Investors of every stripe are increasingly using Environmental, Social and Governance (ESG) data to design their portfolios. While pension funds, insurance companies and sovereign wealth funds have led early ESG integration, mainstream banks are following suit with significant commitments to sustainable finance. Last month, several prominent banks announced programs that indicate the further maturation of global environmental finance and the Green Bond market.
- Citigroup announced a $100-billion commitment to finance climate change mitigation activities, doubling the amount it allocated to such projects in 2007. Over 10 years, the capital will support a wide range of projects to reduce GHG emissions, enhance resource efficiency, and improve infrastructure for clean water procurement, waste management, and green housing.
- Deutsche Bank committed to investing €1 billion in green bonds, environmentally focused securities that encourage sustainability, and the development of brownfield sites. This amount adds to the €200 million that Deutsche Bank has already invested in green bonds and it follows a similar commitment from Barclays last September.
- Also in February, the Bank of England (BoE) published a research agenda acknowledging the impact of climate change on financial markets. While BoE’s previous work on climate change focused on insurance companies’ adaptation to extreme weather events, the paper notes the “impact of environmental change is not limited to the insurance industry.” Instead, BoE highlights the widespread risk to financial stability posed by resource scarcity and possible ‘stranded’ assets in a low-carbon economy. BoE plans to further examine the role of central banks in addressing this systemic risk.
These recent commitments are indicative of growing interest in sustainable investing by major players in the financial industry, and the significant expansion in ESG assets under management. For example, the UN Principle for Responsible Investment (UN PRI) now has nearly 1,400 signatories, up from just 100 in 2006. This represents over an eleven-fold increase in signatories’ collective assets over 9 years, from $4T to $45T. Within the US, assets under management using ESG strategies grew 76 percent from 2012-2014, and now account for “more than one out of every six dollars” under professional management.
More and more individual investors are also interested in sustainable investing, with millennials and women leading the way. According to a recent Morgan Stanley survey, 65 percent of individual investors (n=800) expect sustainable investing to become more prevalent in the next five years. The survey indicates that millennials are the most open to sustainable investing (84 percent) compared to Gen X (79 percent) and Baby Boomers (66 percent), and that women are twice as likely as men to consider the impact of their investment when making an investment decision.
Growing market penetration of ESG financial products and new environmental indices are facilitating sustainable investment decisions. While major vendors such as Bloomberg, MSCI and Thomas Reuters have offered ESG data on their terminals for several years, green bond indices are just emerging. 2014 saw the launch of three new indices: the S&P Green Bond Index in July, the BofA Merrill Lynch Green Bond Index in October, and the Barclays MSCI Green Bond Index in November. The appearance of these indices reflects the swift growth of this asset class; green bond issuances reached $36.6 billion in 2014, more than triple the amount issued in 2013.
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Banks are also leading efforts to standardize practices in the green bonds market. 13 prominent investment banks, including Deutsche Bank, Citi and BofA Merrill Lynch, were original signatories of the Green Bond Principles (GBP), guidelines to encourage transparency in the development and issuance of green bonds. Published by Ceres, the GBP recommend processes for project evaluation and selection, management and use of proceeds, and reporting. Projects recognized by the principles include renewable energy and energy efficiency, waste management, land and water use, biodiversity conservation, and clean transportation.
Despite the significant expansion of ESG investing, its advancement is still hindered by predominant short-term planning horizons, the discounting of low probability events (e.g., environmental disasters) in calculations of returns, the challenge of valuing intangible assets, and the neglect of systemic risk analysis. Further, activities supported by the green bond market vary widely and standards are still emerging on what constitutes “green.” This nascent bond market is simply too new for indices to fully function as asset class benchmarks.
Still, there is growing consensus that sustainable investments are financially prudent. For example, the majority of individual investors (72 percent) surveyed by Morgan Stanley believe companies with strong ESG practices can achieve higher profitability. Similarly, Citigroup CEO Michael Corbat emphasized the pragmatism of Citi’s sustainability commitments, writing in a statement: “These efforts do not constitute philanthropy, nor do they represent costs. In fact, they reduce costs — and also increase revenues, enhance client relationships, and help manage risk.”
To more and more investors — small or large, individual or institutional — sustainability just makes sense.