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In the spotlight: sustainable finance
Sustainable investment means far-sighted decisions
Dimitri Senik
Director, Investor Trust Services Leader, PwC Switzerland
Finance and the real economy are inextricably linked. This means that sustainable finance creates enormous potential − not just for the financial industry, but for all actors in the economy − to create value and help shape economic systems sustainably. Given that sustainability offers opportunities throughout the value chain and has a positive effect on performance, it should be a standard investment criterion for those seeking and providing capital.
Sustainable business has long been on the agenda of the global community, including Switzerland. There have been various initiatives agreed at an international level designed to safeguard the livelihoods of future generations.
Developments so far
- The UN Global Compact was founded in 2000 as the world’s most important initiative for responsible corporate governance. It is intended to promote an inclusive and sustainable global economy.
- The signatories to the 2015 Paris Climate Agreement committed to setting national reduction targets for their greenhouse gas emissions.
- Also in 2015, the member states of the United Nations set out 17 Sustainable Development Goals that define a vision of sustainable development spanning the social, economic and environmental dimensions. The Addis Ababa Action Agenda used these as a basis for determining financing needs.
- In 2017, the Swiss Federal Office for the Environment (FOEN) and the State Secretariat for International Financial Matters (SIF) initiated a pilot analysis of the climate alignment of financial portfolios. These tests will be offered free of charge to a wider range of financial service providers from 2020.
- In 2018, the European Commission published an action plan on sustainable finance. The Commission calls for it to be integrated into existing financial market regulations and supplemented whenever necessary.
- Numerous private companies are adopting shared principles (e.g. the UN Principles for Responsible Investment – UNPRI) that allow them to contribute to sustainable investment.
- In March 2019, the Swiss Pension Fund Association (Association Suisse des Institutions de Prévoyance – ASIP), in its information circular no. 116, applauded the fact that increasing numbers of pension funds are also building climate, environmental, social and corporate governance considerations into their asset management policies.
- In June 2019, the Swiss Federal Council pronounced itself in favour of promoting the sustainability of the Swiss financial sector and set up a working group for this purpose. In the spring of 2020, it will present its conclusions on the effects of the EU action plan on the Swiss financial sector along with a review of the measures taken to date.
Social and regulatory channels
Public calls for effective environmental protection measures have resulted in heightened awareness in the political and business communities. The EU action plan seeks to establish a standardised method of assessing the sustainability level of investments in relation to their economic performance. The plan defines ‘sustainable finance’ as any form of financial service that integrates environmental, social and governance (ESG) criteria in business and investment decisions to provide sustainable benefits for customers and society (see Figure 1).
The EU thus calls for ESG factors to be taken into account in investment decisions and risk assessments. This approach necessitates standardised disclosure requirements and new reference values for low-carbon investments and balance sheets.
Figure 1: the EU action plan divides the financial system into environmental, social and governance (ESG) factors.
Multifaceted opportunity
Sustainability spans a financial services company’s entire value chain, from development and product design, transaction processing and portfolio management to sales and customer management – and extends far into the real economy (see Figure 2). The potential of sustainable investments is increasing. In Switzerland, it reached a new high of CHF 717 billion in 2018 (see Swiss Sustainable Finance Annual Report 2018, SSF, 2019). Last but not least, by aligning with ESG factors, investors and those providing and raising capital make a concrete contribution to achieving global climate goals and promoting a sustainable society.
Figure 2: sustainability is embedded in every stage of the value chain.
A question of ambition
There’s no way around the ESG requirements for financial service providers. The first question they have to ask is what level of ambition they’re aiming for (see Figure 3). The minimum standard is to meet the legal requirements. Self-regulation guidelines already exist, such as those issued by the Swiss Association for Responsible Investments (SVVK-ASIR). Leadership beckons for those that are able to position themselves systematically in this area, innovate, and capitalise on the market opportunities.
Figure 3: depending on the level of ambition aspired to, various questions may move to the forefront of the sustainability discussion.
More than just one challenge
Depending on the stance a company takes when making investment and financing decisions or pursuing green financial products, it will have to engage with different challenges and strategic questions.
Many investors consider investments that comply with ESG criteria to be less attractive. This is not necessarily true. The fact is that companies that take account of sustainability in their financial evaluations post at least as good a performance as those that do not. Companies with ambitious ESG aspirations have a better understanding of the factors that strengthen or weaken performance and are therefore less vulnerable to ESG risks.
Those who select their investments according to ESG criteria often exclude entire industries (alcohol, tobacco, gambling, [controversial] weapons or cement). This doesn’t always work in the interests of sustainable business and transformation. Global cement producers, for example, are responsible for 7% of carbon emissions worldwide (see Cement Produces More Pollution Than All the Trucks in the World, Bloomberg, 2019). But without cement, there’s no energy infrastructure. And the exclusion of controversial weapons raises the ethical question of how to deal with financial instruments issued by states that commission controversial weapons.
Enterprise value and goodwill can be closely linked, for example when companies are deeply rooted in their region or when strong entrepreneurial figures get involved in philanthropic activities. A company’s framework of values can have a perceptible effect on its business performance (see UBS/PwC Billionaires Report 2019, UBS, 2019), especially in family businesses.
There are still no clear ESG standards for the disclosure and evaluation of sustainability. When assessing the ESG fitness of companies, rating agencies apply varying methods and yardsticks. This means that ESG ratings hardly correlate and a fact-based comparison of ESG investments is impossible. Given all this it’s a good idea to select third-party providers carefully for initial assessment and then apply additional evaluation criteria.
Certain asset classes are easy to evaluate. For example if you’re investing in shares of listed companies, it’s easy to get transparent information on ESG factors. It’s harder to evaluate bonds. Although bond issuers can be valued in the same way as share issuers, there is currently no format for evaluating a bond according to ESG criteria − apart from green and climate bonds.
In the case of alternative asset classes and money market instruments, assessment according to ESG criteria is also problematic owing to a lack of standardisation. Standards for energy efficiency and sustainable construction are currently being developed in the real estate sector. Nevertheless, we recommend carrying out an individual ESG assessment.
Best to get a bird’s eye view
Sustainability is a highly complex objective that goes far beyond climate issues and expert debates. It concerns the entire value-creation cycle as well as the overall economic performance of market products and services and the way they’re financed. Decision-makers should therefore take a holistic and forward-looking approach to assessing the sustainability of investments. The fact of the matter is that sustainability cannot be ignored. The Swiss Federal Council, Parliament, Financial Market Supervisory Authority, Swiss National Bank and other stakeholders in the Swiss financial and business sectors all have it on their radar. In the not too distant future, regulators and standard-setters will create guidelines. By that time, at the latest, companies should be ready for ESG compliance.
Summary
The EU action plan seeks to establish a standardised method of assessing the sustainability level of investments in relation to their economic performance. By “sustainable finance”, it means any form of financial service that integrates environmental, social and governance (ESG) criteria in business and investment decisions to provide sustainable benefits for customers and society.
Regulators and standard-setters will soon create guidelines. So, the first question companies have to address is how ambitious they are. The minimum standard is to meet the legal requirements. A leading position will be achieved by those who orient themselves strategically in this area and take advantage of the added value.
Depending on the approach, there are further challenges: Does the company rely on sustainability or profitability, exclusion or transformation, assets or performance? What standards does the company apply? What asset classes are involved?
Sustainability concerns the overall economic design of market services and their financing.
Decision-makers should therefore assess the degree of sustainability of investments from a holistic perspective.
Find more information on sustainable finance here.
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