Abstract
Sustainable finance proponents argue that integrating environmental, social, and governance (ESG) factors into investment decisions should have a positive long-term material impact on financial performance and ultimately benefit wider society as a whole. This chapter is based on interviews and an ESG materiality survey that was run among 20 prominent South African asset managers. The results demonstrate that if there is a growing awareness of ESG factors among the respondents, there are some perceived tensions around how to practically embed ESG factors within investment processes. In addition, the results show that the integration of ESG factors into financial valuation are not yet mainstream and that more needs to be done to demonstrate how the integration of ESG factors within investment processes materially impacts financial performance and meanwhile contributes to the sustainable development of economies.
TopIntroduction
This chapter investigates the role of ESG factors and their materiality in sustainable finance by exploring how asset managers in a given emerging market context, South Africa, understand and integrate ESG factors in their investment processes. In this chapter, sustainable finance refers to any form of financial service integrating environmental, social and governance (ESG) criteria into the business or investment decisions for the lasting benefit of both clients and society at large. These last five years, sustainable finance has become a growing phenomena notably in Europe and the United States which mainstreamed and regulated appropriately could positively impact the long term sustainability of our globalized world that has been shaken to its core by the current pandemic. It is then of utmost importance to inquire further how sustainable finance is taking roots not only in developed economies but also in the the greater South including the African continent.
Carroll, Pawlicki and Schneider (2013: 2) provides a first definition of materiality: ‘a matter is material if it is of such relevance and importance that it could substantively influence the assessments of providers of financial capital with regard to the organization’s ability to create value over the short, medium and long term.’ In this chapter, under the term ESG materiality, we are particulary interested by the the fact that different ESG factors can be considered more or less material by investors whose job is to assess whether organisations are creating financial value over the short, medium and long term. Some research has shown that companies that address their material sustainability issues outperform the market over time (Khan, Serafeim and Yoon, 2016). In addition, following a survey of 582 institutional investors and 750 retail investors, Eccles et al., (2017) found the results strongly supported the importance of materiality, which make them conclude that full ESG integration can lead to the creation of value for both investors and society as a whole. However, discussions and explorations are still ongoing between practitioners, policy makers and academics about how to define the financial materiality of integrating ESG factors versus its ‘sustainability materiality’ (Bansal & DesJardine, 2014; Flammer, Hong and Minor, 2019) also known as ‘double materiality’ (Responsible-investor.com, 2021).
Supported by interviews and an ESG materiality survey with 20 South African asset managers representing approximately over 67% of assets under management (AUM) in the country (see Appendix 1), the main goal of this chapter is to provide background empirical insights on what ESG materiality is and the shapes it takes within an emerging market investment industry such as South Africa. To contextualise our empirical insights, we discuss first some academic and practitioners considerations around ESG factors and their potential materiality. We end this chapter with a discussion of what the next steps are to see further convergence and integration between investment processes and ESG factors.
Key Terms in this Chapter
Financial Valuation: A quantitative process of determining the fair value of an asset or a firm.
ESG Materiality: The active search by investors for understanding, calculating and reporting about the financial and potentially the sustainability impact of integrating ESG factors within their investment processes.
ESG: Environment, social, and governance.
ESG Integration: One of the most common investment strategy in Sustainable Finance. This refers to the systematic integration ESG factors into investment analysis, valuation, and decision making based on appropriate research ressources and metrics.
Sustainable Finance: There are nowadays many slightly overlapping definitions of sustainable finance. In this chapter, we define sustainable finance as any form of financial service integrating environmental, social and governance (ESG) criteria into the business or investment decisions for the lasting benefit of both clients and society at large. Activities that fall under the heading of sustainable finance, to name just a few, include sustainable/ESG/SRI funds, green bonds, impact investing, microfinance, active ownership, credits for sustainable projects and development of the whole financial system in a more sustainable way.
Investor Engagement: Investor engagement is about seeking to influence company be behaviour by actice ownership through proxy voting, board participation, and/or engagement with companies on ESG matters.
Institutional Investor: A legal entity that has obligations in terms of investment analysis, activities, and returns to ultimate beneficiaries. Examples of institutional investors include pension funds, insurance companies, sovereign wealth funds and mutuals funds. Institutional investors are sometimes called asset owners.
Sustainable Investment: As a sub-category of sustainable finance, sustainable investment can be defined as an investment approach that “considers environmental, social and governance (ESG) factors in portfolio selection and management.” Sustainable investment activities and strategies encompass negative or exclusionary screening, positive/best-in-class screening, norms-based screening, ESG integration, sustainability-themed investing, impact/community investing and corporate engagement and shareholder action. Sustainable investment can be also be called socially responsible investing, ESG or responsible investing.
Sustainability: Focuses on meeting the needs of the present without compromising the ability of future generations to meet theirs. The concept of sustainability is composed of three pillars: economic, environmental, and social, that stakeholders (including investors) should strive to make work in harmony and in the respect of the world’s resources limitations.
Asset Managers: Term used in the financial sector to describe people and companies who manage investments on behalf of others. Those include, for example, investment managers that manage the assets of a pension fund.
Double Materiality: Double materiality refers to the inclusion of information about how an entity impacts social and environmental issues, as well as how such issues may impact financial performance.
Financial Analyst: An investment professional also known sometimes as fundamental analyst focussed on assessing the financial condition of a business or asset to inform the investment decisions of an investor.
ESG Analyst: A specialised analyst also known sometimes as sustainability analyst focussed on analysing ESG risks and opportunities as they relate to investment activities.