Investment business and sustainability

The best-known and most widely used system for assessing sustainability-related investments is the ESG rating. ESG stands for environmental, social and governance. ESG factors form the foundation for the various sustainable investment approaches, and ESG ratings constitute an attempt to assess companies’ (and other organizations’) sustainability and express it as a rating. This is done by examining the three areas of sustainable economic activity. The goal of ESG ratings is therefore to determine how seriously a company takes its responsibilities.

Rating agencies assess issuers’ sustainability factors based on their own models. There are various providers that compile ESG ratings and make them available to investors. It should be noted that each rating agency uses its own rating criteria and that this can sometimes mean that an issuer is rated differently depending on the agency. Reasons for these differences might be the inclusion of manufactured products (is a product ultimately sustainable or not?), supply chains (inclusion of the entire supply chain or only the actual production process) or differing definitions and weightings for the individual sustainability factors.

The following illustration shows the basic scheme that can be used to establish an ESG rating.

The Sustainable Development Goals are a collection of 17 objectives set by the United Nations, designed to be implemented by 2030 and act as a catalyst for sustainable development. They cover a wide range of sustainability issues, from ending hunger and fighting climate change to promoting responsible consumption and designing cities more sustainably. 

The link will open in a new window Find more information on the SDGs at globalgoals.org

The central aim of the Paris Agreement is to strengthen the global response to the threat of climate change by keeping a global temperature rise this century to well below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius. For investments in products that seek to match the aspirations of the Paris Agreement, the carbon footprint can be measured and compared with the Agreement’s objectives.

The link will open in a new window Find more information on the Paris Agreement at un.org

The Sustainable Finance Disclosure Regulation (SFDR) is an EU regulation introduced to improve transparency in the market for sustainable investment products, to prevent greenwashing and to increase transparency around sustainability claims made by financial market participants.

There are three categories:

• Article 8: Funds under Article 8 of the SFDR are also known colloquially as “light green” products. It must be stated whether they invest in environmental or social areas. In general, the investments should help to support environmental and social criteria.
• Funds under Article 9 of the SFDR are also known colloquially as “dark green” products. These are subject to stricter requirements, and products can be invested only in “sustainable investments”. These products have a sustainable target that is measurable and must be recorded clearly.
• If a fund is not classified under Art. 8 or 9 of SFDR, it is­ deemed to be under Art. 6 SFDR.

The provisions of the SFDR apply to all products subject to EU law. These provisions are not binding for funds domiciled in Switzerland.

The link will open in a new window Find more information on the Sustainable Finance Disclosure Regulation at eurosif.org

Exclusion (also known as negative selection or standards- or values-based exclusion) is when a conscious decision is made to exclude investments in specific companies, countries or issuers from a portfolio. The exclusion criteria can relate to different aspects, such as product categories, business activities or practices. Exclusions can be divided into two main categories:

• Unconditional exclusions of products or business activities that contradict the investor’s values (e.g. arms production) – also referred to as values-based exclusions – or that entail excessive ESG risks (e.g. coal mining). 
• Conditional exclusions of companies based on their negative business practices, such as violations of certain standards, regulations or global ESG standards (e.g. systematic human rights violations) – often referred to as standards-based exclusions.

Please note:
There are various forms of exclusion criteria, and they are defined with varying degrees of stringency, depending on an investor’s goals and preferences. However, if applicable laws and guidelines prohibit an activity, its exclusion cannot credibly be used as an exclusion criterion for an ESG product. For example, the Federal Act on War Materiel prohibits the financing of controversial weapons in Switzerland. This means that investments that exclude only controversial weapons manufacturers or companies should not claim use of the “Exclusion” sustainability approach. However, it is sensible to inform investors about use of this criterion.

Positive selection is when investments must meet certain binding minimum sustainability criteria if they are to be considered for investment. Minimum criteria can be defined based on factors such as sustainability ratings or other sustainability indicators.

In the following example, a defined minimum ESG rating of BBB is defined for positive selection (on a scale from AAA to CCC). Companies that do not fulfil this criterion are excluded from the investment universe for the fund in question.

The best-in-class approach considers investments that are rated as particularly sustainable in terms of environmental, social and governance (ESG) performance within their category, sector or peer group. All issuers with a rating above a predefined threshold are considered investible. The threshold can be defined in different ways. Sectors in this approach can also include those in which the products or production methods are not considered sustainable per se, but the leading companies in terms of sustainability within the industry are considered. This is why the portfolios for many sustainability funds include companies in sectors you would not expect to find, such as those in the chemical, petroleum and automotive industries.

The following illustration shows an example of how the most sustainable companies are taken into account for each sector. Unlike with positive selection, energy companies are part of the portfolio in this example of the best-in-class approach.

ESG integration is the direct incorporation of ESG opportunities and risks into traditional financial analysis. ESG criteria are factored into investment decisions by means of a systematic process and appropriate research sources. This means that, in addition to criteria relating to finances, liquidity and business model, an investment must also meet certain sustainability criteria.

Sustainable thematic investments invest in companies or countries that contribute to the implementation of sustainable solutions in both the environmental and social spheres. In the environmental segment, such investments include renewable energy, energy efficiency, clean technologies, low-carbon transport infrastructure, water treatment and resource efficiency. In the social sphere, the focus is on issues such as education, healthcare systems, poverty reduction or solutions for an ageing society.

In addition to a financial return, impact investments also aim to have a measurable positive impact on environmental and social developments. Their impact must be recorded transparently.

Engagement (company dialogue)

Engagement is when investors rely on using their rights as shareholders to influence companies, with the goal of persuading companies’ management to give due regard to environmental, social and governance criteria. This is a dialogue that includes both communication with companies’ Executive Board and Board of Directors and submission of or support for shareholder proposals. Where successful, engagement can lead to companies changing their strategy and processes with a view to improving ESG performance and reducing ESG risks. Engagement can take the form of direct interactions between an investor and an investee or of cooperative engagement, where several investors come together with a view to conducting a shared dialogue.

Exercise of voting rights

This term refers to the active exercise of voting rights by investors based on ESG principles, with a view to expressing their concerns about environmental, social and governance issues.