When doing research into due diligence the other day, I came across some interesting articles that explored the relationship between investors and sustainability credentials within their portfolio. At the crux is a correlation between ESG investing and higher returns, lower risk and long-term business sustainability. But when you begin to consider how the implementation of ESG within a company can be transformative for both investor and business owner alike, how can businesses ensure they align their goals and principles to ESG measures?
When looking into ESG DD, I came across a survey by KPMG which found over half of its respondents had cancelled deals due to findings during the ESD DD process, with over two thirds of investors agreeing they would pay a premium for companies that aligned with their ESG principles. I wanted to explore the paradigm shift in investments and the role ESG consulting have on your companies ESG credentials.
80% of asset owners now have an ESG component in their investment strategies, with 68% finding significant improved returns from their portfolio’s integration of an ESG strategy. A PWC report comments on the two key forces driving ESG investment, these include:
Regulation has been a driving force behind ESG investing thanks to The European Green Deal pushing for a climate-neutral continent by 2050. The European Grean Deal Investment Plan hopes to unlock €1 trillion of sustainable investments in 2030 as a support into to the climate neutrality transition.
Asset managers have been left with a choice of how to adopt new legislation and guidance into their portfolio, either by accepting the shift and adapting to the new legislation or viewing the shift as an opportunity to establish ESG as part of their DNA to align with ambitious long-term industry trends. Both of these options are feasible for asset managers and will be approached through strategy, client offering and risk management.
Whilst asset managers shift toward ESG investing, they are also looking for a breadth of ESG compliance throughout sectors, this leaves companies who are vulnerable to stagnation the opportunity to adapt and deliver ESG prospects for investors. Through consulting an ESG expert, companies will be able to develop their ESG strategy and align with the new international investment goals.
The ESG consultancy sector is growing rapidly, with a market trajectory of 17% CAGR from 2022-2027, the ESG consultancy global market is expected to reach $16 billion by 2027. This rapid growth is expected due to a consistent uptick in ESG decision making within organisations of all sizes and sectors. This uptick in ESG adoption is due to a proven track record of benefits to the bottoms lines, improved returns and financial performance, along with investor power and global regulation.
“As we continue the countdown in this ‘decade of action’ [..] the E&S consulting sector is ideally positioned to grow in scale, scope and stature” – Liz Trew, Environment Analyst
Data from the Environment Analyst has demonstrated a pack of industry leaders exerting their ESG-driven market dominance. Perfect conditions have increased M&A deal activity, whilst PE funds have increasingly established direct funds for the ESG space to encourage sustainable investment strategies.
Green-driven changes to the regulatory environment have encouraged companies to seek ESG consultancy advice to strategically advance ESG credentials and follow new implemented legislation. In February 2022, the European Commission adapted a proposal for the corporate sustainability due diligence directive (CSDD) to necessitate strategic and operational change within global business.
The EU’s Corporate Sustainability Reporting Directive (CSRD) is transforming the way companies must report their ESG credentials. Almost 50,000 companies are subject to mandatory sustainability reporting, starting in 2024. These companies include non-EU companies who have subsidiaries in the EU. This has put pressure on companies to enforce new ESG regulations.
ESG reporting is now going mainstream as companies reporting is coming under growing scrutiny, to ensure compliance is followed companies can do the following:
By incorporating even a few of these practices into your daily business operations, the company will seamlessly align with the new ESG reporting frameworks and demonstrate its credentials. Additionally, this will propel your company’s valuation forward and incentivise investors to dedicate time to scrutinising your business. When your company is nearing the point of M&A you can be assured that your ESG DD will be a smooth and positive process, boasting your ESG performance to the new shareholder.
The top 20 equity investors in the fashion industry have holdings of over $275 billion, which is not particularly surprising considering it is the third largest manufacturing sector (behind automobiles and technology). What is surprising, however, is its regular inclusion within sustainability funds. The Ellen MacArthur Foundation estimates the industry contributes c.10% to global carbon emissions, more than international flights and maritime shipping combined.
The rise of ‘fast fashion’, compounded by a business model that benefits from high consumption rather than high quality, has seen clothing production double since 2000 and average consumption increase by 60%. In the end, this leads to increased waste, with less than 1% of used clothing being recycled into new garments. The remaining is typically incinerated or finds its way to landfill.
With ESG becoming more prominent, are sustainable funds an active representation of where investors believe their money is being distributed? Typically, these funds strip out the obvious candidates within oil & gas and defence, to leave the rest. The textiles industry can certainly talk the talk, throwing terms from organic cotton to recycled fibres out there, while still heavily relying on oil for synthetic fibres, chemicals for dyes, and fertilisers to grow cotton.
It could be argued that trying to make change from within, as an active shareholder, is better than staying away. However, the industry has been slow to adapt on areas where there isn’t a profit to be made. A report by non-profit Planet Tracker found that of the top 30 textile producers by revenue, over half lack any link between ESG metrics and executive compensation. Only two, Adidas and Puma, had clear links between sustainability objectives, reporting and pay.
Of the 99 fashion companies to register for the industry charter for climate action, just 44 have set public climate targets needed to keep global temperatures under 1.5°C. One obvious point is the lack of information in the sector and the difficulty in extracting that data accurately across a global supply chain to measure the negative impact.
