Senior Business Consultant, SimCorp
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PhD, Global Practice Lead, SimCorp
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Read the article and learn about:
- ESG and the current market standards
- ESG - the benefits, challenges, and sustainable investment trends
- The challenges of integrating ESG themes and data in the investment management process
This article provides a high-level industry overview of ESG (environmental, social, governance) realities and challenges, including a recap of some of the major market events that have made the topic of ESG mainstream, a description of the main aspirations behind ESG, and, finally, current market trends and the goals and challenges of implementing ESG in the investment management industry.
ESG is an increasingly prominent theme in the investment management industry. We are probably all familiar with recent scandals connected to environmental, social, and governance related topics. Similarly, investors are familiar with the consequent price movements of the corresponding securities involved in the scandals. At the same time, asset managers have been active in launching and servicing a range of innovative ESG products.
ESG in brief – background and recent scandals
Not long ago, we have seen the CEO of McDonald’s lose his job for having violated the company’s code of conduct after his affair with an employee was unveiled. Companies, especially in the US, have become intolerant to personal relationships between executives and employees. The issue has never been the deed itself, but rather its implications. Ultimately, it is hard to distinguish an innocent relationship from the one that exploits the power structure in a corporation. This attitude reflects the unwillingness of investors to take risks related to governance and conflict of interests.
In recent years, investors have proven to be intolerant to scandals related to environmental, social, or governance matters. Most readers would be familiar with the Diesel scandal, even without having to mention the name of the involved company (See Figure 1).
Similarly, data-leaks and attempts of influencing elections remind us of the data scandal with Cambridge Analytica. In both cases, the respective shares of Volkswagen Group and Facebook, Inc. fell more than 20% in a single trading day (See Figure 2). This is the definition of a drawdown, usually perceived as an unlikely tail event, hitting the investors’ portfolios hard.
What is ESG?
The Universal Declaration of Human Rights dates back to the year 1948. “A common standard of achievements for all peoples and all nations. It sets out, for the first time, fundamental human rights to be universally protected”, it says about the declaration on the United Nations website.1 Taking a more practical approach, the United Nations has in recent years set 16 Sustainable Development Goals (SDGs), recently adding the 17th goal, Partnerships (See Figure 3). The SDGs aim to align its concrete targets with the Universal Declaration of Human Rights in terms of rights and livability on the planet. Based on the SDGs, a group of CEOs around the world has started an initiative to help facilitate the implementation of the universal principles of the SDGs, which has resulted in the UN Global Compact commitment. The UN Global Compact covers four areas and specifies commitments within each of them:
- Human Rights under which the companies are expected to respect the universal declaration and the United Nations treaties such as the prohibition of nuclear or mass destruction weapons.
- Environment under which the companies should take precautionary measures to avoid environmental disasters and encourage environmental friendly technologies.
- Labor under which the companies should ensure respectful business practices and a solid code of conduct.
- Anti-corruption under which companies enforce the compliance to a solid corporate governance to promote transparency and fairness.