Investment- Environmental Factors The range of environmental factors that have a meaningful impact on investments – the ‘E’ in ESG — is large and far-reaching. Environmental dangers have continued to acquire prominence and are creating heightened concern worldwide. We shall cover three essential elements relating to the environment: Climate Change Climate change is defined as a shift, directly or indirectly related to human activity, that modifies the composition of the global atmosphere, and which is, in addition to natural climate variability, observable over comparable time periods. It is one of the most complex issues facing us today. It is an issue having local manifestations (e.g., extreme weather events, such as more frequent and/or more intense tropical cyclones) and global repercussions (e.g., rising global average temperatures and sea levels), which are predicted to increase in severity over time. The principal man-made cause of the warming of the world is increased emissions of heat-trapping greenhouse gases (GHGs). Greenhouse gasses trap heat in the atmosphere, boosting the atmosphere’s temperature. CO2 is the most significant contributor to the warming impact; the display below demonstrates that its concentration in the atmosphere has bounced between 200 and 300 ppm (parts per million), and presently sits at 415 ppm and growing, leading to elevated physical and transition dangers. Climate change will damage economies and markets in the coming decades at an accelerated rate if we do not bend the PPM curve back towards the x-axis. Additionally, climate change could influence our brains; research published in the journal Environmental Health Perspectives indicated that at roughly 945 ppm concentration of CO2 in the atmosphere, human cognitive function reduces by about 15%. With a CO2 level of 1,400 ppm, cognitive performance is expected to diminish by around 50% Physical Climate-Related Risks Physical climate-related risks emerge from extreme weather occurrences, either acute or chronic dangers from longer-term shifts in climate patterns — for example, increased temperatures. Transition Risks Transition risks are a result of changes in climate and energy policies, a shift to low carbon technologies, and liability difficulties. Pressure on Natural Resources Nearly 70% of the planet is covered by water, but just 2.5% of it is fresh water.2 Water is a key natural resource, not just for human consumption, but also for a range of agricultural, industrial, and home energy generation and for recreational and environmental activities. Water shortage is the lack of freshwater supplies to meet water demand. The UN’s Sustainable Development Goal (SDG) 6 is the requirement ‘to ensure availability and sustainable management of water and sanitation to all’ by 2030.3 Water shortage — caused either by economic issues, such as lack of investment, or by physical repercussions connected to climate change — continues to generate substantial concern, especially among developing and emerging economies. Biodiversity, as defined by the Convention on Biological Diversity, means the ‘variability among living organisms from all sources, including among other things, terrestrial, marine, and other aquatic ecosystems and the ecological complexes of which they are part; this includes diversity within species, between species, and of ecosystems’. Unfortunately, global biodiversity is undergoing a catastrophic reduction. In 2019, the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) presented a historic assessment, which stated that about one million animal and plant species are now threatened with extinction, many within decades, more than at any other time in human history Land use management strategies and forestry, commonly known as agricultural, forestry, and other land use (AFOLU), have a huge impact on natural resources like water, soil, nutrients, plants, and animals. Covering nearly 30% of the world’s land area, or little under 4 billion hectares, forests are a critical element of the carbon cycle. They convert the CO2 in the air to oxygen, through the process of photosynthesis, and are a natural regulator of CO2, with the world’s tropical forests playing a particularly vital role in sequestering carbon. The more trees, the less CO2, and the more oxygen there is in the atmosphere. Unfortunately, deforestation is accelerating: From 2001 to 2019, there was a total of 386 million hectares of tree cover loss globally, corresponding to a 9.7% decline in tree cover since 2000 and 105 mega tons of CO2 emissions, according to Global Forest Watch Absorbing 50 times more CO2 than the atmosphere, the ocean is the planet’s largest carbon sink, with photosynthetic micro-organisms on its surface layer providing over half of the world’s oxygen. It is one of the most important natural resources. The OECD (Organisation for Economic Cooperation and Development) estimates that ocean-based industries provide around EUR1.3 trillion to global gross value added. Oceans supply fish and are commonly used for transportation (shipping). They are also mined for minerals (salt, sand, and gravel as well as some manganese, copper, nickel, iron, and cobalt, which can be found in the deep sea) and drilled for crude oil. The oceans’ riches are a source of economic growth and are also known as the blue economy.6 Communities in close association with coastal ecosystems, small islands (especially Small Island Developing States), polar zones, and high mountains are particularly sensitive to ocean change, such as the rise in sea level and temperature. Pollution, Waste, and a Circular Economy Pollution is the leading environmental cause of disease and premature death in the world today. According to findings published in October 2017 by the Lancet Commission on pollution and health, diseases caused by pollution were responsible for an estimated 9 million premature deaths in 2015 — 16% of all deaths worldwide — which is three times more deaths than from AIDS, tuberculosis, and malaria combined and 15 times more than from all wars and other forms of violence. New research published in the journal Environmental Research in February 2021 demonstrates that the combustion of fossil fuels is a substantial source of airborne fine particulate matter and a key contributor to the worldwide burden of mortality and disease. Water pollution occurs when contaminants (such as toxic chemicals or microbes) are introduced into the natural environment through the ocean, rivers, streams, lakes, or groundwater. Water contamination can be caused by spills and