There has been a tectonic shift in how financial capital is allocated over the last decade. Responsible investment strategies with an environmental, social or corporate governance (ESG) focus are now a critical consideration for shareholders, investors and asset managers alike, and correspondingly, those seeking to access that capital.
As the world population nears 7.6 billion and the earth's ecological boundaries are strained, public and private capital is increasingly being mobilised towards sustainable investment options, as technology combines with financial capital creating a paradigm shift in what constitutes shareholder value.
Whilst ethical or socially responsible investment has been around for centuries (think the Quakers and Methodist religious movements in the 19th century), the Australian responsible investment market has exploded from its nascent state in the late 1980s to more than $622 billion in assets under management (AUM) in 2016, with nearly half (44%) of Australian assets under management now being invested through some form of responsible investment strategy (whether it be a broad ESG filter or screen or purer, core socially responsible investment (SRI) offerings, including social impact funds and bonds). This has also seen an accelerating shift in investment from broad ESG to core SRI funds, with the latter growing at an exponential rate now representing over 10% of SRI and 5% of the total market. Recent research also demonstrates outperformance of SRI funds compared to mainstream funds over a 10 year cycle.
The Australian experience reflects global trends with the United Nation's supported PRI's launch of responsible investment (RI) principles in 2006 and a gathering of momentum in the past few years with the UN's Sustainable Development Goals released in 2015, the landmark 2015 Paris Agreement tackling the impacts of climate change and the recent Taskforce for Climate Related Financial Disclosures, all highlighting the role of private capital in enabling the economic transformation required to meet sustainable development goals and climate mitigation and adaptation strategies.
The coming tipping point in RI (where the majority of Australian AUM will be SRI badged or aligned) and the exponential growth in core SRI funds, green and climate aligned and social impact bond markets are simply a few indicators of this tectonic shift.
The growth of RI reflecting changing community expectations and preferences has led to new financial products and asset classes emerging and marketed to different investor groups, across a spectrum of financial and social risk and reward appetites – from investors seeking maximum financial return, with the "conscience protection" of some ESG or social impact benefit, whilst at the other end of that spectrum, there are those with a focus on maximising social impact, with some capital protection or financial return. Investment products are being developed to cater to these differing appetites and this alternative asset class also provides risk diversification benefits – over and above the social benefits.
Another factor in the sustainability drive, is the broadening of the fiduciary duty beyond shareholder primacy – there has been a long debate over the need to change company directors' statutory and fiduciary duties to broaden the extent to which directors can – or must - have regard to other stakeholders, beyond shareholders (creditors, suppliers, employees, the environment, community and so-on), however, we have now seen a number of prominent legal counsel warn of the risks to directors in ignoring ESG and sustainability factors in discharging their due care fiduciary duty if they fail to fully consider the physical impact and economic transition risks posed by climate change on their businesses – and, in another emerging trend, recently a class action has been launched against a major bank and its directors in relation to the failure to make appropriate climate risk related disclosures.
Critically, the market has also moved and we have seen the world's largest shareholders (such as BlackRock and Vanguard) warn investee boards that they will use their influence (money and voting power) to ensure that the companies they invest in appropriately recognise, manage and disclose climate and sustainability risks (and opportunities) in their businesses. The consequence for failure – removal from office and denial of capital.
Accordingly, despite allegations of "fake news", the trashing of the media and a broader challenge to reason and the scientific approach, building the evidence base and gathering the data to build the necessary data sets and financial models for informed decision making (and for required market disclosures) has never been more critical. Data analytics, sensitivity analysis and modelling skills are essential for corporate survival and access to capital. This is all heavily dependent on technology and computing power.
The market is demanding that company's (both big and small) demonstrate their long-term sustainability and management of capital, not simply financial capital – but human, intellectual, natural, social, reputational and other capital forms that go to social licence, brand and reputation. Larry Fink, CEO of BlackRock, the largest asset manager in the world (with over USD5tn in AUM), in a letter to CEOs noted that “ESG factors relevant to a company’s business can provide essential insights into management effectiveness and thus its long-term prospects".
This push to gather evidence and undertake the required analysis as part of the corporate survival strategy, feeds into the other major tectonic shift - the rise of 'big data' or the data ecosystem. Advances in computing power and storage (the proliferation of the internet, APPs, the advent of the cloud), 10 years of the smartphone, computer sensor ubiquity, the emerging Internet of Things and Artificial Intelligence - all embodying the power of Moore's Law – have provided new tools to extract economic value from data. Data analytics provides new means of identifying trends or correlations, develop preventative strategies, shave costs, increase revenues or change or disrupt business models – all delivering value.
The increasing and integral role of technology and data analytics is combining with responsible financial capital to tackle social and ecological issues and drive innovation and new approaches to such issues.
The power, agility and mobility of private capital and the emerging business for purpose models, coupled with the speed and depth of technological advancement and human ingenuity, provides a reason for optimism in our ability to tackle the many social and ecological challenges we currently face.
Increasingly, business decisions are evaluated as sound and sustainable choices when they serve to deliver not just a financial return, but also positive impact on the environment and society. Decisions purely intended to create financial shareholder value, but which destroy environmental and societal value, will place any business' long-term viability in jeopardy.
The shift in shareholder mindset from a traditional focus solely on financial outcomes, to choices in terms of environmental and social outcomes and best practice governance will impact all levels of the market, from small business to multinationals, for profit and non-profit entities alike and clearly has broader societal and community benefits.
Quantifying environmental and societal risk and reward is a difficult process in terms of monetary value, particularly within current economic models and historic cost management and financial accounting frameworks, but international accounting bodies and standard setters – are developing and refining those accounting frameworks and standards for measuring the use of natural capital in supply chains, GHG emissions and other externalities to bring those costs into the pricing and value chain. Likewise, social impact measurement is a burgeoning discipline seeking to evaluate the social return on investment of programs.
This again reinforces the role of technology and the importance of collecting data and building databases to enable more granular decision making and a transition to a more sustainable economic model, better accounting and reporting frameworks and pricing approaches. Without under-estimating the scale of the challenge of adaptation, over time this approach will lead to better and more sustainable resource allocation – and allocation of capital to truly sustainable business. This will take time, but the process needs to start somewhere.
Those businesses which are able to adapt in this environment will be rewarded with capital and will survive and thrive, others will fall by the wayside. The benefits to society from this approach will be manifest, and as BlackRock's stewardship statement makes clear, this is being demanded by those who hold the financial capital of those who seek access to it.
Big data can help paint a picture that executives can understand and act on. Those businesses that choose to act, develop and scale will be rewarded with access to capital, those that can't will be denied. This approach provides a pathway to a more sustainable and productive global economy and one which can meet the challenges we currently face.
