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What sustainability-driven investors consider in firms

Energy and infrastructure projects have for the longest time attracted the attention of ESG (environmental, social and governance) regulators and watchdogs.  More recently however, ESG concepts have gained prominence in almost all other sectors of the global economy as boardrooms all over the world move to integrate ESG principles and metrics in their decision making.

The ESG acronym has been freely bandied about, but what does it really mean? Simply put, ESG is an umbrella term encompassing a wide range of standards through which investors assess the impact of a project or company’s operations on environmental, social and governance outcomes, with a view to driving capital towards sustainable investments.

The environmental attributes are concerned with the company’s impact on the natural environment and assess factors such as carbon footprint, management of waste and pollution, resource efficiency and impacts on biodiversity.

In a similar vein, the social aspect of ESG is concerned with how a company impacts and relates with the communities among which it operates, compliance with labor standards and human rights, health and safety standards and relationships with other corporations such as its suppliers and customers that hold similar values. 

The governance aspect looks into how the company is run, e.g. whether it uses accurate and transparent accounting methods, compliance with anti-bribery laws and policies on board diversity, internal controls and shareholder rights.

Taken together, these ESG factors help investors evaluate the expected performance of a company - for instance, a company complying with environmental requirements is less likely to lose its environmental permits.  The resulting undisrupted revenue generation improves its ROI forecast.

Based on market reports, ESG investing is increasingly gaining a foothold in mainstream investments unlike previously where it was confined to a few sectors such as petroleum, power or roads.   Its rise to prominence has been aided by climate change, which is now an undeniable reality, and the visible upsurge in public concern and activism in pursuit of cleaner environments and social equity.

So dominant are ESG considerations becoming, that major investors are setting aside significant chunks of their investment wallets to promote ESG compliant projects.  This is not simply about virtue signaling or the ‘feel good’ factor – ESG compliance has a direct impact on the bottom line and the share price.  It is also about corporate survival as we have seen large corporates felled by ESG failings. Who can forget the Volkswagen carbon emissions scandal or the dramatic fallout from oceanic oil spills by some of the oil majors?

Closer home, one casualty has been the proposed Lamu Coal Power Plant in Kenya, which suffered a recent set back due to its biggest financier, the Industrial and Commercial Bank of China, pulling out of the project citing environmental and social risks.  Previously, other lenders had backed off the project on grounds of scaling down investments in coal and citing a focus on clean energy.  As if this is not enough, the project has been plagued with lawsuits in connection with its anticipated environmental impact.  Another local example would the the suspension by UK supermarket giant - Tesco, of supply of avocados from a Kenyan plantation due to allegations of systemic human rights abuses.  

These examples make it clear that ESG considerations are no longer optional or just ‘good-to-have’ – they are pivotal to any company or project that is hoping to woo or retain investors and customers.

Multilateral lending agencies and development institutions were ahead of the ESG curve as they have generally been more conscious of sustainable development and often have a raft of ESG standards that their projects are required to adhere to, in addition to the customary covenants based on commercial bank facility agreements and host country requirements.

Other investors in the project finance space such as institutional investors and PE funds have also taken significant steps to address ESG concerns by attaching ESG conditions to their investments or influencing behavior through voting rights.

Similarly, to the extent that energy and infrastructure projects intend to raise funds from the capital markets, they should be aware that the major rating agencies (such as Standard and Poor’s, Moody’s Investor Services and Fitch Ratings) have now incorporated ESG considerations in their traditional analysis.

In conclusion therefore, ESG is here to stay.  As it takes centre stage, all parties must consider how prepared they are to deal with its demands.

The article was published in the Business Daily on 15 December 2020 and can be accessed here.