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Bridging the gap: aligning finance and ESG investment for sustainability and regeneration

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By Alex Hong

· 19 min read

Introduction: the imperative of alignment in sustainability finance

In today's quickly changing financial market, achieving alignment in sustainability financing is vital. The current dilemma is rooted in a widespread imbalance between financial interests and long-term sustainability aims. This misalignment is more than just a matter of rhetoric; it has real-world consequences for economic development, environmental preservation, and social well-being. Understanding the scope of the problem is critical since it affects governments, companies, and individuals.

Misalignment: a pervasive challenge

Misalignment of financial interests with sustainability goals is a global phenomenon. Despite the increased emphasis on ESG investing, many investors continue to place a premium on short-term financial returns over long-term sustainability objectives. A startling study suggests that worldwide sustainable investment assets will reach $35.3 trillion in 2021, a 15% rise from 2018. However, the emphasis on short-term rewards frequently undermines these investments' revolutionary potential.

Economic ramifications

This imbalance carries serious economic consequences. This idea is shown with an excellent case study from the ASEAN region. Indonesia witnessed disastrous forest fires in 2020, partly as a result of unsustainable farming practises. The consequent environmental damage is estimated to have cost the country $5.2 billion in economic damages. Such practises could have been curtailed if financial interests and sustainability aims had been better aligned, averting this economic disaster.

Environmental consequences

The misalignment also has serious environmental repercussions. Consider the worldwide shipping industry, which accounts for around 2.2% of global greenhouse gas emissions. Despite growing awareness of the need for sustainable shipping practises, progress has been slow. As a result, the industry continues to contribute considerably to climate change, aggravating the imbalance between financial interests and environmental preservation.

Social implications

On the social front, the misalignment impacts vulnerable communities. Consider the garment sector in Southeast Asia, where the constant drive of profit often leads to abusive work practises. This divergence of profit and social duty fosters economic inequality and worker exploitation.

Individual impact

Individual investors are affected by the misalignment on a personal level. According to a 2020 survey, while making investment decisions, the majority of retail investors prioritise financial returns over ESG factors. Individual investors' ability to contribute to long-term change is limited by their focus on short-term rewards.

It is impossible to overestimate the importance of alignment in sustainability finance. Misalignment of financial interests with long-term sustainability goals has an impact on countries, industries, and individuals, resulting in economic, environmental, and social consequences. Addressing this imbalance is not only a moral necessity, but also necessary for a prosperous and sustainable future.

ESG fund bubble during COVID-19

The COVID-19 pandemic accelerated the emergence of ESG (Environmental, Social, and Governance) funds, altering the landscape of sustainability finance. This phenomena, while encouraging, necessitates a thorough examination in order to comprehend the ramifications of the ESG fund bubble.

Evaluation of rapid growth

The ESG fund market had an exceptional boom during the pandemic. Assets under management (AUM) in ESG-focused funds reached a record $1.7 trillion in 2020, representing a stunning 29% increase over the previous year. This expansion can be ascribed to greater awareness of environmental issues, rising investor interest, and a growing commitment to responsible investing.

Sustainability of growth and potential risks

While the rapid growth of ESG funds is welcome, concerns have been raised about the sustainability of this growth. One important source of concern is the possibility of an ESG fund bubble forming. The influx of cash into these funds may cause asset values to rise above their fundamental value, thereby causing market distortions and a market correction.

The capacity of ESG investments to deliver on their promises is also critical to the sustainability of this expansion. ESG fund managers must uphold the integrity of their plans, ensuring that ESG considerations are not just a marketing tool but a true commitment to sustainability.

Examination of investor behaviour

Investor behaviour during the epidemic was critical in propelling the rise of ESG funds. Investors are increasingly looking for investments that correspond with their beliefs and sustainability goals. This shift in behaviour is reflected in significant financial flows into ESG funds. Global ESG equities funds experienced record-breaking net inflows of $347 billion in 2020, showing investors' desire to incorporate ESG concepts into their portfolios.

Impact of COVID-19 on ESG trends

The pandemic of COVID-19 has accelerated and changed ESG trends. It emphasised the significance of resilience and adaptation, emphasising the 'S' (Social) part of ESG. Companies with strong social responsibility and employee well-being programmes were better prepared to deal with the pandemic. Furthermore, the pandemic emphasised the importance of 'G' (Governance) by emphasising the importance of strong company governance and risk management in times of crisis.

