What is sustainable finance, and what are ESG criteria?
The sustainability of an investment is analyzed based upon environmental, social, and corporate governance criteria, often abbreviated as ESG. Each of these can be described as follows:
Good governance criteria
These are criteria that are becoming more widely institutionalized, and although this is a trend that began decades ago as voluntary in nature, it is becoming one that, in practice, is now almost inescapable. Numerous international bodies have published guidelines for investment firms, and some governments are already producing mandatory laws and regulations on the subject. Beginning in August 2022, all financial advising and management firms working in the European Union will be required to ask their clients about their “sustainability preferences” before giving them investment recommendations. It has now become apparent to those working in the finance sector that options with this focus are better accepted by all types of clients.
Because of this, sustainable finance and ESG criteria are now being materialized in the form of investment options such as specific funds, green bonds and loans, and social venture capital. However, they are also being increasingly used as a filter when the time comes to decide upon investments of all types. This is also the case with MAPFRE, which is now offering modalities such as its Capital Responsible fund, which invests in companies that are notable for their ESG strategies, and its Inclusión Responsable fund, which invests in firms that support people with disabilities. In addition, a global decision has been made to avoid investing in companies with 30% or more of their revenue derived from coal, and to refuse to insure any projects involving construction of new coal-fired power plants or operation of new coal mines.
In practice, this expansion of a sustainability focus into the world of finance means that a company may have difficulty surviving unless it demonstrates its good environmental, social, and governance values. This is because it will be gradually excluded from investment sources, especially in countries where commitment to these principles is the strongest. In this way, ESG criteria are becoming a driver of change for industries with the most room for improvement on these subjects, and as an example of this, it is sufficient just to think of the efforts that energy companies are now making to publicize their environmental commitments.
How is compliance with ESG principles analyzed?
Experts say that ESG indicators are not always reliable, and there are many differences among the ones being used. A good analysis must avoid being influenced by deceptive practices such as “greenwashing”, where companies implement certain measures just so they can be labeled as “green”, without actually being very sustainable. This type of analysis also needs to take in a broad perspective. For example, companies in the technology field tend to obtain good scores, far above the typical rating for a mining company, but the materials that the mining company extracts will end up being used to produce the cell phones or computers being sold by those same technology companies. Also, if these principles are applied without sufficient flexibility, they can translate into divestment of funds from the places where they are really needed. An example of this would be the case of an energy company that is taking significant steps towards renewables, but which is still in a transition phase that it cannot successfully complete without external assistance.
In view of these difficulties, the rating systems and methodologies used for responsible investing, and the professionals who specialize in this area, have become a very valuable asset for entities that want to continue along this path. MAPFRE has relied upon creation of its own ESG database, and for this purpose, in 2017 it acquired a 25% stake in the French management firm La Financière Responsable, which is dedicated to responsible investment. With this operation, it gained access to a team with decades of experience in this area, and to a high-quality working system that has been tested over time, in a field that has now become a very important discipline within the finance sector.
“At MAPFRE, we think it is important to emphasize not just financial returns, but societal returns as well. In fact, the two can go perfectly hand-in-hand, and this is being demonstrated by the solid returns being recorded for these options”, explains José Luis Jiménez, group chief investment officer at MAPFRE. This is because far from being contradictory, these two concepts can work in alignment, which is the ultimate objective of sustainable finance.