ESG is turning into a real bad penny in the investment industry. It shows up everywhere and no one seems quite sure what to do with it.
There’s no denying it’s increasingly important, as climate change becomes a more pressing issue and business leaders emphasise the value of social impact and lasting value beyond just shareholders.
On the other hand, someone forgot to send the memo to the markets. The unfortunate truth, as Insight Provider Kyle Rudden demonstrated in a recent Insight on Smartkarma, is that ESG concerns don’t really move stock prices.
“By definition as non-financial data, ESG is always one or more degrees of separation from what really matters. ESG must impact financial metrics before manifesting, indirectly in prices,” he wrote.
Read Kyle Rudden’s full Insight: ESG and Stock Prices: Fat-Tail Events
For example, Rudden looked at the stock performance of six major pharmaceuticals that were involved in the US opioid crisis – which costs the US economy around US$100 billion annually. The impact to stocks like Johnson & Johnson was negligible, even though the company and others like it faced lawsuits and condemnation over their role in the situation.
Despite this, investors might have good reason to pay more attention. A recent report by sustainable investing advocate Ceres found that around 73 major US companies’ earnings took hits due to extreme weather events and supply-chain disruptions related to climate change increased by 29 percent.
A different study by the same company estimated that climate change-related factors could put almost US$1 trillion at risk.
Whether or not ESG-minded investing can have an impact in modern business and investment, there are key players in global markets that take it seriously. And while one might not expect exchanges to lead the charge on this, a survey by the World Federation of Exchanges begs to differ.
Among other findings, the survey noted that a majority of exchanges report some ESG activity (and most of those through some formal initiative), take steps to improve ESG reporting by issuers for investors, focus on their own ESG disclosures, and cite global sustainability concerns as their motivation.
Kyle Rudden wanted to go deeper, so he analysed 22 financial exchange stocks across 33 countries, totalling US$69.1 trillion in aggregate issuer market capitalisation.
To carry out his analysis, he measured each exchange on its proactiveness in facilitating ESG disclosure for its listed companies, and its own ESG performance. This gave him a total “ESG’ness” score.
He wrote up his findings in this comprehensive Insight. The whole thing is a great read to get the full picture, but it’s worth noting a couple of findings:
For one, Asia-Pacific exchanges seem to be leading the charge in ESG, with five out of the top 10 exchanges being based in Asia. HKEX topped the list, which also included Singapore Exchange, Bursa Malaysia, Japan Exchange Group, and BSE.
Read Kyle Rudden’s full Insight: Asia Exchanges Lead in ESG: HKEX, JPX, SGX
This contrasts nicely with the consensus back when Rudden first started looking into ESG investing (when it wasn’t even called ESG yet): that it was led by Europe, was set to grow in the US, and would never catch on in Asia. “I am ecstatic to see how wrong that view was, and how far the region has come. Not just ESG acceptance, but ESG leadership,” he writes.
Another interesting finding was that size of the exchanges didn’t really matter in this analysis. “The average market capitalisation of the top 10 stocks (the exchange market cap this time) is in line with the average (US$14.6 billion vs. US$15 billion), and the largest of the large didn’t make the top ten,” Rudden notes.
European Banks Drive Change
Despite any scepticism one might have about the virtues of ESG principles, the above analysis shows that several major financial institutions are taking them very seriously. And they’re not the only ones.
Last week, the European Investment Bank (EIB) made waves with its announcement that it would no longer fund fossil fuel projects from the end of 2021 onwards. Regardless of where one stands on this issue, there’s no denying the weight of this decision. EIB is one of the biggest public lenders in the world, having loaned US$61.9 billion in 2018, according to DW.
In the vein of his previous analysis, Rudden took the opportunity to score major global banks on how they approach fossil financing. He acknowledges that this type of investment still matters, and will continue to matter, from a purely economic standpoint – especially since fossil financing is not limited to just one sector or industry.
Nevertheless, he found that European banks are particularly well-behaved in this regard – unsurprising, since Europe has always been more climate-progressive than other regions.
Read Kyle Rudden’s full Insight: European Banks: Exemplars of Climate Finance
US banks were, equally predictably, some of the worst performers in the analysis. “In the three years since the Paris Climate Agreement, the world has financed US$2.0 trillion worth of fossil projects. Of that, 54.8 percent was by North American banks and 37.1 percent by US banks,” Rudden notes.
APAC banks take a fairly middle-of-the-road approach here, unlike their exchange compatriots.
Considering this data and global trends and developments, Rudden says it would be wise for investors to “avoid the worst financiers of global warming, and for other stocks to emphasise reductions in fossil activity and adoption of environmentally-proactive policies.”
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