How a sustainable approach to business leads to financial outperformance
“Investors don't need to believe. They simply have to look at the evidence.” #PositiveImpactFinance #Sustainability
Positive Impact Finance to close the gap
Investors tend to be wary of new concepts. They expect financial outperformance, evidence, and benchmarks before placing their money with a scheme. And it is normal. So will the recent formulation of Positive Impact Finance make it a tough sell to investors?
"Absolutely not", says Yannick Ouaknine, senior ESG analyst at Societe Generale Corporate and Investment Banking. "Positive Impact Finance is a development which builds on the progress made with all the other analysis tools. There is ESG, Integrated Reporting, and auditing standards for things like calculating carbon emissions. We can draw on all of those things."
This is a vital point. The idea that business must care about more than just profit went mainstream more than a decade ago. Positive Impact Finance is merely an iteration of a well-established and well-documented approach to business.
ESG, stands for Environmental, Social, and Corporate Governance
ESG is at the heart of it. The acronym stands for Environmental, Social, and Corporate Governance. These three factors cover the wider impact of a business. The first ESG-focussed funds appeared around the turn of the millennium, and are now a normal part of the investing world. Companies report ESG in considerable depth. There's no official methodology or certification with ESG – but that is a strength rather than a weakness. Participants search to find the right approach for their line of business.
For example, Schneider Electric reports 16 indicators such as energy reduction, waste management, and gender pay balance. This bespoke scorecard is the only way to report on the unique range of issues encountered by a diverse industrial conglomerate. The CEO is adamant that ESG contributes to a better commercial performance, as well as fulfilling Schneider Electric's ethical commitments to society.
ESG as a catalyst for outperformance
"We have 15 years of experience with ESG investing to show investors," says Ouaknine. "We have a track record to prove that if you understand what ESG means, and combine that with the right financial criteria, you can outperform. Investors don't need to believe. They simply have to look at the evidence."
Ouaknine has been working with ESG long enough to remember the doubts investors once had. "At the beginning, we were trying to convince investors with little proof of risk reduction or financial performance. Little information was available from the corporate side. Now things are totally different. There is regulation mandating the reporting of ESG criteria. Ratings agencies look at ESG factors. And companies themselves are engaged."
A key factor is considerable risk reduction. By identifying negative impacts, and taking action, companies pre-empt potential bad publicity. For example, a luxury brand can be ruined by a child labor scandal. By investigating the supply chain, it ensures directors, staff, and investors are protected from a public relations disaster. Every company will have similar vulnerabilities which can be addressed by ESG principles.
The links between sustainable approach and elevated performance are confirmed by multiple sources. Investors can look at a long list of available market data, raising also the question of the materiality... Most listed companies are now publishing ESG reports. And academics are also presenting their own independent research which supports the theory.
Other analysis tools aligned with ESG standards
Perhaps the most convincing proof is the vocabulary used by the investment community. "A third of our clients don't run ESG funds," says Ouaknine.
"But they do use the same criteria as ESG, only they call it 'Early Performance Indicators'. They understand the way ESG helps performance and minimizes risk. They just give it a different name."
Integrated Reporting (IR) is another tool being harnessed by Positive Impact Finance. IR is a framework for reporting sustainability issues, introduced by the International Integrated Reporting Council in 2013. A survey at the time conducted by the Chartered Institute of Management Accountants found 94 per cent of top executives globally could see the benefit in terms of value creation. IR is being adopted worldwide. In South Africa for instance, all listed companies on the South African stock exchange produce Integrated Reports. In China, the Ministry of Finance is building Integrated Reporting into its five years plan.
The winners will be the ones leading the change with rigor
The maturity of sustainable reporting means that investors can be sure claims are reliable and meaningful.
There will be no exaggeration – or greenwashing. "Auditing is usually done by an accountancy firm," says Ouaknine. "No one wants to be caught up in a greenwashing scandal. They won't take the risk."
Naturally, each participant will have its own way of implementing any ESG framework. Societe Generale CIB uses a Materiality Matrix, which combines both financial and material ESG issues to focus the effort on what we considered as financially relevant.
Positive Impact Finance takes ethical business to a new level, but the methodologies are still being refined. The big lesson for companies and for investors is that it will pay to be a leader in this movement.