Consulting around 20 recent reports, The Sustainian identified 5 clear game-changers that will shatter the world of finance in the years to come. Read and stay prepared!


Something is happening in the financial markets. Sustainability is gradually entering a sector known for its conservatism and rush to secure quick earnings. A few numbers indicate that not only is there a budding trend going on, but that it is growing – maybe even exponentially! And it should be, if we want to safeguard our future.

More than $8.1 trillion was invested in ESG (Environmental, Social and Governance) portfolios at the end of 2016. To put that number into context, there was $40.3 trillion in total assets under management in the United States in 2016. A survey from 2017 by Schroders involving 22,000 investors in 30 countries revealed that 78% of all interviewees believed that sustainable investing is more important today than five years ago. In fact, 84% of asset owners surveyed in 2018 are at least “actively considering” integrating sustainability criteria into their investment process, with nearly half already integrating it across all their investment decisions.

The snowball has started, and the ESG investment market seems to be unleashing.

But what can be expected in the years to come? The Sustainian digested around 20 recent reports and based on them, we present five solid assumptions for the imminent future of finance. ESG ROI (Return on Investment) will only increase; Active ownership will become the undisputed norm; There will be standardized sustainability metrics for reporting; Millennials will watch you; and There will be stranded fossil fuel assets.

  1. ESG ROI will only increase!

No single report identified a decrease in interest in ESG investments, it was in fact quite the contrary. A considerable surge in interest was a common denominator. Some reports speak about an “explosion” in ESG investments, or use words like “surge”, “spike” or “fundamental shift” to describe the current trends. The snowball has started, and the ESG investment market seems to be unleashing.

Although political will has been faltering over the recent years, investors apparently only see one way forward. But politicians will understand the market signals and bolster the incentive frameworks.

And as the ROI of ESG investments is only becoming more convincing, the whole field is gradually maturing, and it bolsters these once niche-assets with credibility making them appear as less risky objects than just a few years ago. As stated in our interview in this issue with the 100% sustainable pension fund Matter, the pool of sustainable investment funds has grown large enough to be able to ensure investments only in sustainable assets, while enabling sufficient diversification.

The positive trend is inevitable, and will no doubt change the game of finance in the coming years. The question just remains – will it happen in due time?

Money managers already have almost $23 trillion earmarked to ESG mandates, which is roughly 25% of the entire global investment universe. Roughly $8.7 trillion of that is money coming from the US, while European investors account for another $12 trillion, Morgan Stanley data shows. However, the line of demarcation of ESG investments is still disputed, making it hard to assess how sustainable these assets really are.

It should also be noted that it would be lying to claim everything is just hunky-dory, since there are still loads of challenges to be fought. Banks are, for instance, increasingly funding climate crisis as one recent report revealed. But the positive trend is inevitable, and will no doubt change the game of finance in the coming years. The question just remains – will it happen in due time?

  1. Active ownership will become the undisputed norm!

A true mega-trend is, and will be, active ownership. Increasingly, we see investors taking on an active ownership position as a means of good investor stewardship. Why? It is one of the most effective mechanisms to reduce risk, maximize returns and have a positive impact on society and the environment. In fact, evidence shows that investors without active ownership underperform. From a sustainability perspective, it should be noted that divestment alone will not do the job, since this is often just a matter of ditching companies without starting a dialogue or engaging with them, two things which could potentially lead to substantial change.

As an example of active ownership principles, take the world’s largest public fund – the Norwegian Sovereign Wealth Fund. Besides revealing its voting intentions at annual meetings, it has now doubled the companies it analyses in depth regarding sustainability performance. In 2017, the Fund voted at 11,084 shareholder meetings. The Fund is also issuing “position papers” that are setting out its corporate governance principles, as well as signing up for the nomination committees that determine board members.

Active and responsible ownership is the main element of a new EU directive, that applies to more than 8,000 listed companies. The member states have now up to two years to transpose the new provision into domestic law.

For insights on developing – or refining – an active ownership policy, take a look at this guide from the UN’s Principles for Responsible Investment (PRI). Also take a look at PRI’s latest report.

  1. There will be standardized sustainability metrics for reporting!

In all the reports we surveyed, there is an outspoken complaint that standardized metrics for sustainability reporting are missing. A PwC report showed that 82% of investors were frustrated with the inconsistencies in sustainability reporting.

