As most asset managers hold listed companies, banks can play a vital role creating a more sustainable economy.
Sustainability and environmental, social and governance (ESG) principles have become increasingly fashionable terms, particularly among investors who have flocked to ESG-labelled assets, despite unclear definitions. The interest should be welcome. Coupled with banks’ own increasing adoption of sustainability principles, this ultimately leads to a better economic system. We need a few adjustments along the way, however.
According to the Forum for Sustainable and Responsible Investment, sustainable investing accounted for 33% of total US assets under management last year. The European Fund and Asset Management Association has published a report at the end of 2020 about European asset management claiming that firm-level ESG selection strategies were worth a total of €10.7tn, or 45% of the total assets under management the previous year.
These numbers show that ESG investing is already mainstream. But to ensure ESG becomes mainstream across the real economy, we need to work on three factors: ownership, measurementnand performance. Bank finance plays an important role, particularly in the former.
What banks can do
Most capital, tangible and intangible, is not traded in markets. The number of listed stocks declined in the past 20 years, notably in the US, and was about flat for the world. The costs of being listed in a market are numerous and include issues such as excess stock price volatility and the cost of regulation and compliance. (Markets offer indisputable benefits too, because they provide timely valuation and force owners to be transparent and interact, through investors, with society.) Because the vast majority of asset managers’ portfolios hold listed companies, and there are restrictions on unlisted stocks, there is a limit on their impact on the wider economic activity. So we need other big players here: banks.
Numerous academic papers have shown that the difference between ESG investments’ returns and other investments’ is either nonexistent or favourable to the former
Many assets are not publicly traded, but most of them require external financing. This is particularly true in sectors like real estate. The adoption of an ESG lease on the part of banks is key to influencing parts of the economy that would not directly be affected by asset managers. (Private equity and private debt companies would also help.) Although growing, sustainable syndicated loans still account for only about a fifth of the total, according to 2020 figures by data provider Refinitiv. The green, social and sustainable bonds banks structure for corporate clients make up a far smaller fraction of total issuances. The growth of sustainable loans, in particular, will help reach the many smaller companies that underpin Europe’s economy and help mainstream sustainability further.
Both banks and investors need better tools to analyse corporate behaviour. Those available now are time-consuming and expensive. The asset management value chain has naturally followed the division of labour, with consultants and agencies specialising in ESG ratings, and fund managers using the ratings to select securities. Recent academic research has documented the existence of a wide range of ratings for the same company. This is understandable given that we are still searching for exact empirical definitions of sustainability and, in more detail, of ESG. It is, however, worrying. The EU’s green taxonomy may help rating convergence, but only up to a point. It is crucial that we work to better understand how to recognise and measure corporate impact on the environment and society.
Staying the course
Last, we need to highlight the financial performance of sustainable companies: prices remain the best co-ordination mechanism humanity has been able to come up with to measure human activities. ESG investing will remain mainstream provided investors do not lose money relative to other investments. Numerous academic papers have shown that the difference between ESG investments’ returns and other investments’ is either nonexistent or favourable to the former. Research has found that accounting key performance indicators are better for companies considered sustainable, and a new narrative has emerged: ESG investing and lending are the best risk management tools that asset managers and banks have to navigate through the threats of climate change.
Some may still believe that caring for the environment implies a trade-off in terms of returns. But there is enough evidence to show that good business decisions require ESG considerations. That’s why in our view ESG investing and finance are here to stay. Their complementary role is essential to a more sustainable economy.
Andrea Beltratti is professor of finance, Bocconi University; Alessia Bezzecchi is associate professor of practice of corporate finance and real estate, SDA Bocconi School of Management.
