Initiative
has regular information about the state of the green bond market. The Climate Bonds Taxonomy and sector-specific criteria have been scientifically developed to meet the object of the Paris Agreement of keeping global warming under 2°C (3.6°F)
Modern form of ESG investing began when
in 2004 when UN SecretaryGeneral, Kofi Annan, wrote to the CEOs of significant financial institutions to take part in an initiative, under the authority of the UN Global Compact and with the support of the International Finance Corporation (IFC), to integrate ESG into capital markets. The initiative produced a report entitled Who Cares Wins, which effectively coined the term 'ESG'. The report made the case that embedding ESG factors in capital markets makes good business sense and leads to more sustainable markets and better outcomes for societies
The large majority (over 90%) of asset owner signatories of the PRI require
in their investment mandate that asset managers act in accordance with the asset owner's responsible investment policy and over half of the asset owners (65%) also require reporting
The Shareholder Rights Directive (SRD) was issued by the European Union (EU) in September 2020, requiring
investors to be active owners and to act with a more long-term focus
Under SFDR (sustainable finance disclosure regulation)
investors will be required to provide more transparency around: ▶ how the impacts of sustainability risks on their financial products are being systematically assessed (e.g. integrated into due diligence and research processes); ▶ how asset managers consider - and seek to address - the potentially negative implications of investment activities on sustainability factors; and ▶ products labelled with an explicit ESG focus.
what clarified the 2012 iteration of the UK stewardship code
it clarified the roles of asset owners and their und manager and other agents
France has a requirement for...
joint auditors and double voting rights
At a company or project level, investors looking to identify and measure a company's environmental impact or materiality would need to analyse both quantitative and qualitative environmental factors in order to make an informed evaluation of the environmental risks embedded within
judgment is then made on how material the risks are and whether those risks are priced in or not. A scoring system is also typically used to benchmark the company against its peers - Energy Consumption - Water utilization - Waste utilisation
The capital asset pricing model (CAPM)
measures the proportional risk of a security or portfolio relative to market risk in the form of a premium
As of 2018, the largest sustainable investment strategy globally continued to be
negative, or exclusionary screening
it is cheaper to build new wind and solar capacity than to
operate 60% of the operating coal power plants in 2020
The work of the TCFD introduced the influential classification of climate-related risks into
physical and transition risks, recommending that companies report on both of these dimensions. One notable recommendation was the use of climate scenario analysis
Proposing a shareholder resolution in the USA can therefore be the trigger for what?
private engagement, which may reach enough of a satisfactory conclusion for the investor to withdraw the resolution, and thus never coming to public attention
Total relative cost of climate change
quivalent to losing at least 5% of global gross domestic product (GDP) each year, now and forever. Including a wider range of risks and impacts could increase this to 20% of GDP or more
. Every material ESG issue has an issue manageable risk factor (MRF),
ranging from 30% (indicating that a high level of the issue risk is unmanageable) to 100% (indicating that the issue risk is considered fully manageable).
the Network for Greening the Financial System, a group of 102 central banks and supervisors established in 2017, explicitly
recognises climate risks as relevant to a supervisory mandate and it has challenged policymakers, other central banks and supervisors to act to limit the catastrophic impacts of runaway climate change
The stewardship interaction with sovereign debt issuers is
screening or an ESG tilt in the investment process rather than engagement
International Finance Corporation's (IFC) Equator Principles, set out IFC performance standards that address environmental factors
such as resource efficiency, biodiversity and land resettlement as well as other social-oriented standards.
In December 2020, over 30 asset managers managing over US$9tn (£6.5tn) in assets joined the Net Zero Asset Manager initiative, pledging to
support investing aligned with net zero emissions by 2050 or sooner
The practitioner argument for causality is
that a transparency bias towards large companies favours ESG because a common characteristic of high-ranking ESG companies is strong transparency and disclosure. Large companies, not surprisingly, are better equipped and staffed to address these issues, resulting in higher ESG scores. The linkage between quality and ESG as factors stems from the intuition that the governance of higher ESG-rated companies drives stronger decision-making around capital allocation and shareholder returns.
SFDR stipulates areas of mandatory disclosure at two levels,
that of the investment firm and that of the product. Further it introduces a new concept into the EU's regulatory environment: Principal Adverse Impacts (PAIs).
German law indicates
that there needs to be a 2 year gap between departure from the management board and joining the supervisory board unless the individual is elected after having been nominated by 25% of shareholders.
Board structures In Australia
the CEO is usually the board's single executive director and does NOT usually chair the board. but is typically not subject to election by shareholders.
