7.7.2018

What are UN PRI, ESG and SDG to SRI investing?

Pasi Vanttinen, Managing partner, Vana Capital & Ventures

Investors are more concerned about the sustainability in the planet. UN Principles for Responsible Investments (PRI) have over 1800 signatories and over 68 trillion USD in capital commitments by 2017. Sustainable, Responsible and Impact (SRI) investment market have grown to 22.9 trillion USD in 2016.

Sustainable and Responsible Investingaims to incorporate environmental, social and governance (ESG) factors into investment decisions for better risk management and more stable long-term returns.

Impact Investing aims to incorporate environmental or social factors into its investments decisions to get positive measurable impact in sustainable development along with the financial returns.

United Nations launched a set of six investment principles encouraging the incorporation of ESG factors into investment practice in 2006. These Principles for Responsible Investment (UN PRI) were developed by investors for investors and major financial institutions to create more sustainable global financial system.

There are different ESG approaches and strategies from exclusionary screening to active ownership, which have positive effect on society and environment. Impact investing goes further with positive social or environmental impact. UN Sustainable Development Goals are targets for positive sustainability impact.

UN PRI, ESG and UN SDGs have different frames for factors, which are used in guiding and in measuring of results either to positive effect in society and environment or positive impact in society or in environment.

UN Principles for Responsible Investments (PRI)

The appetite for sustainable and responsible investing with UN PRI commitments have continued to grow with concerns over climate change, pollution, economic/social exclusion and other issues in sustainability.

UN PRI aims for guiding and in providing measuring frame for investments to make positive effect in society and environment, and enabling better long-term returns and more sustainable global financial system.

What are the key 6 UN PRIs and related investors actions?

Principle 1: Investors will incorporate ESG issues into investment analysis and decision-making processes.

Investor actions includes:

  • Addressing ESG issues in investment policy statements;
  • Assessing the capabilities of internal investment managers to incorporate ESG issues;
  • Assessing the capabilities of external investment managers to incorporate ESG issues;
  • Asking investment service providers (e.g. financial analysts, research firms or rating companies) to integrate ESG factors into evolving research and analysis;
  • Advocating ESG training for investment professionals.

Principle 2: Investors will be active owners and incorporate ESG issues into ownership policies and practices.

Investor actions includes:

  • Developing and disclosing an active ownership policy consistent with PRI;
  • Exercising voting rights or monitoring compliance with voting policy;
  • Developing an engagement capability and engaging with companies on ESG issues;
  • Filing shareholder resolutions consistent with long-term ESG considerations;
  • Reporting on ESG-related engagement.

Principle 3: Investors will seek appropriate disclosure on ESG issues by the entities in which they invest.

Investor actions includes:

  • Asking for standardized reporting on ESG issues (f.e. demanding the use of GRI standard);
  • Asking for ESG issues to be integrated within annual financial reports;
  • Asking for information from companies regarding adoption of relevant official norms, standards, codes of conduct or international initiatives (such as the UN Sustainable Development Goals);
  • Supporting shareholder initiatives and resolutions promoting ESG disclosure.

Principle 4: Investors will promote acceptance and implementation of the Principles within the industry.

Investor actions includes:

  • Aligning investment mandates, monitoring procedures, performance indicators and incentive structures reflect long-term time horizons;
  • Communicating ESG expectations to investment service providers;
  • Revisiting relationships with service providers that fail to meet ESG expectations;
  • Supporting the development of tools for benchmarking ESG integration;
  • Supporting regulatory or policy developments that enable implementation of the Principles.

Principle 5: Investors will work together to enhance the effectiveness in implementing the Principles.

Investor actions includes:

  • Supporting/participating in networks and information platforms to share tools, pool resources and make use of investor reporting as a source of learning;
  • Addressing collectively relevant emerging issues;
  • Developing or supporting appropriate collaborative initiatives.

Principle 6: Investors will each report on the activities and progress towards implementing the Principles.

Investor actions includes:

  • Disclosing how ESG issues are integrated within investment practices;
  • Disclosing active ownership activities (e.g. voting, engagement, and/or policy dialogue);
  • Disclosing what is required from service providers in relation to the Principles;
  • Communicating with beneficiaries about ESG issues and the Principles;
  • Make use of reporting to raise awareness among a broader group of stakeholders.

