Investing goals have historically been focused on generating financial returns by allocating capital to companies and projects that could deliver attractive returns on investment. However, in recent years, investors have realized that factors beyond traditional financial metrics can significantly impact an investment’s long-term performance. ESG criteria consider how well companies and projects safeguard the environment and the communities they work in, as well as how they ensure management and corporate governance meet standards. ESG frameworks encompass a wide range of issues, including climate change, human rights, labor standards, board diversity and corruption. These factors are often used by investors to evaluate the long-term sustainability of a company’s business model and its ability to generate financial returns over time. By considering ESG factors, investors get a more holistic view of the companies they back, which helps mitigate risk while identifying opportunities.
Criteria used to evaluate companies for ESG investing:
| Environmental | Social | Governance |
| Carbon footprint | Labor practices | Board diversity and structure |
| Energy efficiency | Diversity and inclusion | Executive compensation |
| Renewable energy usage | Human rights | Shareholder rights |
| Water usage | Community relationships | Risk management |
| Pollution | Health and safety | Supply chain management |
| Waste management | ||
| Biodiversity impact |
Benefits of integrating ESG criteria in decision-making
Integrating ESG criteria into investment decision-making is important, as ESG criteria can help investors identify potential risks and opportunities that may not be captured by traditional financial analysis. This leads to additional benefits including:
| Area | Investment and reporting benefits |
| Risk management | Helps manage risks related to regulatory changes, reputational damage and financial performance |
| Long-term value creation | Contributes to long-term financial returns by building more resilient portfolios |
| Innovation and growth | Opportunities associated with ESG investing include innovation and growth |
| Enhanced stakeholder engagement | Leads to enhanced stakeholder engagement |
| Regulatory and reputational risk management | Companies that manage ESG factors well are likely to be more efficient and less exposed to regulatory and reputational risk. |
Incorporating ESG factors into investment strategies has been shown to lead to more stable returns and reduce the likelihood of negative events that can harm both the environment and society. ESG integration depends on the availability of sufficient ESG information for the applicable investment universe.
Pain points in integrating ESG into operational and investment decisions
Integrating ESG factors into investments can present several challenges:
| Challenges | Description |
| Fear of financial loss
|
Some investors may fear that prioritizing ESG factors could lead to financial loss. However, it’s a misconception that incorporating ESG factors into investment decision-making puts income at risk. |
| Greenwashing
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This is the practice of providing misleading information about a company’s products that encourages consumers to believe they are more environmentally sound than they actually are. Greenwashing is a threat that masks the value of ESG and its ability to have maximum impact. |
| Metric misapplication
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The misapplication and misleading metric analysis make it hard for investors and advisers to understand ESG ratings. A single, data-driven ESG rating cannot try to be everything at once. |
| Regulatory challenges
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Lack of regulatory clarity is a significant challenge. Asset owners identified a range of growing ESG implementation challenges this year, ranking market data, the market environment and regulation highest. |
| Data challenges
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ESG market data is hindered by a lack of standardization, reliability and timeliness. |
| Impact on returns | Sustainable investment strategies had a challenging year in 2022 amid the strong performance of the carbon-intensive energy and utilities sectors and the downturn of more ESG-friendly technology stocks. |
Remember, these challenges do not undermine the importance of ESG factors in investment decisions. They merely represent areas that need further work and development.
ESG integration strategies
Integrating ESG factors into investment strategies can be done through several approaches:
| Strategy | Description |
| Explicit and systematic inclusion | Analyzing all material factors in investment analysis and investment decisions, including ESG factors |
| Exclusionary screening
|
Excluding certain sectors, countries and companies based on specific ESG criteria |
| Best-in-class selection
|
Selecting companies that are leaders in managing ESG issues within their industry |
| Thematic investing | Investing in themes or assets specifically related to ESG opportunities |
| Impact investing | Investments made in companies, organizations, and funds with the intention to generate social and environmental impact alongside a financial return |
| Active ownership
|
Using shareholder power to influence corporate behavior |
| Setting internal ESG investing standards and goals | The use of diverse types of strategies, datasets, and methods to integrate ESG factors into the decision-making process |
A step-by-step ESG integration process involves identifying relevant ESG issues, assessing current ESG performance, setting targets and goals, engaging with stakeholders and measuring and reporting progress.
Integrating ESG data into finance
ESG data varies in accuracy and granularity. Integrating ESG data can be a challenge if the most granular data cannot be accessed. The Partnership for Carbon Accounting Financials (PCAF) focuses specifically on financial institutions, providing a Scope 3 emissions calculation methodology for investment (Category 15) emissions. It assigns different reliability scores to distinct types of data as follows:
| Certainty | Data quality score | Data |
| Least uncertainty | Score 1 | Audited emissions data or actual primary energy data |
| Score 2 | Non-audited emissions data or other primary data | |
| Score 3 | Energy-specific primary data or production data | |
| Score 4 | Proxy data based on country or region | |
| Most uncertainty | Score 5 | Estimated data with limited support |
Using the most granular data available and limiting the use of spend-based or average data is always recommended when possible. The more investors can engage with investments and have a flow of data informing actual and potentially real-time emissions intensity, the better their decisions can be with respect to supplier or product substitution.
Software solution/role of software enablement
In the evolving realm of sustainability reporting and data management, software plays a crucial role in streamlining the collection, aggregation and validation of sustainability data and ensuring transparency.
These technology-driven tools serve as central repositories, consolidating data from disparate sources like energy consumption and supply chain records. This eliminates manual aggregation, reduces errors and saves valuable time. Advanced features like target-setting help organizations track progress toward sustainability goals and identify areas for improvement. The software allows financial institutions to accurately collect, calculate, report and manage financed emissions utilizing AI and advanced analytics.
Conclusion
In review, financed emissions are greenhouse gas (GHG) emissions indirectly caused by the financial activities of institutions like banks, investment managers and insurers. When an entity invests in or lends money to another entity, it’s not just providing a capital infusion to that business—it is also becoming party to the emissions the business generates.
There are three key opportunities for investors and financial institutions to act on regarding financed emissions. The first is to get ahead of the mounting pressure from regulators, investors and activists who are demanding greater transparency and action on financed emissions. Secondly, they need to be proactive in measuring and reducing emissions as they strive toward reaching net-zero goals. Third: They must stay current and avoid becoming a laggard in the complex and evolving landscape of regulations.
Organizations don’t have to embark down this path alone; they can partner with a recognized leader in sustainability solutions. Sphera is an award-winning and recognized market leader in providing robust and comprehensive solutions. Our SpheraCloud Corporate Sustainability–Portfolio Management solution includes automated data collection, a robust calculation engine, integrated emissions factor libraries, portfolio performance management and audit-proof reporting.
Learn more about Sphera’s award-winning Corporate Sustainability Software by contacting us now.
“Calculating financed emissions is extremely complex, but it is of utmost importance for financial entities to have a holistic view of their GHG inventory and identify climate-related risks and opportunities. PwC is excited to continue collaborating with Sphera, helping bring these new capabilities to the market to support financial institutions with reporting in line with PCAF standards.”
Sammy Lakshmanan, a Principal at PwC
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