What is changing in the Financial Industry?

The way ESG emerged in the financial industry and markets was somewhat surprising. The COVID-19 pandemic accelerated the process, the transfer of wealth revealed new motivations and the world is clamoring for sustainability as the new normal.

After asa2020  of intense change, the financial industry is fully available in the availability of tools, models, instruments and analyzes that highlight the concept and importance of the ESG in investment portfolios.

 

A CROSS CHANGE

The CFA Institute, the global association of investment professionals that sets the standard for professional excellence and financial industry credentials, has launched the first global ESG investment certificate. This new global education program sets standards, allowing investment professionals to analyze and integrate ESG factors into their investment process.

It is a first step to establish a set of rules, e metric procedures and sustainable practices in the investment process, ultimately contributing to a more holistic and integrated financial and equity analysis.

This step, taken by a reference institution, is also fundamental given the ambiguity that the acronym ESG and the very definitions of sustainability and investment with impact carry.

In fact, in recent months, several investment products have appeared, new or renamed, in the form of ETF, investment funds or even bonds, with the ESG, sustainability and socially responsible seal.

The creation of more uniform and precise rules then seems to be the next step to support this concept and make it effective and decisive in the investment process, especially on the passive investment side (investment that goes through an index), where the selection of assets is made according to the reference index.

Also for this reason, the first institutions to launch metrics and ratings for the ESG have been the index companies, such as the FTSE Russell, MSCI or the Sustainalytics, as the industry of collective investment bodies with a passive approach to the markets depends on them, such as the ETF (Exchange-traded funds) and the index funds, popularized by Vanguard.

 

ESG INVESTING - POSITIVE FACTOR OR PLACEBO AND DISTRACTION?

As noted by John Authers in his Points of Return newsletter, the ratings used for ESG indices are comical and varied. The chart below demonstrates the degree of correlation between the FTSE Russell, MSCI and Sustainalytics ratings.

 

This analysis by academics Elroy Dimson, Paul Marsh, and Mike Staunton for the 2020 Credit Suisse Global Investment Returns Yearbook suggests that it is still dangerous to try to use these metrics in passive investment.

Traditionally, to deal with a negative externality such as pollution, the recipe was to make it more expensive by issuing carbon emission fees, environmental fines or licenses.

However, this approach did not reward companies or industries that presented technology or products to solve the problem. The success of Elon Musk's Tesla or Cathie Wood's Ark shows that working positively based on sustainable goals has a future and can be seen as a properly remunerated option in relation to risk.

Given this scenario, and in the absence of such a systematized and consolidated approach, the industry has turned the discourse and marketing towards positive impact.

However, these theoretically important acronyms are often the pretext to increase the number of available products and increase the industry's turnover.

The industry, always shrouded in exaggerations and opaque strategies, cannot take advantage of this trend only to create products and revenue opportunities in the short term, conveying an idea of ​​impact and responsibility, but which only serves as a distraction to the real fight against the climate crisis, to social inequality and ethical issues.

To avoid this illusion and emptiness of results, it must open up the information, make it more personalized and develop more flexible and integrated structures. Going against the investors' motivations and presenting truly independent criteria to evaluate companies and financial products.

 

THE EMISSION OF ESG AND AS METRIC PRODUCTS USED

Regarding the issuance of ESG instruments, Europe is currently the leader in the creation of the ESG ETF. It is also in this region that the ESG ETF have the highest ratings.

Several strategies are used, from values and approaches aligned with investors to the integration of ESG criteria to reduce the long-term risk associated with them, thematic and impact investments.

Therefore, it is not surprising the remarkable growth of the investment flow in ESG ETF, as shown in the following chart:

 

The issuance of green bonds is also an increasingly present reality. It is already possible to analyze the bonds issued that are more in line with the sustainable objectives on several platforms. These issuers, who meet these criteria and this approach, bring advantages to both sides of the market: investors and issuers.

The green bonds finance projects aimed at energy efficiency, pollution prevention, sustainable agriculture, fishing and forestry, protection of aquatic and terrestrial ecosystems, clean transport, clean water and sustainable water management.

 

EXAMPLE OF METRICS USED IN AN ESG ETF

By consulting the information of an ETF, it is possible to analyze the sustainable characteristics of the product, more sustainable alternatives and specific businesses in which the ETF is involved.

Take as an example the iShares Core MSCI World UCITS ETF, one of the most popular ETFs on the market. It is possible to analyze SRI (socially responsible investment) and ESG alternatives, and also consult sustainability metrics and characteristics.

The metrics are based on the MSCI ESG Fund Ratings and in them we can see the ETF rating (between AAA-CCC), an analysis of quality scorings in relation to peers, the percentage of companies that make up the index that have an ESG rating and the exposure fund to carbon-intensive companies.

 

In the business engagement de metrics section, investors can obtain a more comprehensive view of the specific activities to which a fund is exposed through its investments:

• Nuclear, controversial and produced weapons for civil society;
• Tobacco;
• Companies that make up the fund that did not comply with the UN Global Compact principles;
• Production in coal plants;
• Extraction of oil from tar sands.

Thus, the reality is that investors now have more options to invest on the sustainable and responsible side, but also more complexity in making these investment decisions.

The financial industry must play its fundamental role in transparency, understandable and clear metrics and in the certainty of being on both sides: on the buy side and on the sell side.

 

As Sérgio Godinho says:

"In the new normal
nothing will ever be
Never the same”.

PT:
“No novo normal
Nunca nada vai ser
Nunca igual”.