The Better Business, Better World’s focus report on sustainable finance states that an “increase in interest of reporting has not been accompanied by a standard set of reporting requirements, indicators and frameworks. As a result there has been an extraordinary proliferation in competing reporting guidelines for businesses.” This adds to the confusion and complexity that makes companies abstain from ESG investments.

The EU has recently launched a proposal to develop over time a unified classification system on what can be considered sustainable economic activities, thus facilitating sustainable investments.

The increasing demand for better comparability and better transparency in disclosures as well as a growing political will to address the problem will no doubt bring about more reliable classifications soon.

  1. Millennials will watch you!

The so-called Millennial generation, individuals born between 1980 and 2000, are setting the bar for ethical business as they attain purchasing power. And these Millennials will most likely demand change. The recent, annual Millennial survey by Deloitte revealed a severe decline in Millennials’ trust in companies. Since the 2008 Global Finance Crisis, the  financial sector as a whole is still suffering from loss of credibility, and the sector is generally the least trusted of all industries as the latest Edelman Trust Barometer revealed.  

This might also be one of the reasons that the CEO of the largest asset manager BlackRock, Larry Fink, publicly urged companies to take on a broader societal responsibility.

A future mantra will be: Adapt to the expectations of Millennials – or die.

Millennials are generally skeptical of the whole financial sector’s business models, which they perceive as old-fashioned and often unethical. They do not seem to care about what their bank is telling them (most would rather go to the dentist than listen to their banker!) or other financial institutions. In fact – if Millennials are considering investing – 86% say they are interested in sustainable investing. Millennials demand something from companies in terms of purpose. They are looking for meaningful business.

As a recent PwC report outlines, wealth and asset managers have to enhance transparency and ethical business conduct if they want to attract Millennials. Issues like tax evasion and opaque fees and costs will be severely condemned by this segment – not to speak about investments in unsustainable assets. A future mantra will be: Adapt to the expectations of Millennials – or die.

  1. There will be stranded fossil fuel assets!

The last game-changer is a long bet, admittedly. But take this into consideration – if we are serious about meeting the targets of the Paris agreement (i.e. stay well below a 2℃ rise in global temperatures to avoid a climate catastrophe) it means that 60%-80% of coal, oil and gas reserves of publicly listed companies could be classified unburnable. This imposes a huge “transition risk” for the whole financial sector with a risk of US $30 trillion of stranded assets in the oil sector alone.

By comparison, the bail-out for the stranded mortgage assets, which triggered the 2008 financial crisis and put over 200 million people in poverty, was US $250 million.

This could happen because of political regulation, a drop in returns due to market fluctuations, or because fossil fuels could become increasingly difficult to access due to distance, floods, droughts, etc.

Carbon Tracker continuously takes stock of the prospects of stranded assets. There is actually an inherent risk that traditional financial analysis is blind to the possibility of stranded fossil fuel assets.

This scenario is not limited to coal, oil and gas, other ‘sin assets’ are also likely to be stranded, if the factors mentioned above push markets in a direction favoring ESG.

 

Here is a list of the most useful reports we digested for this article:

Incorporating ESG in Fixed-Income Investment, World Bank Group (2018)

Sustainable Signals Asset Owners Embrace Sustainability, Morgan Stanley (2018)

Better Finance, Better World. Blended Finance Task Forces (2018)

Schroders Institutional Investor Study, Schroders (2018)

Financing Sustainable Growth, The European Commission Action Plan (2018)

Sustainable Signals. Asset Owners Embrace Sustainability, Morgan Stanley, Institute for Sustainable Investing (June, 2018)

Mobile Money in Emerging Markets. The Business Case for Financial Inclusion, McKinsey (2018)

Banking on Climate Change 2018

Synthesis Report, G20 Sustainable Finance Study Group (2018)

Sustainable Investing in Emerging Markets, EMPEA (2017)

OECD guidelines for responsible investments (2017)

Schroders Global Investor Study 2017: Sustainable investing on the rise. Schroders (2017)

Ideas for action for a long-term and sustainable financial system, Business & Sustainable Development Commission (2017)

Guide to Banking and Sustainability, 2. Edition. UNEP (2016)