Can investors drive the global ESG agenda?

“Activity follows capital and capital follows returns. When money moves, things get done,” argued Bill Green, Managing Partner of Climate Adaptive Infrastructure recently. So, can international capital and institutional investors drive real and sustainable progress on the ESG agenda?

“It wasn’t that long ago you had to convince the big investors that ESG was directly relevant to what they were doing. With the way the market and society have moved in the past year, no one needs convincing anymore,” notes Clark Savolaine, a Director with KPMG in Canada’s Deal Advisory – Infrastructure practice.

“We are committed to being a responsible asset manager for our clients,” argues Darryl Murphy, Managing Director, Infrastructure at Aviva Investors in the UK. “That means we are placing a greater focus on ESG impact as opposed to just ESG risk, ensuring these factors are considered in every investment we make and throughout the investment lifecycle. Asset managers can no longer afford to wait until their clients demand more ESG focus; it is their responsibility to lead the way.”

It's not just Aviva Investors placing greater focus on ESG impact. The trend is spreading – according to stats recently published in the Economist, on average, two new ESG funds are launched every day and so far this year, inflows into ESG funds accounted for about a quarter of the total, up from a tenth in 2018.¹

Many investors now recognize that the primary motivation for ESG is not corporate stewardship or making community impact, it’s about creating and preserving value. “Investors need to recognize that you can’t un-fry an egg,” notes Green. “If you are investing in a toll road that sits below sea level, you can’t just move it if the area floods due to global warming. You are going to lose money on that proposition.”

ESG is complex. And it now includes an increasingly diverse set of issues, challenges and priorities. Knowing where to focus can often be challenging. For the larger institutional investors – the large pension, sovereign wealth and infrastructure funds, for example – that has led to a broadening of scope on the ESG agenda.

“Some of the areas of concern are fairly obvious – human rights, community impact and workplace safety, for example,” explains Savolaine. “But the ESG agenda also now includes things like cyber security, operational resilience and even political and social issues. We’re seeing a lot of these topics rise higher up the agenda for institutional investors.”

For Green, the broadening of the ESG agenda serves as a distraction from the real ‘big issue’ of the climate crisis. “If you knew your house was on fire, you would be 100 percent focused on putting out that fire. The climate crisis is that fire. But we are diluting our focus through a complex, multi-faceted dialogue about ESG,” argues Green. “We’re investing about US$2 trillion a year into the infrastructure that will largely determine our climate future. I would argue that this is about focus. And climate crisis considerations need to be the focus of our infrastructure investments.”

“We continue to make increasingly strong commitments in relation to climate change, and our commitment to combating it has not wavered,” notes Murphy. “But I believe the experience of the global pandemic has elevated the ‘S’ in ESG, particularly in the context of real assets, where there is a strong connection between assets and the local community. We recognize that our investments need to contribute to a healthy, fair and connected society – and one that actively accounts for wider stakeholder groups.”

Evidence suggests that many of the larger institutional investors are taking a much broader approach to their ESG activities. They are evolving their conversations about climate impact to drive action across the ESG agenda – through their portfolios and into their assets.

We increasingly talk with asset owners and managers keen to enhance and broaden their ESG strategy as a core value driver for their businesses. Most are working on how to properly measure, manage and report their activity and progress.

At Aviva Investors, for example, Murphy’s team has developed an in-house ESG scoring system that assesses all potential investments on a range of factors including climate risk. “We have also developed sustainable transition loan impact frameworks to guide ESG impact where relevant,” he notes. “And within Real Assets we have set a series of clear objectives such as our commitment to invest GBP2.5 billion in low-carbon and renewable energy infrastructure and buildings by 2025.”

“There are a million competing ways to evaluate all of this and integrate it into your decision making and reporting. I think many institutional investors are struggling to decide how best to do this for their portfolios of assets,” adds Savolaine. “There’s also a lot of work going on to tie results and CEO compensation to something more than just financial metrics at the portfolio company level.”

While Savolaine certainly does not disagree that climate change is likely the most pressing of the ESG agenda items, he has been advising his clients (which include many of the world’s largest pension and sovereign wealth funds) to think more holistically about the various social risks and opportunities related to ESG.

“Everyone is now sensitive to the potential for large, unforeseen social disruptions. And they are recognizing that these events can be driven by a range of trends, climate included. That is leading them to create and drive a much more consistent approach to ESG across their investments and their asset monitoring framework,” notes Savolaine.

“The focus on ESG is pervasive across our organization, catalyzed in different ways,” adds Murphy. “Our governance structure ensures ownership; our planning and review processes ensure accountability; our reporting ensures alignment to our goals; our reward frameworks incentivize employee engagement; and our subject matter experts deliver advice and support across the organization.”

Given the direct impact infrastructure has on peoples’ daily lives, it is clear it has a massive role to play in the delivery of ESG goals globally. And that means we should think more clearly about how the investments made today are supporting the outcomes we want for future generations.

“The assets we build today will do what we built them to do for the next 100 years. So why would you want to build something you know we can only use for the next 5 to 10 years? It’s nuts,” argues Green. “Any investor or allocator of capital that fails to embrace climate adaptive infrastructure is going to lose money. It’s only a question of when and how much.”

KPMG’s conversations with many of the larger investors suggest they already understand this and have been fairly active shifting their investment portfolios and working with their portfolio companies to respond. That may leave the slower asset managers behind the curve. And in this highly competitive industry, investors can’t afford to fall behind.

“To remain competitive, asset managers need to be proactive in their approach to ESG investment and reporting. We believe our leading position as a responsible investor not only supports our clients and benefits society but also our overall business,” argues Murphy.

Clearly, investors have a role to play in driving the ESG agenda. But exactly what that role is, where they should be focusing, how they should be measuring results, and how they should be reporting them are questions that are still taking shape.

Ultimately, institutional investors should step forward. They play a critical role in informing the new ESG agenda; their voices must be heard.