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26 Jan 2022 
Claude 
The challenge for investors and assets managers becomes « seeking for investments that are in the same time financially profitable and socially beneficial.» Therefore, companies have introduced some measures that demonstrate their ESG’s engagement and ensured that entities in which they invest are also committed from their side. Rising customer demand for these types of products such as green bonds and ESG funds has boosted the responsible investment market. However, responsible investment does not often go in the direction of economic performance.
Starks and als, found that institutional investors, in the United States, are increasingly making their voices heard in shareholder’s assemblies to make their investments compatible with ESG requirements. In the same way, « Hatzmark and Sussman (2018), found that mutual funds collectively reveal the preference for good ESG performance.» According to a study conducted by Bloomberg in May 2019, 34% of companies that have introduced sustainable measures have done it in response to customer demand.
The second key factor was the maintain of long-term performance (25% of companies). Zhan and als (2018) have demonstrated a relationship between the valuation of a company’s share and the degree of its ESG commitment. Therefore, stocks which are seen to be under-valued on the market and which have little commitment to sustainable development « have the highest risk adjusted returns. While most overpriced stocks with good ESG performance have the lowest risk adjusted returns.»
Cao et als (2018) mentioned that ESG investments became popular from the year 2004 and their considerable growth during the recent period has significantly affected the efficiency of the stock markets. While Strark et als (2017) explain this inefficiency by the fact that financial institutions which are «oriented towards responsible investment are more patient with companies when their shares are overvalued because of superiority in ESG performance.
Conversely, they do not buy undervalued securities when their ESG performance is weak. They conclude also that socially responsible institutional investors
The challenge of sustainable development is so important for several reasons including: − The uncontrolled increase in the world population, which demands more and more resources for their consumption. − Capitalism has pushed economic agents towards a massive exploitation of natural resources by making them increasingly scarce. For example, modern lifestyle encouraged people to have their own vehicle instead of using public transportation. Moreover manufacturers are producing goods with a limited lifespan.
All these actions allow companies to maximize their profits regardless the harmful effects of their activity on nature or people. − The scarcity of non-renewable resources such as oil or gas, can lead to their exhaustion if we continue at the current rate of their use. − Climate change is producing harmful effects such as cyclones, extreme heat that reduces water resources; increase sea level or population displacements.
Inaction will lead to more losses, which will affect all economic sectors, in particular, banks that are linked to local and global economy. The DARA Group’s report indicates that 5 million people die each year as victims of climate change and carbon emissions. Furthermore, it mentions « that climate disruption is already costing US $1.2 trillion annually, cutting global GDP by 1.6%. While, the United States will lose 2% of its GDP by 2030 according this report’s estimates.» Hence, we see that our global economic system has reached its limits.
The awareness of preserving the planet and having a world of ethical and human approach for doing business is more than ever the priority of our century. Because these serious threats that the topic of sustainability has become a challenge at all levels for decades. The definition of sustainable development was introduced in 1987 in the « Bruntland report as development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs.»
Sustainable development topic has a very broad scope including among others the protection of natural resources, solving social problems, or even the fight against corruption and the reduction of poverty. Under the aegis of the United Nations, the Sustainable Development Goals (SDGs) summit in 2015 brought together representatives from 193 countries to adopt the 17 sustainable development goals. Actions to achieve these objectives will have to improve the daily lives of people around the world. In order to follow the progress of this 15-year action plan, the September 2019 summit in New York took place. It was concluded that at the current rate, countries are not doing enough to achieve the goals by 2030.
As a result, countries have been asked to integrate the goals of sustainable development into their actions and strategies in a more transformative way, to involve civil societies and work collaboratively to reduce the trade-offs that may arise. At microeconomic level, the commitment of a company as an active player requires first of all defining the objectives (SDG’s) that it wants to achieve. Then, managers need to implement an integral approach in their action plan, which affect all of the predefined objectives. Then, a system of control and monitoring of achievements will assess the non-financial performance of the company.
Sustainability is an issue that affects all economic agents, corporations, government, consumers, and civil society, etc. It is also strategies that are established between countries on a global scale. SDG’s can orient investors to tackle global issues and at the same time create profitable business opportunities. For example, reducing air pollution and the nuisance caused by vehicles is the origin of car-pooling companies. Thus, there is not one model that applies to everyone.
Each country has its specificities and priorities on which it must focus more than others. For example, in some countries like France, some nuclear power plants are being dismantled to protect the population against possible risks of pollution and disease. While in Switzerland ethical finance is on the agenda, following pressure from the European Union to end banking secrecy. Private as well as public companies, associations and civil society, citizens, are increasingly involved in the effort to preserve the planet and protect the environment. The efforts of governments faced to multiple political and social challenges, cannot be enough to provide the necessary funding.
