A complete history of the consideration of environmental, ethical, and social factors in investing would go back at least 2,500 years, to biblical prohibitions on the charging of interest on loans, or possibly another thousand years beyond that to Urukagina’s legal reforms (aka “governance code”) in the city of Lagash in early Mesopotamia. This post is not that history. Instead, I’m going to skip ahead to just a few years ago, and the transition of ESG investing (as it’s currently referred to) from the periphery of professional investment management into the mainstream.

The separation of business and finance from the social context in which it occurs is, from a historical perspective, a fairly recent phenomenon. But by the late twentieth century, as far as professional investment management was concerned, there was basically just one measure that mattered: money. Broader social or environmental impacts were treated as largely irrelevant, with rare exceptions such as the anti-apartheid movement or divesting from the manufacturers of biological and cluster munitions.

What caused this to change was an emphasis by proponents on the financial risk aspects of ESG factors. The argument, in effect, that this stuff does affect the money.  At a time when environmental and social concerns – with climate change to the fore – were very much top of mind for the broader public, this approach resonated.

So there was a receptive audience, for example, for a well-crafted report such as the Carbon Tracker Initiative’s 2011 paper Unburnable Carbon: Are the World’s Financial Markets Carrying a Carbon Bubble? This paper established the concept of stranded assets by demonstrating the discrepancy between the volume of global fossil fuel reserves held on company balance sheets and the volume that the scientific community consider can be used without driving atmospheric concentrations of greenhouse gases to unacceptable levels. That being so, it is not possible to meaningfully analyze a company whose balance sheet includes significant amounts of fossil fuel reserves without considering the risk that a large part of those reserves might ultimately prove unusable.

So it was an emphasis on financial materiality that opened the door to paying a lot more attention to things that had previously been seen as outside the domain of serious investment. But – as I noted in a previous post – when that door opened, what walked through was not just the financial implications. The full impacts go far beyond the financial realm: even though those considerations are financially material, their impacts are not primarily financial, and most asset management organizations aren’t quite sure how to handle that. The struggle that I talk about in that post is where we are today. 

What comes next for ESG investing?

The current situation is one of rapid development on multiple fronts. In some ways, ESG is becoming just part of investment. The observation that different investors have different sustainability preferences is becoming no more remarkable than saying that they have different risk tolerances. ESG integration into investment processes is far from seamless, but it’s happening. Monitoring and reporting environmental and social impacts will one day be routine. We’re not there yet, but we’re on that path.

In a fast-changing, complex environment such as this, there are few certainties about how exactly that path will go. But looking out to the immediate horizon, here are a few thoughts:

• Consumer preferences will evolve in response to broadening investment product choice. Investment firms will be paying close attention to what types of offering manage to resonate with the market place, and which ones fail to gain traction. The successful products will not only reflect consumer preferences, but refine and shape them.
• Greater delineation of the issues. Humans identify more closely with the specific than with the general. So a broad “environmental, social and governance” story may become subdivided into the particulars: GHG emissions; the health of the oceans; diversity and inclusion; human rights. The list is long. And there may well be surprises in which issues do – and which do not – turn out to dominate.
• The term “ESG investing” won’t survive. It is, itself, a fairly recent term. And as the recognition that ESG factors are financially material becomes more embedded into investment processes, it becomes less and less distinct from simply “investing.”
• There will be a clearer acknowledgement of double materiality. The materiality of ESG factors on financial outcomes is one thing, and the materiality of investment choices on the wider world is another. So, as the term ESG fades, we may hear more about “impact” to refer to that second form of materiality.  
• More regulation. At the last update in Q1, the UNPRI global regulation database listed 868 ESG policy interventions, of which 225 had come in 2021 alone. Although the trend is global, each country has its own emphasis. I’d expect transparency and reporting to continue to be a particular area of focus.
• Proliferation in every area, eventually followed by consolidation. There’s a whole ecosystem of tools, data and analytics required to support greater transparency into what companies are really doing. The market will respond to that demand.
• In particular, expect a far greater richness of ratings. “How great is the financial risk exposure of this entity to ESG factors, including climate change, over a three to five year time horizon?” is not the same question as “What is the environmental footprint of this entity?” or “What is the nature and the scale of the social impacts of this entity?” They are all questions worth asking about any investment holding, but they are different things.

I’d love to hear what others think: what’s right about my list? what’s wrong? what am I missing? So I’ll put a summary of this post onto linkedin – please do head on over there and add your bit.