However, it is critical to note that the pandemic exposed gaps in ESG data availability and materiality, limiting investors' capacity to make educated judgements based on full ESG metrics.

The quick expansion of ESG funds during the COVID-19 pandemic demonstrates the growing importance of sustainability in the investment industry. However, it is critical to examine the long-term viability of this expansion, manage the risks associated with a potential ESG fund bubble, and guarantee that ESG investments deliver on their promises. The pandemic has altered investor behaviour and ESG trends, emphasising the significance of responsible and sustainable investing in a post-pandemic society.

Politicization of ESG in the United States

Environmental, Social, and Governance (ESG) elements have become politicised in the United States, altering the landscape of sustainable finance and investments. This politicisation has far-reaching consequences, both domestically and abroad.

Exploration of politicization

ESG, which tries to solve environmental and social issues through corporate governance and investment strategies, has become a politically heated topic in the United States. The schism is principally caused by opposing perspectives on the role of government regulation in tackling environmental challenges.

The one side calls for substantial government intervention and regulation to promote sustainable practises, while the other supports market-driven solutions with less government engagement. This ideological schism has resulted in the politicisation of ESG, which has made it a sensitive topic in American politics.

Analysis of government policies

Government policies have a significant impact on ESG investment decisions. By rejoining the Paris Agreement, setting aggressive climate targets, and proposing laws to encourage ESG integration in the financial industry, the Biden administration has exhibited a commitment to environmental and social responsibility. These policies have changed financial firms' behaviour, pushing them towards greater ESG compliance and disclosure.

The politicisation of ESG, on the other hand, has resulted in policy reversals and regulatory ambiguity as a result of changing administrations and political movements. This uncertainty can make long-term sustainability initiatives difficult for firms and investors.

Challenges of bipartisan consensus

One of the most significant issues in the United States is reaching bipartisan agreement on ESG priorities. The politicisation of ESG has created a polarised landscape in which agreement on legislative and regulatory measures is becoming increasingly difficult.

In the United States, the lack of a uniform approach impedes the establishment of a complete and stable framework for ESG integration and sustainability finance. Bipartisan cooperation is essential for the constant and effective execution of policies that can spur long-term investment.

Global implications

The politicisation of ESG in the United States has worldwide ramifications. As one of the world's leading economies and financial centres, the United States' ESG regulations and attitudes have a considerable impact on international sustainability initiatives.

The developing US position on ESG has an impact on global firms and investors since it can influence international commerce, investment flows, and the adoption of global ESG standards. Furthermore, the absence of a consistent US approach can lead to discrepancies in international sustainability initiatives, thereby stifling progress on major global concerns such as climate change.

The politicisation of environmental, social, and governance (ESG) in the United States has far-reaching ramifications for sustainable finance and investment. It reflects a deeper ideological difference over the role of government regulation in tackling ecological issues. Government policies, difficulties in reaching bipartisan agreement, and worldwide ramifications all contribute to the complex terrain of ESG in the United States. Addressing these issues is critical for building a more harmonious and effective approach to sustainability finance on a national and global scale.

ESG fund returns vs. non-ESG funds

The argument over the financial performance of ESG funds in comparison to non-ESG equivalents is an important facet of sustainability finance. Examining studies and empirical evidence sheds light on this ongoing debate.

Examination of studies

Numerous studies have examined the performance of ESG funds in comparison to non-ESG funds. The data consistently show that ESG funds frequently have marginal differences in returns. These studies demonstrate that ESG investments can provide competitive financial returns while also contributing to positive environmental and social effects.

Marginal differences in performance

One constant element in this research is the typically negligible difference in performance between ESG and non-ESG funds. While there may be differences based on the time horizon and specific funds studied, the consensus implies that ESG funds perform on par with, or slightly behind, their non-ESG counterparts on average.

This convergence in returns calls into question the long-held belief that including ESG variables into investing decisions inevitably results in inferior financial returns.

