ESG Integration and Investing in the SDGs: Why and How?

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This article is a part of the NordSIP Insights – Handbook – “Investing Along the 17 Shades of SDGs”.

Since the establishment of the Principles for Responsible Investments (PRI) in 2006, investors have focused on the role of ESG in informing decisions at the asset class level. However, the focus is shifting to strategic asset allocation, according to Stephanie Maier, Director for Responsible Investments at HSBC GAM.

Stephanie Maier
Director, Responsible Investments
HSBC GAM

“We believe that ESG issues are material to our investment decisions,” says Stephanie Maier. “We were early adopters of the PRI and in 2007, under the direction of our Global CIO, moved quickly to launch a central ESG data platform and training for all of our analysts and fund managers.”

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ESG integration into the investment process allows the bank to understand the complexities of global megatrends, such as climate change. Thus equipped, investors can position themselves to manage the emerging risks and opportunities associated with these new paradigms. Through thoughtful ESG integration, Maier argues investors can guarantee the long-term profitability of their portfolios while helping the world to remain on a sustainable development path.

The Portfolio Impact of Climate Change

To the sustainability specialist, ESG integration is not a fad. It is a tool with which to enhance asset management and inform investment decisions beyond the purely financial considerations that have traditionally been the norm. Along the environmental track of ESG, interest has been increasing in models that simulate and forecast the effects of climate change on GDP and asset returns. Academic research[1] suggests that in a scenario where global temperatures rise by 4°C by 2100, the GDP may fall by 10.5% in the USA, 13% in Canada and 12% in Switzerland.

HSBC’s in-house research echoes these concerns. “Since the end of 2017 we incorporate climate considerations as part of our ESG integration,” the Director for Responsible Investments explains. “However, with the launch of the Taskforce on Climate-related Financial Disclosure (TCFD) recommendations, we started working on the impact of different transition scenarios on equity valuations and then credit ratings”.

HSBC has developed[2] a four-stage approach with which to consider the impact of the low-carbon transition on a diversified equity portfolio. The approach combines scenario design, top-down integrated assessment modelling and bottom-up value stream modelling to estimate equity impacts. It begins by identifying low carbon transition pathways based on expert assessment of policy and technological uncertainties. HSBC then incorporates these assumptions into an integrated assessment model of revenues and costs that are, in turn, treated as an input for companies’ returns.

“We learned a lot in the process [of applying this model] about how the changes in climate policy and technology impact company valuations,” Maier says. “As you would expect, certain scenarios are more challenging for specific sectors, but there is also significant variation within sectors with clear winners and losers. These insights inform our integration and engagement efforts.”

The SDGs and Closing the Investment Gap

The UN’s 17 Sustainable Development Goals (SDGs) represent another useful lens through which investors can identify investment opportunities and potential sources of global GDP growth. Covering topics such as climate change, human rights, inequality and economic growth, the goals were initially aimed at policymakers. However, the SDGs also matter for long term investors. “Failure to achieve the SDGs can present significant sources of systemic risk, in particular for large universal asset owners,” Maier argues.
The danger is material. Estimates suggest that, at current levels, the world is US$1.9-3.1 trillion behind on the US$5-7 trillion of annual investment required to meet the SDGs over the years of 2015 to 2030.

Taking into account the sustainability impact of each asset class enhances asset managers’ understanding of the efficient investment frontier and can result in a more meaningful allocation of capital to SDG-aligned investments, according to HSBC’s Director for Responsible Investments.

Financing the SDGs Through Green Bond Funds

“We are committed to mobilising capital into projects that deliver on SDGs by collaborating with institutional investors, development finance institutions and policy-makers,” Maier explains.

Financially, HSBC has focused on supporting the green bond market. “Green bonds are an excellent asset class through which we can deliver impact due to the clarity around the use of proceeds,” the Director for Responsible Investments explains. “To date, we have seen most green bond issues in developed markets and a few notable emerging markets. Financials have also tended to dominate.”

However, Maier argues that the market needs to grow if we are to meet SDGs. HSBC can help by helping issuers fund their projects. “Catalysing new issues from real economy corporates, delivering capital in the markets where we need to finance the low carbon transition is a huge challenge,” she says. For HSBC, the role of green bond funds is clear. “Increasingly, we are also seeing institutional investors signalling appetite for investments that mobilise capital to address systemic sustainability challenges such as climate change,” says the responsible investments specialist. “This appetite for sustainability sends a strong signal to issuers and creates an incentive for us to find solutions, such as the HSBC Real Economy Green Investment Opportunity (REGIO) GEM Bond fund,” she adds.

Building Green Bond Capacity

Investing in Green bonds can be challenging. As an investor, HSBC requires clarity and transparency from the green bond issuers it invests in. At the same time, it also needed to invest in the internal expertise and capacity to judge the quality and evolution of these projects. Beyond the general training it has provided its employees, specialist stewardship and ESG research teams also provide ESG integration and engagement support to the analysts and fund managers. “We continually review our ESG data sources, tools and training to best support our teams,” says the Director for Responsible Investments.

But HSBC has also invested in Green bond-specific processes and dedicated resources. “We need to have clarity around the types of activities we would include within an impact fund,” Maier explains. She notes that the analysis often needs to go beyond what is offered by existing standards. “The current Green Bond Principles outline broad categories for eligible activities. Nevertheless, in assessing whether a green bond is delivering impact in line with the SDGs, we need to be more specific about for the types of project we would consider.
The need for added sophistication drove HSBC to develop its own classification model of what constitutes a green investment, the ‘Green Impact Investment Guidelines’. “We define the activities we consider to be ‘green’ and map these to specific SDG targets,” the Director for Responsible Investments says. “We developed the framework with input from several development finance institutions, which was invaluable.” These guidelines standardise and clarify what investments HSBC is willing to engage with in-house analysts as well as to potential investees.

“We also have a dedicated Green bonds committee. It is responsible for ensuring that any green bond we invest, within our impact strategies, meets the requirements of the Green Impact Investment Guidelines,” she explains. “The guidelines cover not just the use of proceeds but also the sustainability requirements of the issuers.”

“As the debate deepens, we may see a greater focus on aligning strategic asset allocation to achieve tangible sustainability impacts. Such a shift will unlock more capital to finance the SDGs while delivering on risk and return objectives,” Maier concludes.

[1] https://www.nber.org/papers/w26167

[2] https://www.assetmanagement.hsbc.co.uk/-/media/files/attachments/uk/common/exploring-scenario-analysis-for-equity-valuations.pdf

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