ESG in 2021: New year, new opportunities

For many environmental, social and governance (ESG) professionals, 2020 will be remembered as the year in which their industry finally went mainstream.

The outperformance of ESG assets during the Covid crisis vindicated proponents’ claims for the sector and encouraged record inflows into funds with sustainability characteristics.

The big question now is whether the momentum can be maintained in 2021. Euromoney asks experts across the industry to tell us their predictions for the year ahead.

Topping the list for many is the prediction that the recent rediscovery of ESG’s responsible investing roots, inspired by the pandemic and the Black Lives Matter (BLM) movement, would continue into the new year.

Meggin Thwing Eastman, head of ESG research EMEA at MSCI, says the surge in social bond issuance and an increasing focus by investors on alignment with the United Nations’ social development goals (SDGs) in 2020 is “just the beginning”.

“This year, we expect to see increasing innovation and creativity among investors looking to address social inequalities on a more systemic basis,” she says.

“Institutional investors in particular are starting to really understand that not only does it create ethical and moral problems in the world when you have these great inequalities, but it also poses systemic risks of social instability as well as leaving untapped economic and human potential in a lot of markets.”

Corporates and consumers are equally focused on social issues, says Elree Winnett Seelig, head of ESG for markets at Citi.

“With the rise of social in response to the pandemic and the BLM protests, companies are increasingly thinking in terms of their societal licence to operate, and basing their behaviour and goals on that,” she says.

Experts also note that social will continue to get tailwinds from Covid relief funds in various jurisdictions, as well as moves by the European Union to broaden the scope of its sustainable finance taxonomy to cover social issues.

“This is a positive move because the interaction and intersection between E and S are increasingly relevant and their impact is often combined,” says Roberta Marracino, head of group ESG strategy and impact banking at UniCredit.

It is not just on the social side that a broadening of topics is expected. In environmental terms, ESG has for many years been synonymous with climate change, but 2020 saw an increased focus on other areas such as water, waste and biodiversity.

This is tipped to continue in 2021 – although how it will translate into sustainable finance is a question that remains to be answered.

Biodiversity will be a particularly tough nut to crack, says Daniel Wild, global head of ESG strategy at Credit Suisse.

“Everyone agrees that it’s important, but it’s not always easy to find enough valid projects that are convincing from both an investment and an impact perspective,” he says.

Chris Iggo, chief investment officer for core investments at Axa IM, agrees.

“I think we will see some specific thematic funds emerge in this area, but the problem is that the investment universe is relatively small,” he says.

“We’ve looked at meat-substitute producers, for example, and there just aren’t enough of them to create a credible investment strategy.”

Investors may get more inspiration and guidance from the UN Biodiversity Conference, which is now scheduled to take place in Kunming, China, on May 17 to 30, after being postponed from October.

Others expect corporates and consumers to lead the way on this and other thorny environmental issues.

“They are more focused on biodiversity, single-use plastics, the circular economy and ecosystems than investors and asset managers,” says Citi’s Winnett Seelig. “I think we’ll see a lot of leadership from corporates on that.”

The big date in the ESG diary for this year – and a reminder that climate will continue to top most sustainability agendas – will be November 1, when the UN Climate Change Conference (COP26) gets under way in Glasgow.

“In terms of climate change and sustainability agendas, this year will be defined by the build-up to COP26 and its ultimate success or failure,” says Winnett Seelig.

A raft of new pledges from policymakers on carbon reduction and energy transition are expected around the summit, as well as intense discussion of controversial issues such as coal and carbon markets.

Corporates’ transition plans will also come under increased scrutiny this year, says Armin Peter, global head of debt syndicate and head of sustainable banking EMEA at UBS.

“With the acceleration of net zero commitments, investors are taking a more forward-looking approach,” he says. “Companies need to be able to show exactly what concrete steps they plan to take towards transition, particularly in sectors that are carbon intensive.”