The Banks, as key players in global finance are asked to contribute more than ever in this visionary project that has united the entire stakeholders. In this context, the «President of the European Commission Ursula von der Leyen, has asked the European Investment Bank to become the financial engine of the low-carbon transition. Mr Werner Hoyer, President of the European Investment Bank mentioned that there is a clear business rationale for prioritizing green finance. Investors and rating agencies are increasingly scrutinizing investment portfolios for potential “stranded assets” such as oil and gas projects that will become obsolete as more renewable-energy technologies become commercially viable.»
In 2009, Pollin predicted that the banking system would be profoundly changed after the 2008 financial crisis. Creating value is no longer coming from trading and conventional speculative operations. According to him, redefining and deepening the relationship with customers is a new way of creating value for the bank. Furthermore, innovative products will drive growth thanks to new technologies, which lead to more energy-efficient, resource-efficient consumption and investment policies.
The financial sector was considered for a long time to be outside the scope of sustainable development issues. Initially, attention was paid first to industrial companies considered polluting and abusing the workforce. Through their involvement in financing the economy affecting all sectors, the banks have taken initiatives integrating sustainable development measures in their business.
According to a study done by H.Elabidi and B.Hamdi (2011) economic crises, environmental issues such as global warming and the collapse of social values were among the causes that led leaders to put sustainable development on the priority list. Social commitment is advantageous for companies listed on the stock exchange. Cao and Als show that in the United States these companies are more followed than the others by financial analysts. When these companies are undervalued on the stock market, investors prioritize to buy those with high ESG. Whereas, if the security is overvalued, the investor will hesitate much longer before selling it.
Switzerland a country renowned for its banks and the two international financial centres (Geneva and Zurich) is more concerned than the others by these major changes in finance. Therefore, in October 2019 “ Building Bridge” was the first ever summit organized in Switzerland. The summit brought together representatives of «banks, United Nations, NGO’s, civil society, Government and various stakeholders from the financial sector. The common purpose was to discuss the ways to accelerate transition for world sustainability and to concretize Sustainable Development Goals (SDGs) fixed by the United Nations through sustainable finance.»
According to Mr Ermoti CEO of UBS Group, the UN has estimated that $ 2.5 trillion is needed to achieved the SDG’s. Here the challenge is more than enormous. Several services companies for finance professionals have been interested in creating ESG databases (such as MSCI, morningstar or bloomberg in the United States) in order to assess the social, environmental and governance policies of companies monitored on major markets. MSCI determines scores corresponding to several subcategories «including community relations, the environment impact, product characteristics, employee relations and corporate governance.»
Obviously, it is necessary to subdivide the scoring process in order to have a comprehensive vision, which includes the key action points promoting sustainable development. Through my master project I will also subdivide the work by focusing on each of the three pillars that define sustainable development which are: the economic, social and environmental aspect. Consequently, the questionnaires that allow us to collect data will relate to the three components of sustainable development.
At the level of companies and financial markets, decision-makers are integrating sustainable development as an important objective in their internal management as well as the choice of investment opportunities. However, it is necessary to have indicators in order to measure the effort made and make it quantified. Over the years, several indicators have emerged which have covered relevant aspects such as «The United Nations Human Development Indicator, the ecological footprint index, FTSE Good Index, the index of sustainable and economic welfare developed by Centre for environmental strategy (CES), …»
The methodology for setting up a sustainable development index (SDI) is different from one to another. Generally, each index is composed of several components that we call subdivision assessed separately. The more complex the index, the more we must subdivide to encompass all the relevant elements and make them easily measurable. Singh et al 2008 presented a summary table of the methodology for calculating 41 famous indices (appendix N°1).
In this summary table we find for example: the index of sustainable and economic welfare, which is the result of 7 measures that improve social well-being and 13 measures that reduce it. So the final score is the sum of positive and negative sub-scores. The following diagram (figure n°1) shows a general framework of sustainability assessment carried out by Ness et al (2007) showing three areas of analysis. The first area is linked to indicators the second focuses on services or products according to its life cycle and the third to variation in strategy. The whole is overcome by a time axis that either targets the past or is oriented towards the future.
The indicators have become widely recognized and used on a large scale, because they have made it possible to synthesize diverse and complex data, to convert them into easily understandable and comparable figures. Lundin (2003), specifies that these indicators are very useful and contribute to: – Monitor achievements (Help decision makers to know the goals achieved and to set new objectives.) – «Anticipates and assesses conditions and trend – Allow early warning to prevent environmental, social or economic damages – Formulate strategies and communicate ideas.» I notice that multinationals and large listed companies disclose the sustainable actions they take, either in separate reports or in their annual reports.
