Does the definition of ESG investing need to expand?

Ahead of the ESG Summit 2023 in Melbourne, founder and chief executive officer of Ethical Invest Group, Alexandra Brown, said that she is feeling pressure to use the term environmental, social, and governance (ESG) investing instead of sustainable investing but remains hesitant to make the switch.

“I’m not using ESG investing as a term yet,” she told ifa.

“I like to differentiate between using ESG factors in the analysis process and sustainable investing, where you’re looking at a positive outcome from using ESG factors.

“I’m feeling a lot of push on me now to use the term ESG investing, and I’m not sure whether I should continue to push back or just start using the term because I don’t want to add to the confusion either.”

Her comments preceded her session at the ESG Summit 2023 this week, where she will help advisers navigate difficult conversations with clients to enhance their ESG value proposition.

Explaining why she prefers using sustainable investing instead of ESG investing, Ms Brown — who supports the transition from traditional to ethical adviser — said she uses the Responsible Investment Association Australasia (RIAA) spectrum to understand where ESG fits into the responsible and ethical investment universe.

The responsible investment spectrum places ESG integration on the left after traditional investment, as something that explicitly includes ESG risks and opportunities into financial analysis and investment decisions based on a systematic process and appropriate research sources.

On the right end of the spectrum are sustainability-themed investing — which targets investment themes such as sustainable agriculture or green property — and impact investing, which aims to achieve positive social and environmental impacts, and requires measuring and reporting against these.

“In this context, ESG factors are used in the investment decision-making process as a risk management mechanism,” Ms Brown said.

“Then we would move into negative screening, which is where you would screen out funds based on ESG issues. I think this is where the lines are blurred. ESG integration or analysis is for risk management, but we still use it in ethics and values.”

For example, gender diversity would classify as an “S” or social issue and would be used in ESG risk analysis because it would pose a risk if companies did not have a board with gender diversity.

“But that ‘S’ factor could also be used in a sustainability fund that has a gender lens.”

Ms Brown also noted that advisers and their clients might not understand that ESG integration is about risk management whereas sustainable investing is about targeting themes that could have a positive impact.

A solution to this confusion could be to reach consensus on broadening the definition of ESG investing so that there is universal understanding of the term, Ms Brown proposed.

When asked whether this should be driven by the industry or regulators, she mused that both options would be “fraught” with issues.

“If we look at what is happening with the Sustainable Finance Disclosure Regulation (SFDR) where regulators are trying to impose definitions, it is an example of good intentions but the outcomes aren’t always clear,” she said.

“It can still become a box-ticking exercise and create confusion and greenwashing. Some like how the definitions are regulated, whereas others say this restricts their creativity when creating products that will meet client demand.”

The SFDR is a European regulation that imposes mandatory ESG disclosure obligations for asset managers and other financial market participants, with many provisions effective from March 2021.

Ms Brown said she is leaning towards regulatory nomenclature to reach consensus on the definition of ESG investment and integration, but warned that reaching industry-wide consensus will be a challenging task.

To hear more from Alexandra Brown and about how advisers could communicate the financial and ESG benefits to clients and provide outcomes-based advice, come along to the ESG Summit 2023.

It will be held on 29 March at Grand Hyatt, Melbourne.

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For more information, including agenda and speakers, click here.