leaks from untreated sewage or sanitation systems and industrial waste discharge. The circular economy is an economic model that tries to reduce waste and to conserve the value of resources (raw materials, energy, and water) for as long as feasible. It is an effective model for organizations to examine and manage their operations and resource management since it is an alternate method to the use–make–dispose economy. The circular economy is built on three principles: Design out waste and pollution Keep products and supplies in use Regenerate natural systems Use of these principles can help lessen demand on natural resources and lead to more sustainable behaviors. Companies who employ these principles may also be a more tempting investment possibility for those concerned with environmental problems. Social Factors Social factors – the ‘S’ in ESG — can be divided between those effecting external stakeholders (such as customers, local communities, and governments) and groupings of internal stakeholders (such as a company’s employees). Governance Factors Corporate Governance — the ‘G’ in ESG — is the process by which a corporation is managed and overseen. Governance is about people and processes, although rules vary worldwide. Governance stems from the legal system of the country in which a corporation is incorporated. Corporate governance is about the individuals who manage a corporation and how those people are supported by systems to exercise their responsibilities effectively. Good governance is also about building an acceptable company culture that will back the execution of excellent business performance without excessive risk-taking and via appropriate conduct of business operations. In practice, corporate governance comes down to two ‘A’s’: Accountability and Alignment. Accountability For accountability to work, people require the following: To be granted the authority and duty for decision making To be held accountable for the implications of their decisions and the efficacy of the work they deliver Just as people are most effective when they are mindful of being answerable to someone — often their manager — in the same way, top executives need to feel accountable to the non-executives on the board of directors. In turn, that board will be most effective when its non-executive members feel accountable to shareholders for effective delivery. Therefore, corporate governance has a particular focus on board structure and the independence of directors. The function of the chair of the board is crucial in facilitating a balanced discourse in the boardroom. Consequently, many investors prefer that the chair be an independent non-executive director. ![]() Alignment
Alignment boils down to the challenge of the agency problem. The agency problem arises because the interests of professional managers, the agents, may not always be entirely aligned with the interests of the owners of the firm, and so the company may not be run in the way the owners want it to be run. Corporate governance seeks to guarantee that there is greater alignment in the interests of the agents with the owners through incentives, but also through suitable chains of accountability to limit the possible negative implications of the agency problem. Accountability: Board Committees The three core committees of the board, normally required by corporate governance laws, are established to respond to three key challenges: accountability and the board, accountability and accounting, and alignment and executive pay. Nominations Committee The nominations committee works to ensure that the board overall is balanced and effective, ensuring that management is held accountable Audit Committee The audit committee monitors financial reporting and the audit, delivering accountability in the accounting. The audit committee will also monitor internal audits, when this exists, and unless there is a separate risk committee, will also have responsibility for risk oversight Remuneration Committee The remuneration committee strives to deliver an appropriate alignment between owners and management through executive pay and benefits. Corporate Governance Codes Corporate failures and scandals have been a significant motivation for the formalisation of corporate governance and the adoption of codes. The world’s first formal corporate governance code emerged in the United Kingdom in 1992 and was based on recommendations of the Committee on the Financial Aspects of Corporate Governance in their final report7, also called the ‘Cadbury Report’ because the committee was chaired by Sir Adrian Cadbury. Much of what the report advised is still considered best practice today and has been incorporated in codes and standards globally. The committee’s primary premise is that no one should have ‘unfettered powers of decision’. For example, the duties of chair and CEO should not be mixed. A formalized set of rules for good governance has emerged from the core concepts of accountability and alignment. The following themes are constant across most of the world’s corporate governance codes: Board leadership and company purpose Division of responsibilities Composition, succession, and evaluation Audit, risk, and internal control Remuneration Governance vary from country to country depending on culture and historical development as well as local corporation legislation. At the most basic level, some nations, including Germany and the Netherlands, have two-tier boards with fully non-executive supervisory boards overseeing management boards. Others have single-tier boards, with some dominated by executive directors (in Japan). Some have a combined CEO and chair (most typically seen in the United States and France), and some lie in between these types (for example, the United Kingdom). Of the three ESG criteria, governance is the element most typically taken into consideration by traditional investment analysts. Academic research reveals that among the three ESG elements, governance has the closest link to financial performance. Good governance is crucial to a company’s performance, both in terms of long-term shareholder value creation and the creation of greater prosperity for society and all stakeholders. If a firm delivers good governance, it is more probable that it will also handle environmental and social concerns with the proper long-term attitude, and thus avoid or effectively manage important risks and capture relevant possibilities. Failures of governance can be damaging to shareholders and other capital suppliers.
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