There is little doubt that environmental, social and governance (ESG) investing will be the dominant theme shaping the financial industry and markets over the coming decade. Roughly one-third of all assets under management, or $35 trillion of managed assets worldwide, employ some form of sustainable investing strategy. Granular data is essential to capturing the diverse needs of an expanding investor base. What’s more, today’s ESG investors are far from uniform – and there is a growing need for data and analytics that address both “value” and “values”.
To this end, a double materiality approach to delivering insight can certainly help. It is an approach that encourages ESG practitioners to consider not only how sustainability issues affect enterprise value, financial returns and cost of capital – or, in other words, company risk and performance – but also how such issues affect the society and environment in which a company operates.
Why double materiality?
Increased focus on double materiality has coincided with the emergence of a vast spectrum of investment approaches and philosophies. Integrating ESG factors into portfolio risk management is a dominant strategy, accounting for more than 40 per cent of all global sustainable assets.
Another one-third of assets employ negative or positive screening, while a further 18 per cent are pursuing corporate engagement strategies. Impact and thematic investing, including dedicated green bond funds, make up a smaller portion but are growing in prominence.
And it’s not only investors ramping up their efforts. Policymakers globally are building the regulatory architecture to ease sustainable finance’s growth and development. According to the Principles for Responsible Investment, there are more than 750 policy tools and guidelines related to sustainable finance in place today – up from just 320 in 2012. Many of these policy initiatives – from the EU’s Sustainable Finance Disclosure Regulation to alignment with recommendations from the Task Force on Climate-Related Financial Disclosures – mean that market participants need increasingly holistic datasets and key sustainability performance indicators to meet evolving regulatory requirements.
The importance of stakeholder management explains why double materiality is taking root – not only with policymakers but also among investors. Certainly, a double materiality perspective captures the dynamic nature of materiality: sustainability issues today may evolve into financially material risks tomorrow. Few investors were thinking about the financial relevance of zoonotic diseases, such as coronaviruses, on their global portfolios a couple of years ago. Essentially, a broader toolbox of sustainability indicators may help market participants to identify issues affecting company risk and performance in the future.
But a double materiality approach also facilitates the discussion of environmental and social value creation (or destruction) with a more inclusive range of stakeholders, including communities, customers, employees, creditors and shareholders, reinforcing a company’s social licence to operate. Business Roundtable, an association of CEOs from leading US companies, has championed this broader market promotion of “stakeholder capitalism”.
Applying the double materiality lens
A double materiality perspective becomes even more important as the market begins to address more complex sustainability issues where risks and impact intersect. Take biodiversity, for example. Businesses sometimes engage in activities that may harm nature and lead to biodiversity loss, but they also depend upon natural resources and robust ecosystems. Our research shows that about 38 per cent of approximately 5,300 large companies worldwide have at least one facility associated with habitat loss. That may not be financially material today, but it may well be in the future. More than 1,000 companies representing $4.7 trillion in annual revenue signed a letter this October urging governments to adopt policies now to reverse nature loss by 2030, noting that “there will be no business on a dead planet”.
Yet another example of where a double materiality approach adds value is when assessing the interconnectedness of social and environmental factors. There is growing recognition that companies and investors should support a fair and just transition for workers and communities as they mobilise capital to realise critical climate objectives over the next decade. This means that topics including responsible company reorganisations, career development and retraining, and community relations will be critical components as companies look to decarbonise their business models and balance sheets.
ESG assessments on companies should speak to more than just their ability to manage ESG-driven financial risks. By applying a double materiality lens, our opinions provide a broader view of ESG. This breadth, alongside daily controversy screening, allows us to capture how companies are generating value that extends beyond shareholders to diverse stakeholder communities and the environment itself.
Moody’s is committed to helping market participants advance strategic resilience, responsible capitalism and the greening of the economy. For more information, visit www.moodys.com/esg.
By Rahul Ghosh, Managing Director, Moody’s ESG Solutions