ESG has nowadays become a buzzword, something everyone has heard and recognized as being a disruptive force of change on how companies will conduct business in the next few years.
It might then be worth spending a few words on how Environmental, Social and Governance factors truly affect a company’s performance and how measuring and improving them is fundamental to guarantee a path of sustainable growth.
First of all, a Governance system not aligned to market best practices and/or not adequate to a company’s characteristics (in terms of size and complexity), as well as weaknesses in the environmental or social issues, may have a negative impact on the company’s performances and/or on its sustainability.
As a matter of fact, focusing on ESG factors can result in improved productivity and value added as well as improved company's reputation. ESG elements allow investors to better differentiate risk and identify companies where negative factors may result in a deterioration of the company's performance over time and ultimately of its creditworthiness. Environmental, Social and Governance elements are now the starting points to determine the medium-long term success of a company. In fact, several studies have demonstrated the positive relationship between high performance on relevant ESG issues and superior financial performance. For instance, between 2012 and 2015 companies with the highest ESG ratings outperformed the lowest-rated firms by as much as 40% . Sustainable investing is about materiality, meaning that a company spending vast sums of money trying to address every ESG issue will likely see its financial performance suffer; however, companies that focus on material issues tend to outperform those that don’t. For example, material issues for companies in food retail and distribution include greenhouse gas emissions, energy management and fair labour practices to mention a few. While for media services, the list includes energy management, data security, diversity, inclusion and competitive behaviour.
But, the ESG focus is not only related to how a firm can improve its performance by working on its internal ESG factors. It also involves an enhanced use of finance to support the adoption of ESG elements by companies and contributes to the overall increase of sustainability of the economic systems.
In addition to very well-known green bonds, other ESG products are rising in popularity globally. These products include green loans, green mortgage and many others and they will play a very important role in the future due to stakeholder benefits.
If benefits of these types of products have been confirmed by several analysis, at the same time, many challenges have risen. For example, considering the issuance of Green Covered Bond on a portfolio of residential buildings, the chance of labelling the assets is strictly related to existing energy-efficient data, i.e. EPCs. Financial institutions willing to issue Green Covered Bond products may face severe difficulties identifying the buildings' energy efficiency in their portfolio and complying with the market benchmarks (e.g. top 15% of the existing stock in the country). This complication especially holds when the EPC information is not stored in the datasets as for most European financial institutions that only recently have started gathering energy efficiency information related to the assets they financed, when available.
In addition to that, the development of a viable ESG framework that can be widely used and applied to all companies and use cases presents several challenges, specifically in the context of green finance...
Mr Giordano Giulianelli and Mr Federico Fontolan.
Click here to read more.