null

Blogs

2022 ESG themes

John Tennaro, CIMA®, CSRIC™

January 10, 2022

By Head of ESG & Impact Investing John Tennaro, CIMA®, CSRIC™ and ESG investment associate Rachel Perry 

Historically, environmental, social and governance (ESG) investing has been viewed more as a “luxury” for those who can afford to consider outcomes other than maximizing returns. Opponents or naysayers of ESG suggested the methodology focused on a company’s values, rather than a company’s value. As a result, investors would pay a price for prioritizing social and environmental factors. However, the rise of ESG has shined a light on the importance of a triple bottom line approach, which puts people and planet alongside profit. ESG has helped investors understand how companies act and react to meaningful issues that are typically omitted from traditional analysis. 

As a result, an ongoing “mega-theme” that should continue into 2022 is the transition of ESG from being an add-on to being a focal point. Rather than an extravagance, ESG will likely become an essential mandate by increasing numbers of investors. Therefore, as we look ahead, “ESG investing” should inch closer to just being known as “investing.” We lay out some of the other ESG themes we think will be notable this year:

Climate

Climate-conscious portfolios. Investors are curious about the environmental footprint of their portfolios and how companies are progressing toward a decarbonized world. They may choose to invest in climate solutions, allocate funds to lower-carbon companies, or engage directly with higher-emitting companies to influence corporate behavior.

  • Potential outcome: We expect an increasing number of climate-focused funds that are tracking and measuring companies’ emissions in their respective portfolios and progress towards a lower-carbon world. 

Company journeys towards climate action. In this ever-changing world, companies are realizing they must contribute to climate action to ensure the viability of their business. Net-zero initiatives—plans to balance between greenhouse gasses produced and removed from the atmosphere—are a popular way for businesses to demonstrate their commitment.

Chart 1: Number of companies that set or added decarbonization targets

A recent influx of pledges made by companies and governments to do more across topics such as methane emissions and biodiversity is encouraging. However, we caution that this movement is mainly words—not a concrete road to implementation.

  • Potential outcome: We expect to see a heightened bar for companies to accomplish their ESG goals, prompted by regulatory or investor pressure. Historically, companies had a lower hurdle to jump over, and we expect the bar to be higher and more specific and include accountability measures to track and report progress. 

Biodiversity. Over half of the world’s gross domestic product (GDP), amounting to $44 trillion, is directly or indirectly reliant on natural capital. Ecosystem services such as crop pollination, freshwater, timber, and marine fisheries are critical inputs to ensure a thriving economy. Given the interrelated relationship between our economies and natural assets, the impacts of biodiversity loss are far-reaching.

  • Potential outcome: We expect to see an increase in integrated investment strategies that aim to tackle both climate and biodiversity in tandem, with a particular focus on nature-based solutions. We also expect more action from companies around biodiversity as they paint the link between their supply chain, consumption of natural resources, and consumer demands for sustainability. 

Increase in green, social and sustainability-linked bonds. Sustainable bonds have grown in popularity over the last few years as entities realize sustainability is integral to long-term resilience. Chart 2 reveals a rise in green, social and sustainability-linked bond issuance from 2016 through 2020.

  • Potential outcome: As a growing number of companies announce plans to shift their operations to net-zero, we expect to see an increased issuance of sustainability-linked bonds to fund these projects. We expect use-of-proceeds bonds to increase as they give a clearer picture of exactly how a company is using the raised capital, increasing visibility into the process. 

Chart 2: Annual supranational issuance of green, social and sustainable bonds

Disruption of the status quo/business as usual

Structural inequalities are increasingly apparent. Global economies have long operated by emphasizing GDP and growth of profits, sometimes at the expense of our people and planet. The current “business as usual” scenario is facing increased scrutiny, and a shift towards rethinking how economies have worked is at the forefront of disruptive discussions. For example, healthcare opportunities may be limited in underserved communities, and surrounding habitats experiencing deforestation and biodiversity loss could further drive a rise in infectious diseases.

  • Potential outcome: We expect to see investment solutions that have a deliberate focus on developing economies and emerging markets to help meet the needs of underserved or underrepresented communities. Often through private equity or venture capital, these impact investments emphasize increasing access to quality healthcare, reducing child and maternal mortality, and improving infrastructure around clean drinking water and sanitation. 

Supply chain and other social issues. Governance of a company and its management has been part of financial analysis for decades, and environmental factors are becoming increasingly important.

Going forward, we also expect the “S” in ESG (“social”) to see more attention due to an increased focus on social issues and rising data availability. Companies that reaped the financial returns of prioritizing social factors are starting to see increased benefits to both the company’s bottom line and public perception.

  • Potential outcome: As social issues continue making headlines, we can expect the investment landscape to provide better ways to allocate capital to address these needs. Furthermore, there will likely be a greater focus on supply chain due diligence. Supply chains have been a pressing issue throughout the pandemic and will remain pertinent in 2022. Supply chains will need to become more resilient and responsible, as failure to ensure proper oversight and management of supply chain risks can result in significant financial and reputational losses.

Regulation and policy acceleration

ESG data advancements. The rising usage and demand for ESG data spurred a need for higher-quality, decision-useful information. Most data being disclosed is currently voluntary, and that leaves companies largely responsible for how they  measure and what they report. However, mandatory reporting is being pushed by regulators such as the European Union through the Sustainable Finance Disclosure Regulation and (more recently) the Security and Exchange Commission’s (SEC’s) climate framework.

  • Potential outcome: We expect to see a decrease in deceptive marketing practices that falsely suggest that a company is environmentally friendly (also known as "greenwashing”), as well as funds that inaccurately brand themselves “green,” as companies increase precautions to promote their so-called initiatives. Gone are the days when asset managers and companies could slap an “ESG” tag on products they are selling but change nothing around their process.

SEC’s mandatory climate framework. The SEC’s mandatory climate reporting framework for publicly listed companies is expected in 2022. We anticipate the focus to be divided between two issues: 

i. how firms that claim to use ESG in their investment process do so (i.e., investment process, marketing, disclosure and  procedures), and

ii. requirements that public companies will need to meet to publicly report their efforts toward ESG metrics.

Department of Labor (DOL). This year, the DOL proposed a new rule on ESG investing in retirement plans for Employee Retirement Income Security Act (ERISA) fiduciaries, revealing how ESG factors are an extra layer of analysis that can be financially material to performance when making investment decisions and voting proxies.

  • Potential outcome: We expect ESG strategies to have a greater level of adoption and inclusion in ERISA accounts by fiduciaries and an acceleration in fiduciary understanding of material ESG and climate-related financial risks.