In recent years, one of key elements of sustainable corporate development of the world's leading companies including ensuring reliable access to funding has been the ESG agenda and a focus on responsible investment.
ESG enables to form, first of all, a comprehensive picture of risks and opportunities in terms of creating long-term value, identified as a result of the analysis of significant non-financial criteria and factors related to the environment (E - environmental), social sphere (S - social) and corporate governance (G - governance).
One of the main theses within the framework of the ESG concept is that in modern conditions any business, regardless of the form of ownership, should be guided by full consideration of the interests of all interested parties or «stakeholders», and not only solely by financial gain and its own narrow corporate tasks. For example, stakeholders traditionally include customers, employees, government, investors, lenders, international institutions, local communities, etc.
Based on the UN Sustainable Development Goals (SDGs), ESG business transformation has ceased to be a kind of «niche» product that was previously used from time to time to solve reputational problems and often for outright «greenwashing». Traditionally, investor attention has been focused on reducing corporate governance and financial sustainability risks, while social and environmental responsibility has often been positioned as a significantly less important area.
Now the situation has drastically changed. Investors and financial institutions as providers of capital are already positioning ESG as a key factor in making investment and lending decisions, along with traditional financial and strategic information.
The ESG agenda is becoming a global mainstream, and the Covid-19 pandemic has significantly increased the importance of adequate management of non-financial aspects and contributed to a systemic restructuring of investor approaches.
One of the key elements is a full disclosure of non-financial information by corporate players (according to the Global Reporting Initiative, Sustainability Accounting Standards Board and others related to environmental, social and governance factors) as part of their annual reporting. And also the «involvement» of companies in the leading ESG indices and ratings that allow stakeholders and investors to compare and understand well the vulnerabilities and strengths of a particular business.
Development of global trends in 2020-2021 demonstrates that in a number of major economies (the European Union, China, the United States), as well as in the leading debt and stock markets, compliance with ESG principles, their inclusion in production and investment chains and adequate disclosure of information becomes in fact mandatory requirement, including from the point of view of listing of companies and availability of financing.
The main global trends in ESG can be summarized as follows:
• continuing the shift from a voluntary, often selective, approach to mandatory compliance at a corporate level;
• creation of chains of responsible interaction: manufacturers - suppliers - creditors - investors;
• gradual unification of ESG standards and ratings;
• shift from narrow climate neutrality to a much broader range of ESG commitments;
• intensification of pressure on business from stakeholders.
Increased pressure from regulators, activists and investors is forcing companies and financial institutions to focus on ESG aspects, including rethinking investments in high-risk projects. Fitch Rating and S&P Global forecast further tightening of due diligence in the area of ESG, intensified exclusion of inappropriate projects, and coverage of a wider range of ESG issues in corporate reporting and risk management. That circumstance will additionally affect conditions for attracting financing and investments.
According to the Bloomberg Intelligence Global forecast, assets guided by ESG principles will potentially increase by 15% by 2025 and will exceed $53 trillion. According to the US SIF (Sustainable and Responsible Investment Forum), only US assets managed using sustainable investment strategies have grown to $17.1 trillion in 2020, up from $12 trillion in early 2018.
The ESG and sustainable investment survey conducted in December 2020 by BlackRock Investment Fund in 27 countries among several hundred institutional clients with total assets of $25 trillion showed that half of the participants intend to at least double their presence in sustainable assets within the next 5 years.
In particular, corporate players are integrating ESG principles based on GRI, SASB and TCFD guidelines and standards into their strategies and asset portfolio management process. Active actions in that direction are being taken, among other things, by sovereign wealth funds and large management holdings such as Temasek Holdings (Singapore), Future Fund (Australia), Norges Bank Investment Management (Norway), etc.
All of this demonstrates a tectonic capital shift towards ESG and responsible investing.
At the same time, companies focused on ESG implementation are more commercially viable. To illustrate, according to S&P Global estimates, in 2020 the S&P 500 ESG index was about 17.5%, compared to 16.2% for the «traditional» S&P 500. The yield on the S&P 500 ESG was higher as on the whole calendar year, and during the «hard landing» of the global economy in the spring of 2020.
Of course, today there is still no single generally accepted ESG definition and ESG standards. Also, there is no general approach to ESG integration that largely depends on specifics of a particular business. There is a lack of regulation and ability to validate ESG disclosures.
These factors complicate the situation somewhat. In particular, there are a number of major players in the global ESG rating market such as S&P Global, Sustainalytics, ISS and others. However, despite the growing popularity of ESG ratings, they are still mutually weakly complementary and replaceable, mainly due to different assessment methodologies used by international rating agencies.
However, in the coming years, a process of unification of profile standards and ratings will only intensify.
For example, the leading organizations for integrated non-financial reporting, namely GRI, SASB, CDP, CDSB and IIRC, intend to complete the formation of a comprehensive system of non-financial corporate reporting in a foreseeable future, as evidenced by the agreements they signed in September last year.
In turn, the European Commission launched a process of changing the legislation of the European Union to establish uniform standardized metrics for a disclosure of information on environmental and social policy, as well as corporate governance. Replacing the 2014 directive on non-financial reporting, non-financial disclosure obligations will apply to all European large and medium-sized businesses, not just public companies.
