W.he many areas of investment are teeming with sustainability – mostly in English – technical terms. But German translations usually don’t help either. In the following explanations of some of the most important terms.
ESG, CSR and SRI
Environmental, Social, Governance (ESG) stands for the contribution of the economy to sustainability. Corporate Social Responsibility (CSR) falls under ESG, i.e. entrepreneurial action that takes social and ecological responsibility into account. This also includes responsible investing, Socially Responsible Investing (SRI). This abbreviation can also be found in the names of some financial products that are based on sustainability criteria.
However, the three components of ESG are primarily used as a benchmark for sustainable investment. In addition to consideration for the environment (E) and occupational safety, health protection or diversity (S), these also include questions such as which values apply in companies, how risks are dealt with and corruption is prevented – all points where governance (G ) is measured. Excluding bad companies from one’s portfolio on the basis of such criteria is a common approach to investing more sustainably. Another is the best-in-class principle (see glossary on the following page).
The typical way to orientate oneself on ethical ideas when investing is to completely exclude problematic companies from the portfolio (exclusion principle). For example, stocks and bonds of companies in the arms industry or those with child labor in their supply chain are left out. Nuclear energy or the production of addictive substances are also common knockout criteria.
On the other hand, those who invest solely according to the best-in-class principle do not exclude any industry, but only invest in companies that are leaders in their industry in terms of sustainability. This makes the investment strategy broader than it can be in a portfolio that was composed according to the principle of exclusion. On the other hand, many investors who value sustainability will not like having the most exemplary companies from the oil, arms and tobacco industries in their portfolios. Those who want to go beyond both principles can invest in thematic funds that, for example, only focus on renewable energies.
Green bonds and social bonds
In November, new interest-bearing paper issued by the European Union met with great interest. This is the long-known form of investment social bonds – bonds that are intended to finance social projects. In the case of the EU program SURE, the social goal is to preserve as many jobs as possible during the corona crisis. According to social bonds, the purpose of green bonds is to finance ecological projects. Germany issued green government bonds for the first time in 2020 and will do so regularly in the future.
Green or social bonds can be simple corporate bonds from companies in the environmental sector, in other cases they are linked to specific projects. Even with the latter, the default risk usually depends on the overall creditworthiness of the company issuing the bond – not on the profitability of the respective green or social project. The Green Bond Principles (GBP) and the Social Bond Principles (SBP) set up voluntary standards.
In contrast to investing in stocks and bonds with a sustainability label, impact investing is often about participating in companies over the counter (private equity) or financing them (private debt). Impact investments – in English, for example: impact investments – pursue measurable sustainability goals. The respective company that relies on such investments or financing must be accountable to them. In the best case, the sustainability projects are measured and documented as precisely as the company’s return. Examples are the amount of saved or purified water or the number of newly established schools in poor countries. As with conventional private equity capital, investors can participate in impact investing through special funds. Green bonds or social bonds are also often understood as part of impact investing.
The EU taxonomy regulation, which will apply from 2022, is intended to help classify economic activities on the basis of their ecological sustainability. How environmentally friendly a company’s business model is can thus be assessed using a uniform scheme. This is intended to make it easier for investors to structure their portfolio ecologically. However, the EU taxonomy will not take the step of evaluating individual financial products according to ecological criteria. In addition, the regulation forces companies to disclose their investment behavior, but not to invest more sustainably. Here the EU is building on the fact that just because there is a uniform standard, companies will align their business and investment strategies accordingly. Not everyone sees the taxonomy regulation as a positive success. There are fears, for example, that a green financial bubble could result if the potential risks of sustainable products are out of focus due to taxonomy.