ESG finance: A Journey Through Time

ESG (Environmental, Social and Governance) finance has become a hot topic in recent years, with investors, banks, and insurance companies increasingly focused on the social and environmental impacts of their investments. But where did this concept come from, and how has it evolved over time?

In this blog post, we’ll take a deep dive into the history of ESG finance, exploring its origins, key milestones, and current trends, and examining the challenges and opportunities facing the field today.

The History of ESG Investing

Although the term ESG was first coined in a series of reports by the United Nations Environment Programme’s Finance Initiative, consisting of the Freshfield Report and the “Who Cares Wins” report, the roots of ESG finance can be traced back to the early 20th century, when socially responsible investing (SRI) emerged as a way for investors to align their investments with their ethical and moral values. The first SRI fund, the Pioneer Fund, was launched in 1928 by the Mennonite Church in the United States, with a focus on investing in companies that promoted peace, justice, and equality.

The concept of SRI evolved throughout the 20th century, with the emergence of various movements and campaigns that aimed to address social and environmental issues through investing. One such movement was the anti-apartheid movement in the 1970s and 1980s, which saw investors divest from companies doing business in South Africa, in protest against the country’s racist policies.

Another notable development was the launch of the Dow Jones Sustainability Index in 1999, which provided a benchmark for companies that were leaders in ESG performance. This marked a major turning point for ESG investing, as it provided a standardized way for investors to measure the ESG performance of companies and make investment decisions accordingly.

The 2000s: From Niche to Mainstream

The turn of the millennium saw a significant increase in the popularity of ESG investing, as more investors became aware of the social and environmental impacts of their investments, and the potential risks and opportunities associated with ESG factors. One key trend was the growing interest in climate change and sustainability, which prompted investors and companies to focus on reducing carbon emissions and promoting sustainable practices.

In October 2005, a group of United Nations Environment Programme Finance Initiative (UNEP FI) asset managers together with Freshfields Bruckhaus Deringer, a leading international law firm, published a ground-breaking report titled A Legal Framework for the Integration of Environmental, Social and Governance Issues into Institutional Investment.

Widely referred to as the “Freshfields Report”, the landmark report argued that, “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions,” and became the single most effective document for promoting the integration of ESG issues into institutional investment.

In the four years after the launch of the original Freshfields Report, there was more innovation and evolution in the field of ESG integration than in any other similar time span in history. In the context of the 2008–2009 Global Financial Crisis and the predicted ‘Natural Resources Crisis’, it seemed possible that many fiduciaries would look for new approaches to steward and allocate their assets. Furthermore, historically, some world leaders voiced the urgency to combat climate change, the crucial role of finance and business, and the need for a long-term approach.

Thus in 2009, UNEP FI produced a sequel to the “Freshfields Report” titled Fiduciary Responsibility: legal and practical aspects of integrating environmental, social and governance issues into institutional investment. This follow-on report, termed “Fiduciary II”, provided a legal roadmap for fiduciaries looking for concrete steps to operationalise their commitment to responsible investment.

The 2010s: ESG Goes Global

The 2010s saw a further expansion of ESG finance, as more investors and companies around the world embraced ESG principles and practices. The institutions adopting ESG risk management frameworks were convinced that in a more globalised, interconnected and competitive world the way that environmental, social and corporate governance issues are managed is part of companies’ overall management quality needed to compete successfully. Companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory action or accessing new markets, while at the same time contributing to the sustainable development of the societies in which they operate. Moreover, these issues can have a strong impact on reputation and brands, an increasingly important part of company value.

In this period various standards and frameworks were developed, such as the Global Reporting Initiative, which provided guidelines for companies to report on their ESG performance and practices. Other commonly used frameworks today include CDP, SASB, TCFD, and WDI.

At the same time, the ESG market began to diversify, as new ESG products and strategies emerged, such as green bonds, impact investing, and thematic investing. Green bonds, for example, are fixed-income securities that are issued to finance projects with positive environmental outcomes, such as renewable energy or energy efficiency projects. Impact investing, on the other hand, involves investing in companies or projects that have a specific social or environmental impact, such as affordable housing or clean water.

Thematic investing is a strategy that involves investing in companies that are aligned with a specific theme, such as renewable energy or gender diversity. Thematic investing has gained popularity in recent years, as it allows investors to target specific ESG issues or trends, and provides a way for them to align their investments with their values.

The 2020s: ESG Goes Mainstream

In the past few years, ESG finance has become even more mainstream, as more investors and companies integrate ESG factors into their decision-making processes. One key driver of this trend is the growing awareness of climate change and the need for urgent action to address it. The Paris Agreement, which was signed in 2015 by 196 countries, aims to limit global warming to well below 2 degrees Celsius above pre-industrial levels, and to pursue efforts to limit the increase to 1.5 degrees Celsius.

This has led to a surge in demand for net-zero aligned frameworks, as the finance industry seeks to align their portfolios with the goals of the Paris Agreement and support the transition to a low-carbon economy.

In 2021, the Glasgow Financial Alliance for Net Zero (GFANZ) was born. GFANZ is a global coalition of leading financial institutions committed to accelerating the decarbonization of the economy. Achieving the objective of the Paris Agreement to limit global temperature increases to 1.5°C from pre-industrial levels requires a whole economy transition. Every company, bank, insurer, and investor will need to adjust their business models, develop credible plans for the transition to a low-carbon, climate-resilient future, and then implement those plans.

The net-zero, sector-specific alliances have made significant progress over the past few years, maintaining momentum in the membership growth and supporting their members in turning their net-zero commitments into action.

The Future of ESG Finance

ESG finance has come a long way since its early days. Today, ESG investing is a mainstream trend, with trillions of dollars invested in ESG-focused funds and products. The benefits of ESG finance, including financial performance, risk reduction, positive social and environmental impact, improved corporate behavior, and increased transparency and accountability, make ESG an atrractive option for financial institutions.

However, challenges such as the lack of standardization and the availability and quality of ESG data must be addressed in order for ESG to continue to grow and deliver its full potential. The development of new technologies and the increasing availability of ESG data are likely to make ESG easier and more accessible.

While there are challenges and obstacles to overcome, the potential benefits of ESG finance are too great to ignore. So, let’s continue to invest in a better future for all, one decision at a time!