At the moment, one of the main drivers that contribute to spread of ESG in the world is an interest of clients mainly institutional and portfolio investors.
Among the «strategic» investors that stimulate an introduction of ESG on a global scale, one can distinguish such structures as BlackRock, State Street Global Advisors, PIMCO, Nomura Asset Management and many others. In addition, many international financial institutions, such as the European Bank for Reconstruction and Development, the European Investment Bank and the International Finance Corporation, actively focus on the targeted accounting of ESG. There is a growing number of investors where whole teams of specialists are involved in ESG issues.
Global market participants are increasingly giving preference to companies that are attentive to the analysis and minimization of environmental risks, implement a socially responsible business model, and have strong corporate governance. ESG integration makes business more predictable and sustainable for regulators, lenders, rating agencies and investors, also due to additional requirements and information assessment filters.
Large capital providers interested in better disclosure of material ESG information by companies are purposefully making them relevant requirements, thereby motivating corporate players to make changes. These institutional impact investors benefit from massive, diversified portfolios that are not tied to the performance or success of any one sector – they use it to their advantage by encouraging global change through market and company-specific influence.
Thus, the need to switch to ESG does not act as some kind of directive initiative « from on high», coming, for example, from governments (many countries still pay insufficient attention to ESG, including at the regulatory level) but is a consequence of rapid and cardinal changes in the «ideology» of the global market itself.
Therefore, the leaders in implementing ESG practices and promoting the concept of responsible investment are mainly public companies that are listed on stock exchanges and depend on the ideological approaches of their investors. There has been a significant increase in interest, including among companies in the energy and oil and gas industries, in the disclosure of qualitative and quantitative information about the opportunities and risks associated with climate change and social agenda. However, the lingering gap between political statements and current legislation often requires corporate players to make an independent decision about choosing a degree of their immersion in the area under consideration and incorporation of the ESG principles into their business model.
Leading national and regional regulators will push ahead with tightening of legislation and regulations related to ESG including as a tool for meeting the SDG commitments by 2030.
The European Union example:
• from March 2021, all participants in the financial market of the union (also foreign companies and funds) are obliged to publicly report on the ESG risks in their financial and investment portfolios;
• from 2023, the European Union will begin a phased implementation of the Carbon Border Adjustment Mechanism (CBAM) that involves charging payments for a carbon footprint of certain categories of imported products;
• with a view to 2023-2024, legislation is being prepared on the mandatory audit of large and medium-sized businesses from the point of view of observance of human rights and working conditions along the entire production chain, embracing foreign suppliers.
Some companies from Kazakhstan are also committed to complying with ESG principles and implementing best practices.
However, in general, Kazakhstan is still lagging behind global trends in terms of implementation of ESG principles and factors by large part of national business, although both the cost of ESG risks and pressure from international investors and certain categories of counterparties are increasing. In particular, in the republic the share of companies publishing non-financial statements is lower than the world average.
It is reasonably believed that a lack of a strategic vision in the field of ESG and a refusal to implement effective policies in the field of sustainable development undermines the long-term stability of the business including creating significant reputational and financial risks for its investors. It can be stated that leading investors now view companies' lack of focus on ESG as a confirmation of their imbalanced corporate governance, high exposure to non-financial risks and inability to quickly adapt to changing economic, environmental and social trends.
Main factors constraining the practice of ESG integration are insufficient understanding of the ESG specifics and a lack of comparable data on ESG. For example, many people still associate ESG only with the environment and the climate agenda.
Illustrative examples of long-term challenges and risks for companies ignoring the need to move to ESG business models are:
• depreciation and shrinkage of the overall attractiveness of assets;
• deterioration of the long-term corporate and project risk profile;
• negative impact on credit and investment ratings;
• weakening of availability and deterioration of conditions for attracting debt financing, as well as inability to use popular green financing instruments, among them bonds related to sustainable development (Sustainability-Linked Bonds);
• deterioration of conditions for the export of certain categories of products, primarily to the European Union market;
• outflow of clients and counterparties;
• reduced opportunities for listing on leading stock exchanges;
• growth of reputation costs;
• falling confidence on the part of partners, especially international ones, including an accelerated review by «responsible» investors and creditors of an expediency of further cooperation;
• expansion of criticism from investors, activists, media.
Corporate players that do not meet ESG criteria will have difficulty in attracting financing at acceptable rates and terms in the coming years, especially in Western markets and from international financial institutions operating under the auspices of the UN or the European Union.
The active influence of ESG on the creditworthiness of companies can also be traced. In particular, the leading credit rating agencies (Fitch Group, S&P Global Ratings, Moody’s Corporation), based on the UN Responsible Investment Principles, have undertaken to separately disclose the impact of ESG risks on the issuer rating in their credit ratings. In the future, a significant deterioration in the rating positions of companies that do not meet the basic ESG criteria is forecasted.
In the foreseeable perspective, business compliance with ESG principles will be a mandatory requirement for listing on key international stock exchanges (LSE, NYSE, NASDAQ, etc.) as well as exchanges operating in Kazakhstan (AIX and KASE). This is already confirmed by the implementation in 2020-2021 of the corresponding stringent ESG selection and reporting criteria on the Hong Kong and Singapore stock exchanges.