The conclusion is that UN PRI are used in guiding and in measuring of the investment results for positive effect in societal and in environmental sustainable development by the investment and financial world.

Environmental, Social and Governance (ESG)

Sustainable and Responsible Investing or “ESG Investing” defines that ESG is the consideration of environmental, social and governance factors alongside financial ones in the investment decision-making.

ESG aims to provide good environmental, social and governance information in order for investors and in investments to have better view of the risks faced by companies and risk impacts to potential returns. The goal is to improve the company or portfolio risk-reward characteristics and long-term ROI outperformance.

Sustainable and Responsible or ESG investing market have grown fast to the size that it is 22.9 trillion USD assets under management according to the reports by GSIA organization members in 2016.

Introduction to ESG factors

Environmental, Social and Governance (ESG) factors are numerous and continuously shifting.

Environmental issues and factors covers climate change, greenhouse gas (GHG) emissions, resource depletion (e.g. water, deforestation), waste and pollution related indicators.

Social issues and factors covers working conditions (including slavery and child labor), local communities (including indigenous communities), health and safety, employee relations and diversity related indicators.

Governance issues and factors covers executive pay, board diversity and structure, tax strategy, money laundering, bribery and corruption, political lobbying and donations indicators.

ESG approaches and strategies

Global sustainability challenges are many and wide in scale from flood risk and sea level rise, privacy and data security, demographic shifts, regulatory pressures to many others. These are introducing new risk factors for investors that may not have been seen and considered previously, but they are relevant now.

There are various types of ESG approaches and strategies, which can be confusing and disputed. Many studies and practical results have shown that companies with robust ESG practices have displayed a lower cost of capital, lower volatility, fewer instances of bribery, corruption and fraud problems.

Five typical ESG approaches and strategies are:

  1. Exclusionary Screening

Negative factors fulfilment in ESG criteria measurement leads to excluding these countries, sectors or companies from investments. The aim is to align investors’ money to avoid the companies with perception of ESG risks or negative impact, and exiting them (f.e. gambling or tobacco companies).

  1. Positive Screening

Investing in funds or in companies having demonstrated positive ESG performance relative to peers. The aim is to achieve superior capital appreciation by mitigating ESG risks and acting on opportunities provided by companies demonstrating good ESG behaviors.

  1. ESG Integration

ESG factors are integrated alongside the financial factors in the analysis of assets by the investment managers. The aim is to improve the long-term risk-adjusted returns, mitigating ESG risks and identifying investment opportunities created or supported by positive ESG change.

  1. Impact Investing

Investing in companies, in organizations or in funds that have the commercial purpose of solving social or environmental problem. The aim is to generate good investment returns by allocating capital to companies creating tangible benefits for society and the environment that will last.

  1. Active Ownership

Engaging with companies on ESG issues and concerns that affect their long-term growth, and using shareholder power to influence their overall corporate and management behavior. The aim is to promote positive change within the companies that strengthen their financial performance, and provide a forward-looking view of good ESG performance to reveal new opportunities for returns.

Links and Differences between ESG and Impact Investing

The conclusion is that ESG is used to gain wider view of the risks faced by companies in environmental, social and in corporate governance matters along with their potential effect in returns. Sustainable and responsible investing with ESG process tries to make positive effect on society and the environment.

Impact investing goes a step further with the purpose of creating a positive social or environmental impact. Impact investing strategies prioritize positive social or environmental impact as a specific objective of the investment along with returns. The positive impact measurement requires different frame and factors.

UN Sustainable Development Goals (SDGs)

UN SDGs are a universal set of goals, targets and indicators for global development, which can be used as important guidelines for positive impact measurement and impact investing. UN SDGs serve as a blueprint and roadmap for positively impacting the global economic, environmental and social development by 2030.

SDGs were born at the UN Conference on Sustainable Development in Rio de Janeiro in 2012. SDGs replaced the Millennium Development Goals (MDGs), which were established in 2000.The SDGs have been adopted by 193 governments, hundreds of cities, thousands of companies and organizations in the world.

There are 17 SDGs that balance three primary dimensions of sustainable development: economic, social and environmental. Achieving these goals will require an estimated annual investment of $5-7 trillion until 2030. Approximately $1 trillion will come from public funds from the UN and member countries, but there are private capital and donations needed to fund the remaining $6 trillionon an annual basis.