Axa’s Iggo agrees, adding: “We’re at the stage now where if companies don’t come out with long-term net-zero ambitions you have to ask why. Even if they’re beyond the lifespan of current management, these are living wills and future management will have to abide by them.

“At the same time, they have to be credible, and that means being based on science-based targets which are achievable and setting out a clear pathway. There also has to be much more transparency in reporting of KPIs [key performance indicators] to make sure they are on that pathway.”

Companies that get it right will be rewarded by investors, says Winnett Seelig.

“Investors are starting to look for alpha in sustainability themes,” she says. “We’ve moved beyond headline management to a real focus on who are going to be the winners and losers.”

The other good news for corporates is that, while investors may be getting more demanding, they also have ever-increasing quantities of cash to put to work in sustainable assets.

This is helping to drive rapid growth in ESG investment opportunities. Bankers are predicting another record year for sustainable bond issuance, with Covid relief programmes continuing to drive robust sales of social bonds and sustainability linked products gaining further traction.

“I think everyone is clear that sustainability linked financing will be the hot topic of 2021, because it coincides with the desire for transition financing,” says Peter at UBS.

Transition finance has been a vexed issue during the last few years, with many raising concerns about greenwashing, but the concept is now gaining wider acceptance.

Even the International Capital Market Association (Icma), which had previously resisted calls to provide guidelines for transition bonds, published a Climate Transition Finance Handbook in December.

“There has been a general realization that in order to reach the SDGs, it’s not enough to focus on green companies – we also need to move the mainstream players towards a low carbon economy,” says Credit Suisse’s Wild. “It is estimated that around $3 trillion to $5 trillion a year will be needed to make that transition work, so we want to mobilize capital in that direction.

“Obviously there need to be rigorous standards for transition finance, as with green bonds, but there has to be a way to provide access to capital for players who would otherwise struggle to transition. I believe in 2021 we will start to see this happen on a much larger scale.”

Of course, all this may not be left to markets to decide. In Europe, at least, 2021 is set to be another year of stringent ESG regulation, with a raft of measures due to be implemented and finalized by the end of December.

On March 10, the EU’s Sustainable Finance Disclosure Regulation (SFDR) will come into force, requiring asset managers, banks and insurers to provide full details of the ESG risks – financial and non-financial – associated with investment products.

Some of the more onerous reporting requirements were postponed in December after lobbying by the asset management industry and will likely not come into force until the end of this year or even early 2022.

Nevertheless, the SFDR could have far-reaching consequences.

“It will be significant because the world is watching,” says Wild. “Europe is the first region globally where there is a coordinated attempt to create transparency in the often confusing ESG space, so it will be interesting to see if it works and how it works.

“And obviously many players in Europe are international, so hopefully this will encourage others to join the journey of providing transparency and comparable standards.”

The first quarter will also see the launch of the EU’s renewed sustainable finance strategy. Building on the original strategy from 2018, this is expected to include innovations such as the first pan-European green label for retail investments.

It may also provide pointers to the European Commission’s thinking on sustainable corporate governance. As part of a broader drive to address short-termism, the Commission launched a consultation on the topic in October and is due to publish proposals by the end of June.

Measures being considered include the introduction of a duty of care for directors, linking board remuneration to ESG metrics, prescriptions on board sustainability expertise and requirements for enhanced supply chain due diligence.

Companies may also be required to identify their key stakeholders and report on how they impact them.

“This will be the first time that sustainability has been fully incorporated into corporate governance in a legislative manner,” says Helena Viñes Fiestas, global head of stewardship and policy at BNP Paribas Asset Management. “It marks a continuation of the Commission’s drive to move away from shareholder capitalism towards a stakeholder model.”

However, if the EU goes into 2021 as the global leader on ESG regulation, it may face increasing competition as the year progresses.

All eyes will be on the incoming administration of president-elect Joseph Biden in the US, which has promised to put climate change at the top of its agenda. Whether it will have the same enthusiasm for top-down regulation as European leaders, however, remains to be seen.