The EU SFDR focuses on disclosure at the
the entity (manager) and the product (investment strategy) levels. Notably, the EU SFDR also makes tremendous effort to normalise sustainability risk within all in-scope products. It organises in-scope sustainability investment products into three major groups: Article 9, 8 and 6
The SEC sets requirements for
the independence and skills of members of the audit committee of companies listed in the US - standards were set by SOX
Sustainalytics Rating methodology
the rating sorts companies into five risk categories: 1. negligible; 2. low; 3. medium; 4. high; 5. severe.
Human Rights guidelines do not focus on the impact social factors can have on investments (financial materiality) but on
the responsibility investors have for the adverse impacts their investments/ companies can cause to society
Studies demonstrate that almost 80% of alpha can be attributed to
to portfolio factor risk rather than stock-specific risk, would seem to support research efforts to identify and define ESG as a standalone factor
The EU's Sustainable Finance Disclosure Regulation (SFDR) - investment Funds specific In 2021, the European Union (EU)'s Sustainable Finance Disclosure Regulation (SFDR) came into force. The SFDR is designed to
to support institutional asset owners and retail clients to compare, select and monitor the sustainability characteristics of investment funds' by standardising sustainability disclosures
The KPIS for bonuses will predominantly be financial metrics but
will often include around 20% that is attributable to personal performance or non-financial measures including ESG factors
The EU Action Plan on Financing Sustainable Growth, agreed in 2019, requires the following
» Mandatory disclosure of policies in relation to ESG risk (consistent with the PRI's fiduciary duty recommendations) for all firms and financial products. » Comply or explain disclosure of the principal adverse impacts of the investment on sustainability factors (mandatory for firms with more than 500 staff) at firm and product level. » Enhanced disclosure obligations for firms promoting specific environmental or social objectives.
EU's Shareholder Rights Directive II, which came into force in 2019, seeks to improve the level and quality of investors with their investee companies, better aligning executive pay with corporate performance and increasing disclosure on how an asset manager's investment decisions contribute to the medium- to long-term performance of investee companies. In order to achieve that, it requires investors to have an engagement policy and annually report on:
» how this is integrated into their investment strategy; » how the dialogue is done; » how voting rights and shareholder rights are being executed; » how the manager collaborates with other shareholders; and » how potential conflicts of interest are dealt with
Negative screening represents the avoidance of the worst performers. Functionally speaking, an investor might apply screening towards:
» sectors; » regions; » issuers; » business activities and practices; » product and services; and » even security types such as certain commodities.
Norms-based screening applies existing normative frameworks in order to screen issuers against internationally-recognised minimum standards of business practice. Screening generally applies globallyrecognised frameworks like treaties, protocols, declarations and conventions including
» the UN Global Compact; » the UN Human Rights Declaration; » the ILO's Declaration on Fundamental Principles and Rights at Work; » the Kyoto Protocol; and » the Organisation for Economic Co-operation and Development (OECD) Guidelines for Multinational Enterprises.
Scope 3 emissions
• Purchased goods and services. • Business travel. • Employee commuting. • Waste disposal. • Use of sold products. • Transportation and distribution (up- and downstream). • Investments. • Leased assets and franchises.
There are many hurdles and challenges for ESG integration. These include:
▶ Disclosure and data-related challenges, such as: » data consistency; » data scarcity; » data incompleteness; and » lack of audited data. ▶ comparability difficulties, such as » lack of comparability between ESG ratings agencies; » comparing across different accounting and other standards; » comparisons across geographies and cultures; and » inconsistent use of jargon terminology. ▶ materiality and judgment challenges, such as: » judgments that are difficult and uncertain; and » judgments that are inconsistent. ▶ ESG integration challenges across asset classes: » different types of assets and different strategies integrate ESG using different techniques
SASB provides an interactive proprietary tool that identifies and compares disclosure topics across different industries and sectors, described as a 'materiality map'. Environmental factors cover:
▶ GHG emissions; ▶ air quality; ▶ energy management; ▶ water and wastewater management; ▶ waste and hazardous materials management; and ▶ ecological impacts
SASB provides an interactive proprietary tool that identifies and compares disclosure topics across different industries and sectors, described as a 'materiality map'. Environmental factors cover
▶ GHG emissions; ▶ air quality; ▶ energy management; ▶ water and wastewater management; ▶ waste and hazardous materials management; and ▶ ecological impacts.
