ESG’s Origins

Study Notes:

To understand the origin of how environmental, social, and governance issues came to influence the financial markets and investors’ decision-making, you may need to develop a timeline that extends several centuries.

ESG was essentially derived out of socially responsible investing practices, which mainly focused on excluding certain products that conflicted with certain social, or personal moral, or ethical values and beliefs.

In fact, the concepts and rules of socially responsible investing, or SRI, may be traced as far back as 3,500 years ago, as different religious groups aimed to instill in its members certain specific values such as prohibiting any financial transactions related to alcohol, gambling, tobacco, or firearms, among other products.

Through the lens of the 20th century, examples of SRI’s influence in the U.S. may be found, for example in the Vietnam War protests of the1960s, which included demands that university endowment funds prohibit investing in defense contractors.

Or in 1977, when a spotlight was thrown onto public health and social welfare issues, with the introduction of the Community Reinvestment Act, which was designed to encourage financial institutions to help meet the needs of borrowers residing in low- and moderate-income neighborhoods.

And later, in the mid-1980s, the Forum for Sustainable and Responsible Investment was founded, just some few years after the partial meltdown at the Three Mile Island nuclear power plant spurred fears about environmental disasters.

ESG Investing: Pivotal Events

While SRI practices centered on promoting social, moral, or ethical values in financial decision-making, concerns affecting the environment, society and corporate governance have generally led to a more focused, financially relevant investment discipline: namely ESG investing.

Some of the pivotal events that marked the inception of ESG investing – a strategy that has recently seen an increasing groundswell of inflows into investment funds – go back about 20 years, when Kofi Annan, then the UN Secretary General, formed a joint initiative under the UN Global Compact with the International Finance Corporation and the Swiss government. This initiative, which was intended to devise ways to incorporate ESG into the global capital markets, yielded a detailed report called ‘Who Cares Wins’, while separate efforts conducted by the UN resulted in another pivotal report, known as the ‘Freshfields Report’.

The insights and analyses detailed in these publications ultimately culminated into a more in-depth argument that suggested that by integrating environmental, social and governance factors into the financial markets, there would not only be greater sustainability and societal impacts, but also financial relevance.

Given the evidence from these initiatives, a series of supporting frameworks were developed, including the UN’s Principles for Responsible Investing (PRI), Sustainable Stock Exchanges (SSE), as well as improvements in transparency and accountability such as through the Global Reporting Initiative (GRI), the International Integrated Reporting Council, and the US-based Sustainability Accounting Standards Board (SASB).

Also, by 2015, the UN established Sustainable Development Goals – a collection of 17 interlinked global goals that the UN claims were designed as a blueprint to achieve a “more sustainable future for all”. These SDGs, which comprise certain ideal aims such as ‘no poverty’ and ‘zero hunger’, as well as for industry, innovation and infrastructure, gender equality, and climate action, are intended to be achieved by the year 2030, and are typically used to serve ESG-investment frameworks.

Currently…

In addition to a rise of ESG-related inflows into funds, ESG has also seen a proliferation of advanced technological tools to help improve fundamental analysis, as well as international initiatives to support the issuance of financial assets. It’s also disrupted more traditional, industrial age market business practices, and has since seen many other impacts on investors’ decision-making processes.

Financial market participants also widely expect that ESG, along with other forms of impact investing in the U.S., will continue to blossom under the policies of the Biden administration, which may reinforce corporate strategies to better address concerns related to topics such as climate change, water management, health and safety, supply chain management, and workforce welfare.

While we’ll dive more deeply into some of these strategies in a later lesson, it is important to keep in mind the there are several organizations, both domestic and global, that have evolved over several years to help develop ESG investing into a more fundamental, financially relevant discipline.