ESG investing can boost underachieving companies

Most ESG (environmental, social and governance) commentators focus on the premise that ethical investment is exclusive for companies that comply with stated ESG principles, and shun those industries and companies involved in unethical activities, whether carbon polluters or those involved in weapons or tobacco production.

However, there is an interesting argument that instead of blacklisting ESG underachievers, investors should actively seek ownership of such companies in order to help them to change and become good global ESG citizens. Why is this attractive to some investors?

The reason given is that such an action has the potential to boost large returns to investors, which is an incentive for those seeking higher than normal returns, given that the markets have already priced in the valuations for ESG-compliant companies. There is the added bonus of being seen as the White Knights of ESG. This assumes that such farsighted investors have a good grasp of risk and impact measurement of their newly acquired assets. This involves having a knowledge of current and future data trends.

The aim is that such mega data trends give an understanding of the effects that these investments will have on the local and the global environment, as well as on sustainable development and, more importantly, some insight into the potential of stranded assets if the below-par ESG investments have no future.

The recent debate on climate change has clearly shown that potential scenarios pose a wide range of hard-to-assess transition risks as investors shift their focus from what is acceptable technology now to new climate friendly technology with uncertain outcomes in the future.

Where do such a new breed of investors start and what data is at hand to enable them to better understand these risks and impacts? Disclosures on carbon emissions are an important first step. Diligent investors can gather much information about what is going on in listed and non-listed companies, assisted by earth observation systems, sensors and machine learning.

This is a time-consuming practice that requires not only large data, but an abundance of expertise and connections to obtain such data. So is this approach worthwhile or a lost cause to raise the compliance of below-par ESG companies?

Understanding such constraints, the European Commission had adopted a package of measures, including a legislative proposal for a central registry of corporate data. The establishment of a central data portal, or European Single Access Point, was announced in 2020.

The registry is intended for financial and sustainability-related data about corporates in the EU, and gives companies more visibility vis-à-vis investors, especially for small companies which are often bypassed in the search for below-par ESG companies. It is of particular interest that the ESAP would provide a common source of free public information about EU companies and that all information would be available in a data-extractable format, with the ESAP planned to be operational from 2024. The data source follows a set of principles based on a mission to create ESG as a publicly available free good.

This initiative is a laudable one which hopefully can be mirrored in the Gulf countries as ESG compliance is now an important objective. If this is to be implemented, ESG data should be reported by companies in a clear and consistent manner to make a reasoned judgment, and to be readily accessible for all stakeholders, with the submitted data being the most material ones requested by investors to avoid “white-washing” provision of selective data. If such data access initiatives take off globally, it will confirm an old saying that the greater the obstacle, the more glory in overcoming it.

Making the world an environmentally better place is certainly a glory that these unorthodox investor hunters well deserve.

• Dr. Mohamed Ramady is a former senior banker and professor of finance and economics, King Fahd University of Petroleum and Minerals, Dhahran.