Factors contributing to convergence

Several factors contribute to the convergence of returns between ESG and non-ESG funds:

  1. Market efficiency: Market efficiency improves when ESG factors gain traction. This means that important ESG information is progressively being priced into all assets, diminishing the chances for outperformance based simply on ESG considerations.
  2. Diverse ESG approaches: ESG funds are not all made equal. There are numerous ESG solutions available, ranging from exclusionary screens to impact investing. ESG fund performance might vary greatly depending on their individual ESG criteria and investment style.
  3. Improved ESG metrics: Improved ESG data and indicators enable investors to make better informed decisions, lowering the risk of ESG investments. This enhanced transparency helps to bring results closer together.
  4. Investor behaviour: Investors are putting pressure on corporations to enhance their ESG performance as they become more aware of sustainability challenges. As a result, non-ESG firms are pushed to address ESG concerns, hence closing the performance gap.

Trade-offs between returns and sustainability goals

The convergence of ESG and non-ESG fund returns reveals a trade-off that investors must evaluate. While ESG investments do not necessarily excel in terms of financial performance, they do align with sustainability goals, lowering risks connected with environmental and social concerns.

Investors must strike a balance between maximising financial rewards and meeting environmental and social duties. This trade-off represents the broader shift to a more sustainable global economy in which financial incentives are aligned with long-term societal well-being.

A review of studies comparing ESG and non-ESG fund returns finds that the financial performance difference is frequently small. This emphasises the need of examining the larger objectives of ESG investments, which include environmental and social effects in addition to financial returns. Investors must handle these trade-offs as the financial landscape evolves in order to contribute to a more sustainable future.

Higher interest rates and corporate investment hurdles

The relationship between higher interest rates and corporate investment hurdles is a critical factor in the landscape of sustainability finance and Environmental, Social, and Governance (ESG) investment. Understanding how interest rates impact investment decisions, analyzing their consequences, and exploring mitigation strategies is essential for advancing sustainability goals.

Explanation of impact on corporate investment hurdles

Higher interest rates have a direct impact on the corporate investment landscape because they raise the cost of capital. As interest rates rise, so does the hurdle rate, which is the minimal rate of return required for an investment to be considered viable. This implies that businesses must achieve bigger returns on their investments in order to justify them. As a result, many projects that were economically viable at lower interest rates may no longer satisfy the higher hurdle rate, thus resulting in the cancellation or postponement of investment endeavours.

Analysis of consequences for sustainable investments and ESG strategies

The impact of higher interest rates on sustainability finance and ESG investments is multifaceted:

  1. Reduced attractiveness: Higher hurdle rates may discourage businesses from adopting sustainable projects that, while consistent with ESG objectives, may have longer payback periods or lower short-term profits. This diminished desirability may stymie progress in environmental programmes.
  2. Financial performance pressure: To satisfy higher hurdle rates, companies may prioritise short-term financial performance above long-term sustainability goals. This could result in a temporary departure from ESG commitments.
  3. Risk of stranded assets: As increased interest rates make some sustainable investments less economically viable, there is a risk of stranded assets in the form of projects or assets that lose value or become obsolete.
  4. Strategies to mitigate the impact

Mitigating the impact of rising interest rates on sustainability finance and ESG strategies requires innovative approaches:

  1. Long-term perspective: Encouragement of a longer-term view among investors and corporations can aid in aligning investment decisions with long-term sustainability goals, even in the face of short-term financial constraints.
  2. Financial innovation: Creating financial instruments that give ESG-focused businesses access to low-cost funding can assist mitigate the greater cost of financing.
  3. Regulatory support: Governments can encourage sustainable investment through regulatory measures such as tax breaks, subsidies, or preferential lending conditions.
  4. Risk assessment: Comprehensive risk assessments should include ESG elements, proving that long-term investments can provide resilience and competitiveness.

Higher interest rates complicate sustainability finance and ESG investing by raising corporate investment barriers. Innovative financial approaches, a long-term perspective, regulatory backing, and comprehensive risk evaluations are required to offset these issues. In a rising interest rate environment, balancing financial considerations with sustainability goals is critical to promoting ESG programmes and ensuring continuous progress towards a more sustainable future.

Misalignment of interests in the Asset Management industry

The Asset Management (AM) industry's misalignment of interests poses a substantial impediment to promoting sustainability financing and ESG investment. The industry's primary concentration on asset collecting, its use of ESG as a marketing tool, and the gap between ESG's long-term nature and short-term performance indicators all contribute to this misalignment.

Primary focus on asset gathering

The major goal of the asset management sector is asset accumulation, which is driven by the desire for more fees and increased profitability. Short-term asset accumulation is frequently rewarded in industrial compensation structures. This focus on short-term gains leads to a disconnect with the long-term nature of sustainability and ESG goals.

