Whatever our individual perspectives of ESG may be, we all would agree that it is a complex subject. This State Street report is an effort to cut through the complexity and focus on what matters.
We examine the current ESG universe and provide a framework for thinking about what comes next. Our intent is that this report clarifies what ESG actually means in practice, what the drivers are and where ESG solutions will be found.
Here are a few of the highlights:
ESG is about supply and demand
While having originated in part from social considerations, ESG is a grassroots movement expressing current demands that matter to investors, consumers and employees. At its most fundamental, ESG connects those parts of the world on which we have not placed an explicit value — clean air, fresh water, healthy and supportive social fabric — with the financial economy. By explicitly acknowledging these factors, ESG enables us to include in economic decisions specific things we value but formerly failed to measure. Therefore, ESG is a re-evaluation and a broadening of what matters for investors, companies, and policy makers. It is a bigger and more accurate picture of value creation.
ESG is everywhere now
ESG started with investors in publicly listed companies, but has since spread across the entire financial system. It now extends to public and private companies, financial institutions such as banks and insurers, service providers such as ratings agencies, index providers and consulting firms, and policymakers. Each plays an important role in the ESG value chain, but their motivations and approaches vary considerably.
Technology and know-how drive ESG responses
Impelled by a range of social and cultural values comprising consumer and investor demand, other ESG drivers have increased in importance, including data and analytics, geopolitics, technological change, economic development and financial incentives. As ESG supply expands to meet demand, we expect developments in each of these areas to shape the long-term trajectory of ESG in the marketplace. For example, ongoing improvements in data and analytics will make it easier to measure and account for those areas that previously have not been easily measured, creating a virtuous circle that further drives growth in ESG.
The scope of ESG will continue to evolve
Today, it is fair to say that climate change is the most prominent focus of ESG. Greenhouse gas (GHG) emissions constitute an enormous and largely unpriced negative externality. But the overall scope of ESG is broader and promises to change over time. We identify four trends that will drive developments in ESG in the next 12 to 18 months. These include: a path toward international standards around ESG; the growing importance of transition finance in achieving net zero; greater recognition of nature-related risks; and more focus on the importance of human capital in creating value.
As ESG is increasingly recognized as a necessary response to market demand, solutions will proliferate and improve
We provide a current snapshot of the commercial ESG solution space. While technical innovation, government regulation, standards, policy frameworks, academic research and investor coalitions are enablers of ESG and should work hand in hand with market solutions, we create a market map that categorizes ESG solutions into five groups: investment products and services; data, analytics and research; scores, ratings, and indices; regulatory reporting and compliance and integrated tech platforms; and advisory and consulting services.
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The returns on a portfolio of securities which exclude companies that do not meet the portfolio's specified ESG criteria may trail the returns on a portfolio of securities which include such companies. A portfolio's ESG criteria may result in the portfolio investing in industry sectors or securities which underperform the market as a whole.
Responsible-Factor (R Factor) scoring is designed by State Street to reflect certain ESG characteristics and does not represent investment performance. Results generated out of the scoring model is based on sustainability and corporate governance dimensions of a scored entity.
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