The global allocation of capital in financial markets is still strongly weighted against global interest. This needs to change; we don’t have much time, as atmospheric C02 levels rise humanity is under more threat by the day. Saudi Aramco, Saudi Arabia’s state oil company, is the most profitable company in the world. Making a reported $88211M net profit in 2019. Many of China’s state-owned enterprises are making similarly large profits with equal disregard for their actions' environmental and social impacts. The most profitable investments are rarely ones that regard the long-term interests of all stakeholders in society.
With climate change and its multifarious impacts on the global economy becoming an ever-truer reality by the day, can we really stop and allow capital to continue to flow towards the short-term interests of the World’s richest? I believe the principles of Environmental, Social and Governance (ESG) investing ought to guide a new way in which capital flows. ESG investing is an umbrella term for responsible investments that generate profit from sustainable and ethical companies.
I am not suggesting that we replace the profit incentive as a way for investors to allocate their capital. As this is how the great innovation and efficiency gains we see today arise. Rather, I am suggesting that we guide investments towards profits in all stakeholders' interests. We need to change the way in which capital is allocated, and therefore profit is created, to be beneficial for all in the long term.
Source: Credit Suisse
This does not mean shareholders will not make a profit; the capitalist economy we live in only allows profitable companies to thrive. ESG allows investors to create a positive impact with their money, whilst continuing to get a return on investment. Currently, market forces alone are clearly not enough to redirect capital flows away from companies damaging stakeholder interest. Therefore, I believe the core principles of ESG investing need to be integrated into capital markets – creating change fast.
This could be done in a variety of ways. For example, Triple Bottom Line accounting to include the social and environmental ‘costs’ of operating as well as economic costs. If government regulation made this a mandatory requirement for large companies, they would be incentivised to strive for the type of cost minimisations they do economically with social and environmental costs too. This would cause capital to flow towards companies that better respect stakeholders' interests, as the more profitable companies will have accounted for all costs of operating.
This would make ESG investing easier to implement for investors due to higher transparency of full business costs. However, all this would require an internationally coordinated effort to create an immense paradigm shift in business that goes against the current interests of many of the worlds richest and most powerful.
Obviously, the change I’m suggesting above is a drastic one. However, many institutional investors, such as Credit Suisse, have started using ESG when making investment decisions. This is largely only due to the informal social control of people today expecting change. Furthermore, ESG investments have performed better during the Covid-19 crisis, proving more resilient and the volume of investments in ESG, although difficult to quantify, has undeniably been rising rapidly.
ESG indices proved more resilient in the COVID-19 crisis: Index performance between January 1 and March 25, 2020, in local currencies
Sources: BAML European Equity Strategy, Bloomberg, Morningstar
Many tipping points have been identified by the UNFCC (The UN’s climate change body) to be within the coming decades. Formal restrictions and regulations are needed now to change where capital flows. Finite resources are being used up, and irreversible damages are being done to the very environment the economy is dependent on. All due to the inconsiderate and selfish nature in which some global companies operate today. Time is one thing we certainly have little of.