ESG as a marketing tool

ESG has evolved into a marketing strategy for asset managers in order to attract investors. While this promotes environmental consciousness, it can also lead to superficial ESG integration, where the emphasis is on seeming responsible rather than really incorporating ESG concerns into investment plans. This superficiality jeopardises the efficacy of ESG investments.

Reconciling ESG's long-term nature and short-term metrics

The difficulty comes from aligning ESG's long-term character with the industry's short-term performance criteria. Players in the AM business are often compensated depending on annual success, which is frequently quantified within a calendar year. By definition, ESG and sustainability challenges have longer time horizons. This imbalance prevents industry professionals from placing a premium on long-term sustainability objectives.

Disconnect between functioning and ESG imperatives

A major concern is the continuous gap between how the AM sector operates and the need to address ESG and sustainability challenges. While there is growing interest in ESG, it is frequently subordinate to the industry's profit-driven goals. This misalignment may limit the industry's ability to address serious global sustainability challenges.

Several initiatives can be taken to overcome these difficulties and align the AM industry with sustainability finance and ESG goals:

  1. Investor demand: Investors may hold asset managers responsible for their sustainability promises by demanding transparent ESG integration.
  2. Regulation and reporting standards: Governments and regulators can implement tougher laws and reporting requirements to encourage real ESG integration and long-term sustainability.
  3. Education and awareness: Professionals in the industry and investors should be informed on the advantages of ESG integration for long-term value development. Beyond education communications between regulators,, AMs and clients could be improved to understand the holistic needs of sustainability-related investments. 
  4. Incentivization: Compensation structures can be modified to better correspond with long-term sustainability goals, encouraging industry participants to prioritise ESG.

Addressing the AM industry's mismatch of interests is critical for promoting sustainability financing and ESG investing. To realign the sector's attention towards long-term sustainability and guarantee that ESG is more than simply a marketing tool, but a genuine driver of beneficial environmental and social impact, regulators, industry actors, and investors must work together.

Solutions for re-aligning finance and ESG investment

To close the gaps in sustainable finance and ESG investing, a deliberate effort is needed to re-align financial interests with long-term sustainability goals. Implementing effective solutions is critical in both the ASEAN region and the global context.

Introduction of solutions

Education: It is critical to raise awareness and knowledge of ESG concepts and sustainable finance. Educational programmes aimed at investors, asset managers, and corporate executives can help to develop a culture of responsible investment. This education can cover the importance of ESG factors, incorporating ESG into financial decisions, and measuring ESG performance.

Regulation: Governments and regulatory agencies are critical in encouraging sustainable financing. Strict ESG reporting rules and standards might drive businesses to include sustainability into their operations and disclosures. Green bonds and other sustainable financial instruments can also be made more easily available via regulatory frameworks. It would also be useful if the regulators were to take a more empathic and consultative approach towards driving business success (as a shared responsibility/effort). 

Incentivisation: By aligning reward structures with long-term ESG performance, asset managers and corporate executives can be encouraged to prioritise sustainability. Bonuses and incentives connected to ESG goals have the potential to drive significant change. To successfully evaluate these incentives, precise and verifiable ESG performance measures must be established.

Addressing ASEAN and Global South issues

Specific issues in the ASEAN region and global south need to be considered:

Access to capital: Many ASEAN and global south countries still encounter difficulties in obtaining sustainable credit. Green bonds and impact investment funds, for example, can encourage cash flow to address local sustainability challenges. These financial instruments can be tailored to meet regional sustainability requirements, such as renewable energy or clean water efforts. There are however promises from the International Monetary Fund and the World Bank to reorganise Multilateral Development Banks (MDBs) and to relook at how Special Drawing Rights and Foreign Exchange Assurances can be improved. 

Economic disparities: Economic differences within these regions should be considered in sustainable financing solutions. Inclusionary finance and social impact projects can help close the wealth divide. Sustainable finance can support balanced economic development by focusing on projects that address social injustice.

Cultural sensitivity: ASEAN and the global south's cultural nuances must be acknowledged. Initiatives for sustainable finance should be culturally sensitive and developed to harmonise with local beliefs and traditions. Understanding and applying cultural considerations into ESG practises can improve their acceptability and effectiveness. Sustainable finance often need to be contextualised and involves the consultation of multi-stakeholders to ensure success in the long run. There can be little hope of a “one-size-fits-all” approach. 

