What is ESG and what does it mean for pension plans?
The pension and investment world has been abuzz with discussions about ESG. Headlines about a multi-trillion U.S.-dollar global market have left many to wonder: “What is ESG investing?”
ESG is a set of standards that outline how socially conscious investors can screen investments. But there are often arguments and concerns over what these standards are, how they are applied, how they are reported on and for what purpose.
The practice of ethical investing first surfaced in the early 1900s, but the current trend focuses on three main components — environmental, social and governance principles. Modern pension plans (and other institutional investors) use these factors in the investments they make.
Environmental criteria consist of standards to ensure the investments of institutional investors perform as stewards of nature. This includes, but is not limited to, an investment’s climate-change impacts, ecological footprint and use of resources. Investors will assess environmental risks, from disposal of hazardous waste to water usage, toxic emissions, nature conservation and treatment of animals.
The social side of the acronym covers the relationships the investment has with labour and human rights. This includes, but is not limited to, conditions of employment (health and safety), diversity and equity, community relations and charitable contributions. This can be expanded to include the suppliers with which the company works; for example, whether it works with a supplier that uses sweatshop labour.
Governance criteria focus on the transparency and processes of the potential investment company. Factors include conflicts of interest, illegal practices, transparent financial information, executive pay, anti-corruption measures and other forms of internal controls.
Some proponents of ESG-oriented investment strategies aim to encourage good corporate citizenship and support activist-oriented goals. For others, ESG investment is pragmatic because checking those boxes is also favourable for a company’s market performance and bottom line. Legally, the latter is a priority for pension plan trustees who have a fiduciary duty to plan members.
Considering future trends is important. In the context of climate change, disruptive innovations can have a significant effect on future profitability or the continued existence of the investment, as well as the investor and any beneficiaries who depend upon the returns. Fossil fuel investments may have a short-term return, but their environmental impact over the long-term could lead to catastrophic consequences.
This has led many businesses to rush to paint a flattering picture of themselves and their environmental and human rights records, leading to accusations of “greenwashing,” which means branding something as eco-friendly or “green” when that's not the case.
This highlights the biggest challenge facing ESG: a standardized reporting system and standardized measurables. Governments and financial institutions have created a variety of ESG frameworks. These include the Global Reporting Initiative (GRI), the Sustainable Accounting Standards Board (SASB), the United Nations’ Sustainable Development Goals (SDG), the Task Force for Climate-Related Financial Disclosures (TFCD) or some combination of these.
TFCD is spearheaded by Bloomberg LP CEO Michael Bloomberg and former Bank of Canada governor Mark Carney, and was published by the Financial Stability Board, an international body that monitors and makes recommendations about the global financial system. In June 2021, the G7 endorsed TFCD's framework, with the goal of setting mandatory disclosures.
It remains to be seen if this framework will be more widely adopted. ESG gets media attention, but its principles are not mandated by legislation in most countries and, as a practice, it continues to be unregulated. However, for those who value the sustainability of pension plans — and the wellbeing of this planet and those on it — ESG is a step in the right direction.