Like the real economy, financial markets are wrestling with issues around responding to the climate emergency and supporting decarbonisation. The challenges for all market actors – and certainly for corporate treasurers – are considerable. However supportive treasurers and their boards might be when it comes to looking at investment through an environmental, social and governance (ESG) lens, they are faced with:
- An absence of widely accepted definitions of sustainability in an area of high subjectivity;
- An immature market with evolving methodologies;
- Confusion around how to assess the ESG credentials of assets and funds;
- Considerable operational and reputational risk in the event they make a poor investment choice; and
- Wider current economic uncertainty, geopolitical instability, and higher inflation and interest rates.
At the roundtable discussion, held under Chatham House rule, treasurers from utilities, financial institutions and advisory firms explored some of these disparities and the very real complexities of pursuing an ESG investment policy – particularly when weighed against the treasurer’s foremost concerns and stewardship role to preserve cash and liquidity.
ESG and the investment agenda
ESG ranks high on the public agenda and for policymakers, as well as in conversations between treasurers, their banks and advisers. However, when it comes to a mandate to invest in ESG-friendly vehicles, those conversations are less conclusive as the marketplace for ESG-oriented funding and investment solutions remains small relative to standard alternatives, even while growing rapidly.
One challenge to the adoption of ESG solutions is the level of subjectivity and numerous methodologies that can be applied to achieve different outcomes, making it difficult for treasurers to assess the credibility of solutions in a consistent way or to align with their corporate sustainability objectives.
For example, around 70% of UK local authorities have declared a climate emergency, but this is disconnected to actions. Local authority treasurers are, one panellist argued, increasingly targeted with funds and investment products that claim strong ESG credentials that can be hard to substantiate. A fund selection process might reveal the ruling out of territories such as North Korea or sectors such as arms dealing, which mainstream funds would in any case avoid. Clearly, any credible ESG investment strategy must go much further to distinguish it from standard approaches, and investment managers must be able to demonstrate a rigorous ESG investment process to give investors the confidence to invest, particularly given the lack of industry standardisation.
While ESG has become much more prominent in business and treasury, it is not often the primary consideration for treasurers’ day-to-day decision-making. When it comes to where they place their money, participants argued, other considerations often carry the day – a treasurer’s overarching remit to preserve capital and liquidity remains the priority. What has changed, they said, was the level of visibility of ESG and the onus to report on whether or not considerations of ESG factors played a role in the investment decision-making process.
Even so, a paucity of credible ESG money market funds (MMFs) and a lack of scale to support the largest investors, plus an inconsistent use of peer and investment universes for comparisons on which to base decisions, were all factors emphasised by participants.
So, what kind of conditions might prompt a treasurer to invest in ESG solutions? Conceivably, a treasurer weighing up an ESG MMF against a non-ESG MMF might opt to invest in an ESG fund all other things being equal – particularly if their board had decided on a strategy to move in a more sustainable direction and was prepared to see treasury and investment as enablers in that wider policy. However, in reality, policies may need to be more accommodative of smaller fund sizes, diversification requirements given how few ESG MMFs are available, and potentially lower yields, reflecting reduced exposure to ESG risks and a more constrained investment universe available to ESG MMFs.
Similar issues were discussed when treasurers considered their bank selection and the question of green deposits. Products offering considerably less in yield terms than mainstream offerings will remain unattractive until organisations formalise their sustainable treasury objectives, in doing so balancing the yield and ESG criteria.
As one treasurer noted, it is important to weigh up investment time horizons in relation to ESG. If a treasurer’s investment horizon was 20-plus years, then environmental and social performance would become important and could credibly be a factor in whether to invest in ESG products or not. In the case of much shorter timelines, governance became much more significant. Companies or banks can conceivably fail overnight due to a lack of strong governance, but perhaps not in that time frame due to poor environmental or social policies, as one participant pointed out.
Ratings and data
In that context, credit ratings and assessment of ESG data to discern material risks becomes crucial. However, while issuer credit ratings are widely accessible to investors, access to specialised ESG data remains limited and expensive, meaning a comprehensive view on the sustainability of an issuer is the preserve of only the most well-resourced investment managers. Determining relevant criteria oneself or for an investment client, however, is complex and still highly subjective, unlike credit scores that are binary and effective third party. Investors commonly base decisions on the criteria that are important to them and their members. Currently, there is limited agreement around ESG criteria – far less the impact that investing in ESG funds in aggregate will have. With the collection and reporting of ESG data inconsistent, the risk of greenwashing remains considerable.
The ESG journey
Given all this, is there a case for recognising that the market is on a journey in terms of ESG-oriented investment? If we take existing ESG funds and deposits to be the starting point and if fund managers engage with corporates with a view to encouraging and improving ESG performance, then won’t funds and companies gradually become stronger and more attractive assets in this respect? For instance, companies with a B Corp designation have to demonstrate high social and environmental performance along with strong governance and transparency.
The idea behind the B Corp movement is that companies with high, independently verified ESG standards model the kind of business that the world needs, and there is an argument that if listed and multinational companies were also to pursue more socially equitable policies alongside purely financial outcomes, then they would become more attractive investments.
For the time being, treasurers must invest in markets as they currently stand. However, if ratings organisations were to standardise data and criteria, and as corporate reporting on ESG becomes more extensive, then the universe of investable assets will increase. Part of this success will be dependent on financial markets driving change in corporate and investor behaviour – which in turn suggests meaningful conversations between those parties based on clear criteria and solid ESG data.
It is easy to use a lack of standardisation or an immature market as reasons to avoid looking into ESG investment vehicles. However, for the market to grow, treasurers need to play a role and engage with the investment community. No investment vehicle will be perfect from an ESG perspective, but treasurers need to be able to identify those organisations that have undertaken effective and sufficient due diligence on the instruments they invest in and not be afraid to ask challenging questions to limit the risks of greenwashing.
Treasurers also need to be able to defend their decisions to their boards and transparently disclose any limitations that a particular ESG fund may have.
With a mounting sense of urgency and an imperative for the financial community to rally behind decarbonisation, it is to be hoped that more and more organisations will see their investments and their treasury function as enablers to open up green, socially responsible and sustainable investment.