This presents an opportunity for someone to fill, with ESG data gathering and reporting becoming a hot topic, it is only a matter of time before it’s implemented end-to-end in textiles to present consumers the full picture. The other side is to improve the materials used, making them longer lasting and improving recyclability.
The fastest method to lessen the environmental impact is also the simplest and, unfortunately, least likely – to push consumers to reduce unnecessary consumption. The first step here is education, the more ESG data that can be found and presented, the better informed consumers are on the impact their purchases have, and in deciding which companies best reflect their values.
The rise of environmental, social, and governance (ESG) policies within both small and large businesses has been established in almost every sector. From manufacturing and industrial, to healthcare and professional services, this is a trend that will continue to grow as climate change and environmental disasters transform from long-term to short-term concerns for the upcoming generations.
Polestar has been heavily involved in the ESG market for quite some time now (read some other blog posts here and here). We examined one of the key themes for this year will be ESG in our 2023 Sector Valuation. Just last year, Polestar supported the transaction of Bridges Fund Management, MSCI and Farview Equity backing Evora Global to advance sustainable development goals in the global real estate industry.
ESG is a huge focus for us as a firm, with the wider Sustainability sector now sitting at the heart of our sector wheel. In fact, we recently wrote a blog post on another UN Report centred around Global Risk, and how climate change is the biggest risk society is due to face.
For this reason, it is important to understand what and where investment, both from the public and private sector, has transitioned, and what we will need to do as a society to close the investment gap for climate change. It is important to put your money where your mouth is.
The United Nations published a report analysing previous investment and future investment needed within the ESG market, or what they call “nature-based solutions” (NbS). The report defines NbS as “a category of assets in which businesses, governments and citizens can invest in order to work with nature instead of seeing it as a barrier to economic development and progress”.
These can be solutions such as carbon sequestration on agricultural lands and peatlands, defence from flooding by restoring mangrove populations, or the protection of global biodiversity through forest and other land conservation.
The International Union for Conservation of Nature (IUCN) states that NbS can address climate change in three ways:
In the private market, Polestar has engaged with companies focused on sustainability more broadly. For example, EVORA Global is a leading sustainability consulting firm that offers ESG solutions for commercial real estate. Its software, SIERA, helps organisations find an optimal path to reducing carbon emission to zero.
Another example is Hughes and Salvidge (H&S), which is one of the UK’s leading decommissioning companies. It has a large focus on recycling and the environment, as it aims to recycle in excess of 95% of its waste.
E-green is another example which focuses on “smart packaging”, a new section of the paper and packaging sector. The company began its success with wooden products and, over the years, has developed an extensive range of paper and recyclable plastic items to meet market needs.
Although these companies do not work directly with nature, they work towards the same goals as NbS: to address issues of greenhouse gas emissions and environmental pollutants.
According to the UN, $120bn was invested in NbS in 2020 by the G20 countries. This can be broken down into two categories: (1) public sector and (2) private capital and Public ODA.
Of this total spending, $105 bn is allocated internally towards domestic government programs, a third of which is invested in programs to promote the protection of biodiversity and the landscape. The other two thirds of domestic government investment ($67 billion) funds water management, pollution abatement, general environmental protection, and measures for agriculture, forestry, fishing and hunting.
There is a stark difference when looking at the private sector. In 2020, the private sector contributed $14bn to Nbs; the private sector makes up 60% of total national GDP in most G20 countries, yet contributes just 12% of total NbS investments, leaving the other 88% to the public sector and its taxpayers.
The WEF report has some startling numbers for the future. By 2050, global NbS spending will need to increase to $536bn to achieve all global sustainability targets. This would require more than quadrupling the current total global NbS investment.
Focusing on G20 countries, the organisation estimates that internal annual NbS will need to increase 140% (an additional $165bn) by 2050.
The rest of this will need to come from non-G20 countries to meet the remaining $235bn. This is 58% of the additional total global NbS, however, non-G20 countries only make up 20% of the world’s GDP. This will pose a great challenge as these countries who may not have enough fiscal headroom to meet the future targets. The report states two reasons for these:
G20 countries carry out a majority of global economic and financial activity so their capacity for leadership and decisive action will be key in the future investment. According to the report, the world would benefit from a transition from investment in current unsustainable use of the Earth’s resources towards activities that support the sustainable use of natural assets.
The report lists out steps that can help close the investment gap:
There is a large need to up the ante when it comes to the private sector and NbS. Gathering and then spending $500bn a year to meet targets will be a challenge, but not impossible. Today, we see a large number of corporations with their focus on “ESG” and “sustainability”, but we need this to be more than greenwashing. The future generations will depend on this.
Whilst it is obvious that corporations are trying to meet the needs of a changing consumer base who are more knowledgeable about the environment, it is also obvious that the private sector can be doing a lot more for NbS when compared to governmental spending.
At Polestar, we completed three deals just last year in sustainability. ESG is now a key focus of ours because we see this as the way of the future; the rise in the ESG market shows us that the private sector is heading in the right direction.
With the rapid rise in demand for this space, this could be a good time to explore your options for raising funding or securing a valuable exit. If you want to get in touch about anything ESG related, don’t hesitate to do so. Like always, if you have any interest, do reach out.