“I don’t think US regulation will be as prescriptive as what we’re seeing in Europe, but I think we’ll see more appetite for reporting and standardization measures,” says MSCI’s Thwing Eastman.

Asia is also tipped to play a more important role in the global fight against climate change, following net-zero commitments in October from China, Japan and South Korea.

“We have seen growing awareness about climate change in Asia, as well as a real rise in ESG-aligned assets under management,” says Winnett Seelig.

“What’s fascinating about the region is the collaborative way in which regulators, exchanges, asset managers and banks are coming together to define and accelerate ESG adoption frameworks and best practices in a way that we haven’t seen in other markets.”

She adds: “It is also becoming clear that Asia wants to define ESG for themselves. It’s not about wholesale adoption of the EU taxonomy. They want to make it relevant to their markets.”

Thwing Eastman is equally bullish on Asia, saying: “We’ve seen rapid change in the region on ESG, particularly in China with the new five-year plan and moves towards adopting a sustainability taxonomy.

“If that comes to fruition, it could be extremely influential in the region more broadly. We could even, in due course, see Asia leapfrog the West in terms of ESG.”

The only problem with this vision of a multipolar ESG world is that it could raise further barriers to achieving regulatory alignment across jurisdictions – something global banks, corporates and investors have been calling for.

Thwing Eastman notes that even within the EU, there is not full alignment between the different regulations that are part of the broader package.

Nevertheless, she is optimistic that some form of cooperation across jurisdictions will come with time.

“Maybe not universal global alignment, but perhaps a few different flavours and regions at a level that investors can cope with,” she says.

Similarly, promises last year by various ESG standard setters to work together have raised hopes that some kind of international consensus may emerge on corporate reporting on sustainability.

“There is an urgent need for standards in reporting and some degree of harmonization,” says Peter. “For anyone getting started in ESG and sustainability at the moment, it’s easy to be overwhelmed by the sheer variety and dynamics at play. It can be scary for some people.”

September saw a slew of announcements by global leaders in the field. Five key ESG standard setters vowed to increase cooperation, the World Economic Forum unveiled plans to work with the Big Four accounting firms, and the International Financial Reporting Standards (IFRS) Foundation issued a consultation paper on sustainability.

For most industry professionals, however, the most promising tie-up of last year was that announced in July by Global Reporting Initiative (GRI) and Sustainability Accounting Standards Board (SASB), the key standard setters in Europe and the US respectively.

“The fact that they are now working together is a big step,” says Wild. “GRI probably still has the biggest reach, but SASB has been finding more and more acceptance globally.”

Peter agrees, adding: “SASB and GRI is one of the collaborations to watch. GRI has been established in the market for a long time. SASB came later but brings more stakeholders to the table through its cooperation with investors. Both ultimately have the same aims, so I’m sure this collaboration will be positive.”

As with regulation, however, the danger is that the drive for consensus produces too many competing models.

“My hope is that we don’t see five or 10 significant organizations coming out with individual ESG standards, because that would make reporting very challenging,” says Wild.

For all the activity on sustainability forecast for 2021, however, there are some areas where our experts are not expecting to see much progress in the coming 12 months.

One is bank regulation.

While some jurisdictions – particularly in Europe – are starting to require banks to integrate ESG factors into their risk management, bankers admit there is little hope of seeing this translate into regulatory incentives for sustainable finance in the near future.

More broadly, it is no secret that some of the key issues on climate change have yet to be tackled.

“We’ve done a lot of the easy stuff, but what hasn’t really been addressed yet is the harder stuff,” says Iggo.

“How do we take the steel industry to carbon zero, or how do we produce cement without carbon emissions? The technology to achieve that is really expensive and it requires a big shift in the economics.”

For many, the obvious answer is a big increase in carbon pricing – but few believe there will be any notable global moves in that direction in 2021.

“It’s much too disruptive to vested interests in energy production,” says Iggo. “Maybe in two to three years’ time, when we’re falling behind on carbon-reduction targets, something more dramatic like that will have a greater chance of happening.”