Wednesday, May 18, 2022

The future of finance is sustainable—and profitable

The finance ecosystem—clients and employees, shareholders and stakeholders—is striving for purpose and sustainability. Environmental, social and governance (ESG) considerations are at the forefront of financial decisions, supported by the Sustainable Development Goals (SDGs) and increased awareness of the climate emergency.

Sustainable finance is sometimes referred to as green finance, but it’s not just about reducing emissions or preventing environmental damage.

  • Environmental concerns include air and water pollution, deforestation and biodiversity. More generally, they relate to how a company performs as a steward of nature.
  • Social factors reveal how well a company manages relationships with employees, suppliers, customers and the communities with which it engages. Social issues vary from diversity in the workplace to human rights and labor standards across the supply chain.

The importance of sustainable finance was explained succinctly last year by James Gorman, CEO of Morgan Stanley: “If we don’t have a planet, we’re not going to have a very good financial system.”

There is a sense of inevitability in the transition to green finance. Brian Deese, global head of sustainable investing at BlackRock, said the move to sustainable finance was out of “necessity” as well as “preference”. Mark Carney stated, “Companies that don’t adapt will go bankrupt without question.”

Recently, attitudes have started to change, and the private sector is beginning to take its commitment to the environment seriously. Even oil major Royal Dutch Shell Plc and mining giant Glencore Plc have set environmental targets for the first time.

Sustainability is now a global concern:

  • Thirty-one percent of American consumers say they have rewarded companies that are taking steps to reduce global warming by purchasing their products in the last year.
  • Twenty-one percent of American consumers say they have punished companies for opposing climate action by avoiding their products.
  • In a Unilever study, 21 percent of the people surveyed across five countries said they would actively choose brands if they made their sustainability credentials clearer on their packaging or in their marketing.
  • Shoppers say they feel better when they buy products that are sustainably produced (53 percent in UK, 78 percent in US, 88 percent in India).

Fjord crowdsources the trends that will shape the business and technology landscape over the next year. The 2020 trends identified ‘The Many Faces of Growth.’

Financial growth is no longer a firm’s sole performance metric. Non-financial objectives, particularly ESG criteria, are gaining traction. Consumers want companies to be mission-driven as well as focused on generating shareholder value.

This may explain the success of Patagonia. Since 1973, the outdoor-clothing retail chain estimated by Forbes to be worth $750 million in 2015 has donated over $185 million to environmental groups and conservation efforts, and invested a further $38 million in socially responsible companies.

“It’s time for a new capitalism—a more fair, equal and sustainable capitalism that actually works for everyone, and where businesses don’t just take from society, but truly give back and have a positive impact.”

–Marc Benioff, CEO, Salesforce

Investors want sustainability and financial performance

Banks and investment management companies are following the trend. BlackRock has launched a circular economy fund in partnership with the Ellen MacArthur Foundation, with the goal of mitigating climate change, biodiversity loss and pollution. The actively managed fund started with $20 million seed capital in October 2019, investing in companies that are adopters, enablers or beneficiaries of circular economy activities. Among them is Adidas, which is tackling the issue of plastic waste with a closed-loop production model.

“To be well-positioned for the future, businesses are acknowledging that their long-term value is increasingly linked to their principles, practices and impact on society.”

–Rachel Lord, Head of EMEA, BlackRock

NatWest Group’s corporate strategy is focused on purpose-led banking. New CEO Alison Rose has committed to environmental measures, such as becoming carbon net neutral in 2020 and carbon positive by 2025, as part of a wider initiative to become a more sustainable business. The not-for-profit A Blueprint for Better Business has co-created a framework, which sets out NatWest’s commitment to be a good corporate citizen and a “responsible and responsive employer.

”Sustainability makes business sense and lowers operational risk

Since the 1960s, the economist Milton Friedman argued that regulation and interference from “big government” would always damage the macro economy.1 Classical economic theory stated that the valuation of a company or asset should be predicated almost exclusively on the bottom line.

However, adherence to ESG criteria allows investors to avoid companies whose practices could signal a risk factor. BP’s 2010 oil spill and Volkswagen’s emissions scandal are just two examples of ESG failures that caused stock prices to plummet and resulted in billions of dollars in associated losses.

A 2014 study by Eccles et al. showed that companies that adopted ESG policies in the 1990s have outperformed those that did not. Using a matched sample of 180 US-based companies, 90 of which were classified as high-sustainability and another 90 as low-sustainability, the study showed that over an 18-year period the high-sustainability companies dramatically outperformed the low-sustainability ones in terms of both stock market and accounting performance.

This is corroborated by an Oxford University study, which finds a “remarkable correlation between diligent sustainability business practices and economic performance.” There seems to be little doubt that environmental, social and corporate governance responsibility is complementary to profitability and return on investment.

Sustainable firms attract and keep better skilled and more committed employees and have more loyal customers. Their stronger relationships with stakeholders mean, in turn, that their social license to operate is more secure.

In my next post, I’ll explore how companies can leverage data and technology to become more sustainable and profitable.

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