UN PRI Fiduciary Duty
▶ Incorporate financially material ESG factors into their investment decision-making, consistent with the time frame of the obligation. ▶ Understand and incorporate into their decision making the sustainability preferences of beneficiaries or clients, regardless of whether these preferences are financially material. ▶ Be active owners, encouraging high standards of ESG performance in the companies or other entities in which they are invested. ▶ Support the stability and resilience of the financial system. ▶ Disclose their investment approach in a clear and understandable manner, including how preferences are incorporated into the scheme's investment approach
Sustainalytics and its ESG products & relationships
▶ Morningstar (see Section 4); ▶ Glass Lewis (proxy adviser); ▶ STOXX (index provider); and ▶ since 2018, FTSE Russell (index provider)
Measurement frameworks and tools (2)
▶ The EU Taxonomy for Sustainable Activities and the Climate Bonds Sector Criteria provide sector-specific metrics and indicators to assess if assets, projects and activities across energy, transport, buildings, industry, agriculture and forestry, water and waste management, etc., are compliant with the goals of the Paris Agreement. ▶ The Transparency for Sustainable Economies tool (TRASE), a partnership between the Stockholm Environment Institute and Global Canopy. ▶ The Exploring Natural Capital Opportunities, Risks and Exposure (ENCORE) tool, an initiative of the UN Environmental Program World Conservation Monitoring Center (WCMC), UNEP Finance Initiative and Global Canopy ▶ The Terra Carta (Earth Charter), an initiative under the patronage of the Prince of Wales, providing a roadmap for business action on climate change and biodiversity
Measurement frameworks and tools (1)
▶ The Sustainability Consortium (TSC), which has built a set of performance indicators and a reporting system that highlights sustainability hotspots for more than 110 consumer-product categories, covering 80-90% of the impact of consumer products. ▶ The WWF offers more than 50 performance indicators for measuring the supply-chain risks associated with the production of a range of commodities, as well as the probability and severity of those risks. ▶ CDP and the GRI have created standards and metrics for comparing different types of sustainability impact. ▶ The Sustainability Accounting Standards Board (SASB) has developed standards that help public companies across eleven sectors, including consumer goods, to give investors material information about corporate sustainability performance along the value chain
GRESB's full benchmark report provides:
▶ a composite of peer group information; ▶ overall portfolio key performance indicator (KPI) performance; ▶ aggregate environmental data in terms of usage and efficiency gains; ▶ a GRESB score that weights management, policy and disclosure, risks and opportunities and monitoring and Environmental Management Systems (EMS); ▶ environmental impact reduction targets; and ▶ data validation and assurance
This World Bank dataset considers:
▶ a country's governance score; and ▶ its rankings on: » political stability; » voice and accountability; » government effectiveness; » rule of law; » regulatory quality; and » control of corruption.
The elements of ESG integration include (9)
▶ adjusting forecast financials, for example revenue, operating cost, asset book value or capital expenditure; ▶ adjusting valuation models or multiples, for instance discount rates, terminal values or ratios; ▶ adjusting credit risk and duration; ▶ managing risk, including exposure limits, scenario analysis, value-at-risk models; ▶ ESG factor tilts; ▶ ESG momentum tilts; ▶ strategic asset allocation, including thematic and ESG objective tilts; ▶ tactical asset allocation; and ▶ ESG controversies and positive ESG events
Different managers will integrate ESG in different ways:
▶ as a threshold requirement before investment can be considered; ▶ as a factor that informs the valuation or provides a quant basis for adjusting (or tilting) exposures; ▶ as a risk assessment that offers a level of confidence in the valuation; ▶ as a basis for stewardship engagement; or ▶ as a combination of two or more of these methods, which is very often the case
ESG integration within portfolio management requires a different manner of explanatory power than integration at the individual security level: it should embed ESG considerations into:
▶ at the highest level, asset allocation decisions; ▶ portfolio exposure to non-financial factors; ▶ risk management measures; and ▶ performance attribution
Climate Change Mitigation
▶ avoid significant human interference with the climate system; ▶ stabilise GHG levels in a timeframe sufficient to allow ecosystems to adapt naturally to climate change; ▶ ensure that food production is not threatened; and ▶ enable economic development to proceed in a sustainable manner
Net zero targets can be
▶ be absolute or relative targets; ▶ cover different scopes of emissions (just operational (Scope 1 and 2) or include some or all of the value chain (Scope 3) and different types of emissions (just carbon dioxide or all GHGs); ▶ focus on differing or multiple timeframes; or ▶ rely on offsets.
Investees include all entities in which investments can be made. Among others, these include:
▶ companies; ▶ projects (such as infrastructure projects and joint-ventures); ▶ agencies (including World Bank and International Finance Corporation); and ▶ jurisdictions (for instance, countries/regions, provinces and cities).
