Earning money and doing good – can this succeed with esg and impact investing?

At the beginning of 2020, global sustainable investments reached a value of $35.3 trillion , an increase of 15% in the last two years (2018-2020). The total assets under management of sustainable investments represent 35.9% of the total global assets under management. In 2018, this figure was still 33.4%, so a significant increase can be seen.

Thus, the assets that are defined as sustainable investments have grown significantly in recent years. Are new EU regulations or more sustainable investment guidelines then necessary at all? Apparently so, because what can also be observed, however, is a declining relative sum of sustainable investments compared to all investments in Europe. This is exactly where the EU comes in with the taxonomy, the CFDR and the SFDR to reverse this negative trend. Want to learn more about the latest financial regulations?

Then here’s our article that gives you an overview of the EU regulatory landscape!

There is a lot of momentum not only in the amount of sustainable assets and EU regulations! In addition to traditional investing, seven sustainable investment strategies have emerged in the private finance industry. These are ESG integration, followed by negative screening, corporate engagement and shareholder action, standards-based screening, positive screening and sustainability-focused investing, and impact investing. All of these strategies share the common goal of investing in sustainable projects and enabling retail investors, investors and companies to meet ESG criteria and contribute to the achievement of the SDGs and the EU Green Deal.

But how exactly can these strategies contribute to achieving the 17 SDGs and the Paris Climate Agreement? We create this linkage in the following section.

If an asset is labeled as sustainable, the additional investment criteria are often summarized under the acronym “ESG”, thus the name of the investment strategy is also created. This acronym stands for the financial market-relevant sustainability aspects of environmental, social and governance. Furthermore, investments are also referred to as sustainable if they are launched in accordance with global legal standards of the Agenda 2030 or the Paris Climate Agreement, or if they invest specifically in sustainable areas such as renewable energies. A more precise classification of sustainable investments can also be found in the EU Taxonomy, which plays a central role in the sustainable transformation of the EU-wide financial industry.

An important step in understanding how ESG investments can promote greater sustainability is to link the SDGs to the ESG criteria. With the chart below, we not only show what ESG actually means in detail, but we also link the criteria to the SDGs defined in the 2030 Agenda. Thanks to this link, investors and financial institutions can identify sustainable projects, keep up with the latest regulatory requirements, and provide financing for the European Green Deal.

So how exactly are the ESG ratings mentioned above provided and calculated by rating agencies like MSCI and Sustainalytics? Contrary to what many people think, most ratings have nothing to do with actual corporate responsibility, which usually relates to ESG factors.

Instead, they measure the degree to which a company’s economic value is at risk due to ESG factors. For example, a company could be a significant source of emissions but still receive a decent ESG rating if the rating agency believes the environmentally harmful behavior is well managed or does not jeopardize the company’s financial value.

So if companies are hedged against these risks, they can still get a good ESG score from one of the rating agencies. This is one of the reasons why major oil companies like Exxon and BP still have a good ESG rating. Further, the rating agencies consider the future aspirations of the companies to do good. When Philip Morris stated that they were committed to a smoke-free future, their ESG rating was raised significantly. Rating agencies might perceive this statement as a (future) reduction in regulatory risk, even though the next generation of products continues to be addictive and, of course, harmful to society and individuals.

So, we clearly see that ESG investing and ESG ratings are not free of problems. There are opportunities for improving ESG investment strategy that need to be exploited to make the financial industry more sustainable. It is a good start that ESG investing is financially viable, but investors have more transparent information available about a company’s sustainability to increase the impact of their sustainability-focused investments. VCs in particular can take responsibility here and have a significant impact on the sustainable transformation of the financial industry.

Why exactly is impact investing a seventh and meaningful sustainable investment strategy? And what are the characteristics of this strategy that make it different from the other investment strategies? Impact investing comes into play to focus even more on corporate social responsibility and to expand ESG criteria. To understand the basic idea, it is necessary to point out the difference between impact investing and ESG investing.

The main difference between ESG and impact investing is that impact investing is much more focused on the positive social and environmental outcomes of the investment object. As a result, there is a greater focus on corporate social responsibility and the company is viewed as a corporate citizen. The basic idea is that the sustainable development of our society requires a social, economic and environmental bottom line. ESG investing with its criteria focuses more on immediate financial returns and assessing risks related to ESG criteria. Impact investing focuses on the immediate impact of the investment project on ESG criteria for society.

Therefore, impact investing is characterized by a direct link between these value- and ethics-based priorities and the deployment of investor:s capital and influence. It ultimately places more social responsibility on investor:s and underscores the importance of corporate social responsibility. Investor:s are not only required to report on financial returns, but also generate measurable KPIs that track the positive social impact of the investment and quantify impact. Thus, this investment strategy represents a new level of responsibility for financial institutions.

If venture capital firms closely follow the trends in the various SDGs, new investment opportunities will open up for them. By keeping up to date with sustainable, technological and overall societal trends and developments, more sustainable business practices, products and services offer new investment opportunities with high growth potential.

If VCs implement ESG criteria and align their investment activities with sustainable development goals and impact investing criteria, significant financial benefits can be realized, but also positive social and environmental change. We clearly show that sustainability and return on investment are not competitors, but can act hand in hand to serve society and benefit VCs and their stakeholders!