However, these companies do not communicate what action must achieve which objectives. In addition, there are no comparisons over time because from one year to another the measures carried out are different in their nature and could not be compared directly. This is why it is necessary to value in a quantified way any effort whatever its nature. If we want these actions to be carried out as part of the corporate strategy, we should have sustainable development indicators among the key performance indicators (KPIs) in the managers’ dashboards.
As mentioned above, several indicators have been created to have assessments of countries such as the human development index or the Gross Domestic Product … but sustainable development indices as managerial tools are often ignored in favour of financial indicators. The specificity of banking companies is that they deliver services that by nature are not supposed to be harmful to nature or to people. However, given their financing power, whether direct or indirect (through investments for customer’s benefit or through money lending), they can strongly steer the economy towards radical transformations which may or not, meet the objectives of sustainable development.
Mr Ralph Hamers CEO of ING Group says that: « Sustainability is a source of competitive advantage. We can help facilitate the transition to a fairer, greener economy by financing projects that accelerate client’s sustainable transitions and supporting clients that contribute solutions to environmental and social challenges.» The United Nations Environment Programme (UNEP) report (2016) indicates that to be considered a sustainable bank, it must be able to take actions and assume their responsibilities at all levels and in all functions. This means that the commitment manifests itself in concrete actions, which involves all human resources and in continuous way over time. These should not be one-off actions.
Financial institutions have seen that the trend of sustainable development has more advantages than disadvantages and can therefore be a source of added value, so they took the bandwagon. The question here is why is it important for banks to be sustainable? As the economic performance is a primordial aspect in a bank, it has been shown that sustainability and profitability are not mutually exclusive. The Mc Kinsey report published in 2014 has shown that the most committed companies do this because it has a financial impact on their business, where the potential financial gain is estimated at around 3%. Among the advantages of being a sustainable bank:
• The bank will be better monitored by a wider number of stakeholders and will be better assessed.
• The image of the bank will be improved as well as its reputation (example: the bank gains popularity with citizens when it finances sports and cultural events)
• Bank staff will be more efficient, the turnover rate will drop given the equal opportunities and the bank’s interest in improving their conditions
• A reduction in operating costs (example: lower consumption of energy, reduction of office supplies such as paper costs.)
• Adapt to market changes and thus retain customers who are very sensitive to issues related to sustainable development. However, the non-involvement in the movement that promotes sustainability presents significant risks, which can jeopardize business continuity, in particular:
• « Loss of business opportunities and financing options through a failure to adapt to changing market realities
• Higher overall risk exposure through a failure to understand the materiality of environmental and social risks
• Potential pressure or disengagement of investors prioritizing sustainable investment choices • Lack of preparedness for regulatory and policy adjustments
• Risks to reputation, credibility and image of the bank through a failure to respond to stakeholder expectations.»
In an interview with Bertrand Gacon, co-founder of the Impaakt collaborative platform in Geneva, he confirms the practical difficulty of making a comparative evaluation. He explains this by a problem related to the collection and data analysis, which are the bases of the methodology and the design of a grading scale. « There is a data problem in social and environmental analyzes, called ESG. Data used by the banking industry looks at business practices, how employees and suppliers are treated, good governance, their CO2 emissions, but does not take into account their core business.
Banks struggle to measure the real social and ecological impact of societies on the planet. For example: a tobacco manufacturer can get a good ESG rating if they use organic fertilizer, subsidize medical aid for poor, helps to ensure drinking water sources or ensure pay equity between women and men. However, tobacco causes lung cancer and does nothing in societal terms. In reality, ESG analyses do not allow for a thorough rethinking of capital allocation.» It is obvious that classic ESG data are insufficient; there is a whole new field of impact measurement that is opening up.
The capital must be redirected towards companies with strong societal impact. It is absolutely clear that investing in the electric car manufacturer Tesla is more sustainable than in Japan Tobacco International, but we cannot distinguish whether the UBS bank is better committed on a sustainable basis than the HSBC bank. Switzerland as a pioneer country must position itself more aggressively as a global hub for sustainable finance. This involves establishing norms and standards, launching green products or even certification by labels in this segment of investment that still remains a niche for commercial banks.
Several interesting products are created to invest sustainably: “green bonds”, microfinance, philanthropy, and sustainable funds. Green bonds are at the center of investors’ attention, it makes it possible to seek financing for projects having a real impact on the planet, whether in terms of renewable energy, green transport or energy efficiency.