Reconciling Finance and Sustainable Development: Take the ESG Corner!
The “One Planet Summit” held on December 12 in Paris was concluded with the publication of 12 international commitments. Some of these announcements come from different governments or state institutions, such as the launch of the” green finance” network of central banks and financial market authorities (the Bank of France, the Bank of England, the central banks of Mexico, Netherlands, Germany, Singapore and China).
The heart of the summit, however, was its potential to bring the private and financial sector into account and to invest in the implementation of the Paris Agreement, in order to concretely translate the commitments made during COP 21. The mobilization of institutional investors during the summit was thus reflected by the launch of the “Climate Action 100+” coalition bringing together 225 large institutional investors representing more than 26 300 billion dollars of assets under management to coordinate their actions the top 100 listed companies that emit the most greenhouse gases.
If the financial sector seems, in part, inclined to mobilize against climate change, an effort must be made to support investors in determining a sustainable management strategy. This is particularly the purpose of the ESG rating approach, taking into account the extra-financial aspects (environmental, social, governance) of companies or states.
ESG adjusted GDP vs. Reported GDP (Global and per pillar)
Regarding Sovereign asset class, ESG integration has been hindered by lack of associated financial materiality. There is a need to adjust country financial wealth by its ESG performance. With ESG Factor-IN, Beyond Ratings has built a statistical identification of the most relevant ESG factors with regards to GDP growth through the creation of a specific model for five country groups based on income levels.
Final indicators are a computation of a Sustainable GDP per country and sensitivity analysis of financial ratings as key financial metrics. This approach provides an ESG-adjusted GDP per capita (appreciated or depreciated GDP per capita according to ESG factors) and an ESG performance score (appreciation or depreciation of GDP per capita according to ESG factors, in percent of GDP per capita). For example, in 2015, Russia’s ESG-adjusted GDP per capita stood at USD 20,362 vs. USD 23,895 for traditional GDP per capita, a depreciation (or ESG score) of -14.8% (cf. Figure below).
The Beyond Ratings research note published with this weekly digest seeks to identify the contributions of the Beyond Ratings ESG Factor-IN model when assessing Sovereign Yield Performance. Key findings are the following:
- We show that the ESG Factor-In model performs as well as traditional credit ratings in assessing yield performance, as ESG-adjusted GDP per capita has a slightly better explanatory power of sovereign yields than Credit Rating Agencies’ ratings;
- We also prove that an ESG approach provides additional and powerful information in the analysis of sovereign spread, as ESG factors remain statistically significant with traditional macro-financial indicators used as control variables.
As we proved that ESG integration through Beyond Ratings ESG score can provide relevant information to risk assessment and investment strategy, investors have now at their disposal a first support allowing the implementation of a sustainable management strategy. This is a first step towards a conciliation of finance and sustainable development, indispensable for the respect of the commitments in favor of the climate.