Changing investment expectations

Shifting investment expectations is essential:

Long-term perspective: Investors should understand that ESG investments frequently produce long-term benefits. Expecting immediate gains may jeopardise these investments' long-term sustainability goals. When pursuing long-term results, it is critical to educate investors on the value of patience.

Risk-return trade-off: Understanding the risk-return trade-off in sustainable investing is critical. While certain ESG investments may have slightly lower short-term returns, they frequently have reduced risk and contribute to long-term stability. It is critical to adequately communicate this risk-return profile to investors in order to manage their expectations.

Measurement beyond financial metrics: When assessing the effectiveness of ESG investments, investors should widen their measuring criteria to include non-financial variables. This includes elements such as environmental effect, social advantages, and governance enhancements. It is critical for transparency to have standardised measurements and reporting frameworks for non-financial performance.

Re-aligning finance and ESG investment for sustainability demands a multifaceted approach in both the ASEAN region and the global south. Education, regulation, incentivizing, and taking into account regional issues are critical. It is critical to shift investment expectations in order to prioritise long-term sustainability goals in order to achieve a more sustainable and regenerative future.

A call to action

In order to achieve a more sustainable and regenerative future, all stakeholders, including governments, corporations, and investors, must prioritise financial and Environmental, Social, and Governance (ESG) investment. This is a comprehensive call to action to overcome the current gaps in sustainability finance in the ASEAN region and globally.

Prioritize long-term sustainability

Government initiatives: Governments should set a good example by incorporating sustainability into their policies and practises. ESG reporting criteria should be enforced by regulatory bodies, promoting transparency and accountability. Businesses that exhibit high ESG performance may be eligible for tax breaks. This is seen in the European Union's Sustainable Finance Disclosure Regulation (SFDR), which requires financial market players to provide ESG disclosures.

Corporate leadership: Businesses must include ESG factors into their basic strategies. ESG experts should be included on boards of directors, and compensation structures should be tied to ESG goals. Companies are encouraged to implement sustainable and responsible strategies through initiatives such as the United Nations Global Compact.

Investor commitment: Investors should prioritise ESG integration and sustainability in their investing decisions. Asset managers can actively interact with companies to drive ESG improvements. ESG-focused funds and portfolios can be created to match with long-term sustainability goals, demonstrating asset managers' dedication to these principles.

Collaboration and innovation

Multi-stakeholder partnerships: Collaboration is vital among governments, businesses, investors, and civil society. Multi-stakeholder collaboration can spur innovation and increase the impact of sustainability programmes. For example, the ASEAN area might build collaborative platforms to solve regional sustainability concerns jointly.

Innovation in financial products: Financial institutions should innovate in order to produce financial products that are in line with sustainability objectives. Green bonds and impact investment instruments, for example, can channel cash towards initiatives with positive environmental and social consequences. Local challenges, such as renewable energy projects in ASEAN countries, should be the emphasis of these ideas.

Embrace the regenerative mindset

Shift the paradigm: A paradigm change is also involved in the call to action. Sustainability must be recognised as an investment in a regenerative future by all stakeholders. Sustainable practises, technologies, and infrastructure investments can result in a more resilient planet and long-term economic growth.

Measure impact: The effectiveness of sustainability and regeneration projects should be thoroughly assessed. Standardised measurements for evaluating investment's environmental, social, and economic results are critical for openness and accountability. Sustainability initiatives' social worth can be quantified using metrics such as the Social Return on Investment (SROI).

Accelerating sustainability and regeneration necessitates consistent commitment on the part of governments, corporations, and investors. Prioritising long-term sustainability, encouraging cooperation and innovation, and adopting a regenerative attitude are critical to closing the sustainable financing gap. We can work together to make the world more sustainable, egalitarian, and resilient for future generations.

illuminem Voices is a democratic space presenting the thoughts and opinions of leading Energy & Sustainability writers, their opinions do not necessarily represent those of illuminem.

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About the author

Alex Hong is the Executive Director of Digipulse Data and strategic advisor. He is the Chief Sustainability Coordinator of the Youth Networking Business Committee (YNBC). Alex is LinkedIn’s Top Voices (Green) in Singapore 2022 and represents the Global Blockchain Business Council (GBBC) as the Ambassador of Southeast Asia.

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