Both companies and investors are feeling the pressure of sustainable practices however, a lack of clarity surrounding environmental, social and governance (ESG) terminology, benchmarks and policies threaten to hinder the economy’s adjustment to climate risk.
According to a study by S&P Global titled Accounting for Climate: The Next Frontier in ESG, there is still a significant cause for concern that corporations and sovereigns are not acting quickly enough to address the issue of climate risk.
For this issue to be resolved, a common framework for communicating the standard and practices of sustainable investing needs to be put in place by regulators and policymakers.
S&P Global believes internationally developed principles for sustainable investing will encourage more investors to increase exposure in clean energy and sustainable infrastructure.
There are roughly 130 banks with $47trn in assets that have signed up to the Principles for Responsible Banking, a commitment designed to drive and transition to sustainable economies.
Investors are showing there is a demand for ESG-screened products. In April, UBS launched the first ETF tracking the S&P 500 ESG index and has racked up over $230m in assets in six months. Additionally, its performance is matching its benchmark, the world’s most popular index, the S&P 500.
Comparing UBS S&P 500 ESG UCITS ETF (5ESG) with its parent product, the UBS S&P 500 UCITS ETF (S5USAS), the returns have been closely matched. The six-month returns for 5ESG and S5USAS are 3.44% and 3.16%, respectively, which puts the ESG product slightly in favour.
5ESG (Black) and S5USAS (Yello) six-month performance - Source: Bloomberg
There have been several arguments supporting the fact that sustainable investing does not need to negatively impact returns, however, it is also being argued that the exclusion method does not work for ESG.
While investors seek to pour more cash into ESG products, they have also experienced pressure from shareholders and activists to pull their investments in carbon-intensive industries such as energy. Lyxor Asset Management has implemented a climate policy for its responsible investing strategy.
The European Union is far ahead of the US when it comes to transitioning to clean energy and climate risk due to the fractious political climate causing a divide within federal policy in the States.
Michael Wilkins, head of sustainable finance at S&P Global Ratings, believes there are other challenges within the green bond market despite its growth in size and popularity.
Wilkins said: “The pricing of green bonds does not correlate with the environmental impact being provided by the green bond and that is something we think will change over time.
“You usually see a correlation between the credit spread and the credit rating so the higher the rating, the smaller the spread to reflect risk or lack of risk. At the moment that spread advantage is not correlated to the greenness of the bond.”