MARTYN DAVIES: Sustainable finance is driving investment in changing the future

We have a narrow window of time — the next 10 years — to take the decisions needed to alter the trajectory of climate change.

The choices made today will determine our future. We have the opportunity to create a new engine for sustainable economic prosperity while preventing the worst consequences of a warming world. How capital is allocated towards supporting this mega shift is crucial and this trend has been labelled “sustainable finance”. How should corporates and countries embrace this?

Considering the recent disruptions and volatility of global energy markets due to the conflict in the Ukraine, energy transition, an element of sustainability, has become top of mind for many executives.

Reducing the reliance on oil and gas as a major source of energy and transitioning towards green or sustainable energy is not just an environmental concern but is becoming a business imperative to improve energy security and resilience. In some sort of brutal historical irony, recent tragic events such as the Covid-19 pandemic and the conflict in the Ukraine are likely contributors and accelerants of dramatic change in the energy sector.

Sustainable energy is quickly evolving into a source of competitive advantage for countries and companies. For organisations to gain this advantage, it is important to shift towards a focus on long term value through embracing the new strategic theme that is sustainable finance.

Companies and their finance functions have increasingly been dealing with the question of sustainability. However, while the costs and regulatory burdens associated with addressing sustainability were quite evident, the benefits of doing so have until recently been less visible and quantifiable.

That has changed in recent times as public awareness of the world’s environmental and social challenges has grown and with it the demand for businesses and policymakers to take action. This has risen to the top of the agenda post-COP26 at the tail end of last year.

A growing body of evidence shows that a focus on environmental, social & governance issues (ESG) serves to improve companies’ financial and operational performance in the long term. Deloitte research shows that embracing ESG creates value for all stakeholders and that consumers, employees as well as investors are seeking greater transparency around ESG related issues.

Companies across all industries are beginning to recognise this and are making strong purpose-driven commitments and strategic shifts to differentiate themselves in the market. Take MasterCard, which pledged to bring 1-billion people into the digital economy by 2025, or Goldman Sachs, which aims to deploy $750bn of sustainable finance by 2030.

Good business strategy

An integrated ESG strategy aligned to corporate purpose and focused on the differentiated role a company serves in society is good business strategy that drives sustainable, long-term value. We have found that 82% of investors agree (35% “strongly agree”) that ESG integration into business strategy will lead to equity outperformance over the next three years, and 70% agree (17% strongly agree) in fixed income.

ESG assets are expected to double by 2025 among investors with $25-trillion in assets. Almost eight in 10 asset managers surveyed globally (78%) incorporate qualitative or quantitative ESG factor assessments into their investment processes.

A driving force behind ESG is the increasing launch of sustainability investment funds in the marketplace resulting from demand from both retail and institutional investors. Differentiation in the market will become more important (and more competitive) as many firms are increasing their ESG investment offerings.

As a result, it is expected that by 2025 half of all professionally managed assets in the US could well be ESG-mandated assets. It will be difficult for investment managers to effectively compete for capital allocations without a client-centric ESG strategy that encompasses credible ESG disclosure and practices. This point is crucial as all investors and regulators are demanding greater transparency and access to more information pertaining to firms’ ESG strategies and practices. Beyond transparency towards accountability is an identifiable trend.

By embedding ESG into their strategies, companies are positively influencing their brand, corporate reputation, improve capital access, market valuation, enhance operational efficiencies and notably attract talent into their organisation. This last point is particularly relevant for younger talent seeking employment with companies that embrace deeper societal and an emerging consistent set of global values. A recent study found that 78% of respondents indicated that they would prefer to work for a “purpose-driven” company.

Our research reveals that over two thirds of consumers want to be “in the know” when it comes to understanding how the brands they use embrace ESG issues and they are willing to be more sympathetic towards purpose-driven companies.

This observation has become even more prevalent in recent weeks in light of the conflict in the European region and how companies and consumers are responding. This trend has thus become very evident, and it is apparent that to be a global leading company and brand, a stance on social (and now even geopolitical) issues has become an imperative for business. Corporate management of political activity is undoubtedly becoming more relevant as well as challenging, not just domestically but internationally.

Sustainable finance and investing into ESG-aligned and ultimately compliant metrics have rapidly moved from niche to the norm. It is now accepted wisdom that embedded ESG in corporate business strategy and operations is essential to successful capital allocation and utilisation.

How countries regulate the rapidly emerging sector will also serve as a competitive national advantage. Public policymakers need to thus craft a regulatory environment that best enables the growth of ESG capital markets in their respective countries that will be a key defining trend in the years to come.

• Dr Davies is MD: emerging markets at Deloitte.