Real Impact Tracker The RIT takes a more holistic approach, doing deep dive due diligence on its manager assessments. Its 'certified community' is publicly available with details of the assessment undertaken. Rather than use a 'holdings-based approach', the RIT will assess:
▶ culture; ▶ philosophy; ▶ process impact; and ▶ public policy efforts.
full ESG integration strategies often take greater efforts to
▶ evidence internal and external research resources; ▶ document how ESG is embedded, typically in a process slide; ▶ track and report on engagement activities with company management; ▶ include portfolio exposure and weightings into sustainability themes like the SDGs; ▶ provide positive impact measurements of the portfolio against metrics like resource efficiency, water and energy consumption; and ▶ support the process with investment case studies
Biodiversity underpins ecosystem services, provides natural resources and constitutes our 'natural capital'. Some of these ecosystem services include:
▶ food; ▶ clean water; ▶ genetic resources; ▶ flood protection; ▶ nutrient cycling; and ▶ climate regulation, amongst many others.
Company ESG Assessment and Rating:
▶ fundamental including risk, business model, policies and preparedness; ▶ operational including carbon impact, water stress and human capital management; ▶ disclosure-based assessment; and ▶ algorithm and news-based including controversies (Truvalue Labs and RepRisk predominantly use this assessment whereas fundamental, operational and disclosure-based are used by most ratings companies)
While intuitively easy to understand the aim of these temperature alignment measures and seemingly easy to compare temperatures, there is significant variation in the market around such metrics. They:
▶ go under different names (e.g. 'implied temperature rise', 'global warming potential' or 'temperature alignment'); ▶ use different inputs for climate performance (including carbon footprint, share of investments in 'green' technologies, proportion of investee companies with (science-based) emissions targets); and ▶ result in a different quantification of output - a binary statement (aligned or not), a score, a percentage of misalignment or a temperature number).
Some of the main environmental risks in the supply chain include:
▶ material toxicity and chemicals; ▶ raw material use; ▶ recyclability and end-of-life products; ▶ GHG emissions; ▶ energy use; ▶ water use and wastewater treatment; ▶ air pollution; ▶ biodiversity; an
Municipal credit ESG analysis can differ as well. In the municipal space (region, state or city) both the issuer's governance and management practices can be assessed as well as their:
▶ overall transparency; ▶ reporting; ▶ corruption levels; ▶ budgetary practices; ▶ pension liabilities; and ▶ contracts.
Blue Economy Development Framework aims to create a roadmap to assist governments to
▶ prepare policy, fiscal, and administrative reforms; ▶ identify value creation opportunities from blue economy sectors; and ▶ identify strategic financial investments.
Under the DNSH principle in the Technical Expert Group Final Report on the EU Taxonomy, economic activities that make a substantial environmental contribution to the climate change mitigation or adaptation must not cause significant harm to the other designated environmental objectives. These include
▶ sustainable use and protection of water and marine resources; ▶ transition to a circular economy, waste prevention and recycling; ▶ pollution prevention and control; and ▶ protection of healthy ecosystems.98
Asset owner associations
▶ the Asian Corporate Governance Association (ACGA); ▶ Associação de Investidores no Mercado de Capitais (AMEC) in Brazil; ▶ Assogestioni in Italy; ▶ the Australian Council of Superannuation Investors (ACSI); ▶ the Council of Institutional Investors (CII) in the USA; ▶ Eumedion in the Netherlands; and ▶ the Pensions and Lifetime Savings Association ((PLSA), formerly the National Association of Pension Funds (NAPF)) in the UK
Examples of global traceability schemes include:
▶ the Forest Stewardship Council (FSC); ▶ the Marine Stewardship Council (MSC); ▶ Roundtable for Sustainable Palm Oil (RSPO); and ▶ the Fairtrade Labelling Organizations International (FLO).
Analysts (particularly fundamental analysts) present and justify their views in 'a story' or 'investment thesis' of a security, which generally entails incorporating different factors. These factors often include:
▶ the intrinsic value of the security; ▶ credit analysis; ▶ the potential for a rerating or derating in valuation; ▶ potential risks; ▶ short-term and long-term catalysts; and ▶ an expectation on the security's earnings growth and cash flow profile.
Many of the challenges pf ESG ratings for credit investors are similar to equity ESG ratings. These challenges include:
▶ the lack of transparency; ▶ inconsistent or changing methodologies; ▶ the use of estimated data; and ▶ the lack of comparability through time and between providers and companies.
