‘Decision Critical’ – Four ESG Themes Investors Should Be Aware of Right Now

We’re often asked about the most important ESG themes that investors should consider. As bottom-up, active managers, we unsurprisingly tend to focus on those issues that are most material for each investment case. That said, there are several overarching ESG topics that we believe are increasingly important for investors to be aware of right now. 

1) Carbon Disclosure – pressure to improve

Climate change is perhaps the most obvious theme, due to the broad consensus around the need for large-scale concerted action. We expect this to remain a significant focus in 2018 and beyond, with major debates – including around divestment and stranded assets – certain to rumble on. From an investment perspective, a major challenge so far has been the lack of consistent (and relevant) climate change reporting by companies, in turn complicated by absence of measurement standards (dealing with emissions classification, potential double counting etc.). The good news is that this is changing, thanks in no small measure to initiatives like CDP^[1] (formerly the ‘Carbon Disclosure Project’) and the Task Force on Climate-related Financial Disclosures (TFCD). Indeed, last year saw the publication of the TFCD’s high-profile recommendations. These provide a very useful framework for companies – structured around ‘Governance’, ‘Strategy’, ‘Risk-management’ and ‘Metrics and targets’ – making sure that the information reported is ‘decision-critical’ for investors.

2) Cybersecurity – an increasing threat

Another ESG issue that should be at the forefront of investors’ minds is cybersecurity. Last year saw no let up in major attacks, illustrating the growing sophistication of hackers. Besides spending more on their cyber defences, we believe companies will increasingly question the risk/reward of holding certain data, not least due to more stringent regulation. The most significant development here in 2018 is the introduction of the European Union’s General Data Protection Regulation (GDPR^[2]), which European companies must comply with by the end of May. The GDPR is not without bite – failure to comply can lead to fines of up to €20 million, or 4% of annual group turnover (whichever is larger). In addition, companies will be required to report data breaches within 72 hours of discovery. Cybersecurity is an important area for our research and company engagement and a reason why we are involved in a collective initiative co-ordinated by the PRI.

3) Sustainable Development Goals (SDGs) – a growing focus

We also need to mention just how important the United Nation’s Sustainable Development Goals (SDGs) are becoming to asset owners and the fiduciaries they employ. We are increasingly seeing these incorporated into reporting frameworks, with the sizeable number of goals (17) and sub-targets (169) organised on the grounds of materiality. Indeed, while some of the goals may only have a tenuous link to business activity, many are directly investable. From a risk perspective, we believe that companies whose business models conflict with the SDGs risk eroding their licences to operate. Conversely, those businesses that take a proactive approach to sustainability are likely to strengthen their competitive positions.

4) Sustainable finance – moving into the spotlight

Finally, with the recent publication of the European Commission’s High-Level Expert Group (HLEG)’s final recommendations on how to create a sustainable financial system, we can expect to see much greater transparency of companies’ ESG policies as well as investors’ duties regarding sustainability. Specifically, HLEG has proposed a clearer taxonomy around sustainability. Notably around investors’ obligations when it comes to creating a more sustainable financial system and better disclosure as to how sustainability features in decision making for investors and companies. In our view, this is a very significant report as it will feed directly into the Commission’s ‘Action Plan’ on sustainable finance, thus having a real impact on policy in the coming years.

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About Martin Currie

Martin Currie is an active equity specialist, crafting high-conviction portfolios for client-focused solutions. Investment excellence is at the heart of its business. Central to this philosophy is a stock-driven approach, based on in-depth fundamental research, active ownership of companies and skilled portfolio construction. As an affiliate of Legg Mason, it also has the backing of one of the world’s largest asset management firms.

About Legg Mason

Guided by a mission of Investing to Improve Lives,^TM  Legg Mason helps investors globally achieve better financial outcomes by expanding choice across investment strategies, vehicles and investor access through independent investment managers with diverse expertise in equity, fixed income, alternative and liquidity investments.  Legg Mason’s assets under management are $767 billion as of December 31, 2017.  To learn more, visit our web site, our newsroom, or follow us on LinkedIn, Twitter, or Facebook. 

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^[1] A carbon disclosure rating is a numerical score that indicates the level of reporting of a company's climate-change initiatives. The best-known carbon disclosure rating is based on a survey issued by CDP, a nonprofit formerly known as the Climate Disclosure Project. Investopedia

^[2] The General Data Protection Regulation (GDPR) is a legal framework that sets guidelines for the collection and processing of personal information of individuals within the European Union (EU). Investopedia