Did you know that the value of ESG ETF Assets Worldwide has been rapidly rising over the last few years and is currently 378bn USD[1]? This article explains how this trend came to be and what eventual caveats ESG brings with it.
To combat climate change, an international accord was adopted in 2015 by the majority of nations called The Paris Agreement. This agreement sets a legally binding treaty on climate change, which aims to limit global warming well below 2 degrees Celsius. Preferably to 1.6 degrees Celsius, compared to pre-industrial levels.
What followed?
Following this accord, the European Green Deal was approved in 2020. It is a set of policy initiatives by the European Commission with the overarching aim of a climate-neutral European Union (EU) in 2050. The 2030 Climate Target Plan aims to reduce Greenhouse Gas (GHG) emissions by 55% compared to 1990 levels as part of the European Green Deal. To achieve these goals, existing legislation needs to be reviewed on its climate merits. Additionally, new legislation is introduced on subjects such as the circular economy, building renovation, biodiversity, farming, and innovation.
Numerous parties have already aimed to gain insight into their sustainable activities and how to expand them. However, these initiatives created an opportunity for greenwashing. To prevent greenwashing and accelerate the transition to a sustainable economy, the EU created legislation to obtain a standardised process of reporting on a company’s sustainability and require companies to report on sustainability metrics.
“Greenwashing is a form of marketing spin in which green PR and green marketing are deceptively used to persuade the public that an organisation’s products, aims and policies are environmentally friendly.” [2]
Who followed?
Industries like oil, mining, and passenger transport are not the only ones that have to take action and responsibility in the context of climate change. Legislators also look at financial institutions and how they contribute to climate change mitigation.
Multiple regulations have been introduced to ensure that corporations take responsibility. Amongst others, these include:
- EU Taxonomy: classification of the corporation’s activities that are considered sustainable.
- NFRD: compels large corporations to disclose non-financial metrics. For example, the intensity of investments that result in GHG emissions.
- Pillar 3: provides a standardised process for reporting sustainable metrics.
Implications of ESG
To adhere to those regulations, companies need to gain insight into the physical and transitional risks they are prone to. Physical risk entails the chance that a company is exposed to as a result of climate change. For example, the flood in Limburg of summer 2021 had a death toll of at least 38 people and a financial impact of more than 38 billion euros in five countries.
As a bank, would you finance real estate in a high-risk environment?
Transitional risk can occur when moving towards a less polluting, greener economy. Such transitions could mean that some sectors of the economy face significant shifts in asset values or higher business costs.
What is the impact of phasing out non-sustainable assets on portfolio performance?
ESG, A new way of finance?
When financial institutions are giving insight into the volume of products and portfolios classified as green, the likely next step of the legislators is to assign thresholds to the sustainable metrics. The thresholds could limit the ease of receiving financing.
Do you think banks will choose to exclude non-sustainable projects for financing to meet the thresholds set by the legislators?
A new chapter is heading towards the financial industry, with Environmental Social Governance (ESG) as a new insight into the degree of sustainability of the financial world industry. Ultimately, ESG does not only provide insight, but it is also a risk factor and a metric of success.
If you want to learn more about ESG, or our consulting services, let us contact you, or please feel free to contact the authors of this article:
Jordi Kenswil | j.kenswil@vbadvisory.nl
[2] https://en.wikipedia.org/wiki/Greenwashing
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