Impact Investing and SDGs

As sustainable and responsible investing have become more universally understood option for investments in the recent years. The investment industry has taken steps further by beginning to embrace impact investing. Impact investing has been well established in family offices, non-governmental organizations (NGOs) and social enterprise world, in which it has expanded to the mainstream investment industry now.

Impact investing is focused on providing capital to developing new capabilities, products and companies that address and offer solution to some specific social or environmental problem in the world. These target companies, organizations or projects aim to reduce environmental footprint and resources consumption, improve new energy sources and efficiency, invest in employee skills and knowledge development. These are long-term investments with needing forward-looking companies and sustainable business models.

Positive measurable impact for environmental or social problem is important for impact investing. Impact measurement requires frame, which is good for future goals and targets setting along with needed actions. UN SDGs provide good frame to build needed model for positive impact measurement in impact investing.

Why do SDGs matter for investors?

These 17 SDGs and 169 sub-goals provide the breadth of opportunities to set goals, targets and action plans for more sustainable development along with positive social or environmental impact in the future.

SDGs and sub-goals are addressing issues including from access to clean water, sanitation and pollution management, food and energy security, urbanization, climate change, preservation of biodiversity, improvement of healthcare and education, financial inclusion, promotion of a living wage and quality jobs, and cyber security represent enormous opportunities and challenges needed to be solved in the future.

SDGs could be seen and described as the beta of future growth meaning that companies need to find solutions to address these different under met needs in the global economy. Investing in these can be seen as an opportunity for ensuring financial returns and making positive impact in sustainable development.

SDGs provide a useful framework, in which impact investors can build their measurement frame and factors for positive impact in relation to the achievement of these 17 goals or 169 sub-goals. Governments and cities across the world are introducing regulations and incentives to promote the SDGs, which offers and open up opportunities to invest in along with new business opportunities for innovative companies.

SDGs and commitments have lead many governments and regulators to be determined to align investment and business practices policies with the interests of more sustainable economic, environmental and societal development in the future. Long-term value creation, benefits and impact have become more important than short-term rewards and returns. For example many pension funds have found that impact investing and SDGs with long-term outlook for benefits and returns suits them better than short-term.

SDGs have also become important key frame and factors set for impact measurement models to impact venture capital and private equity investing, which is looking for good returns and positive impact in sustainable economic, environmental and social development globally. So SDGs are not only used for impact measurement in environmental or social problem in impact investing.

Conclusion

We are all concerned about the sustainable economic, environmental and social development in the future.

Investors are concerned about sustainability and resilience, which are important factors in building long-term investment portfolios. These are not only concerns for preserving wealth, but they are also resistant to shocks in the system, through tackling issues such as climate change and poverty. We know that failure to create a resilient system and a more sustainable future will almost inevitably result to damaging heightened financial market volatility and reduction in the net present value of future assets (f.e. pensions).

Sustainable and responsible or ESG investingaims to make positive effect in society and environment with incorporating environmental, social and governance (ESG) factors into investment decisions for better risk management and more stable long-term returns. Impact Investing aims to incorporate environmental and social factors into its investments decisions for positive impact in sustainable development and returns.

United Nations launched a set of six investment principles encouraging the incorporation of ESG factors into investment practice in 2006. These Principles for Responsible Investment (UN PRI) were developed by investors for investors and major financial institutions to create more sustainable global financial system.

There are different ESG approaches and strategies from exclusionary screening to active ownership, which have positive effect on society and environment. Impact investing goes further with positive social or environmental impact. UN Sustainable Development Goals are targets for positive sustainability impact.

UN PRI, ESG and SDGs are all key elements to understand better SRI investing. UN PRI, ESG and UN SDGs are used differently in guiding and in measuring of results either to positive effect in society and environment or positive impact in society or in environment in SRI investing.

SRI investing is not about giving up returns nor is it also about philanthropy, which we have seen by the evidence of good returns and positive impact in sustainability during the past years and over last decade.

SRI investing and PRI, ESG and SDGs should not been seen as a separate issue in financing or in investing rather have these fully integrated into thinking and investment process in the future.