Responsible investments include incorporating the investment process with corporate governance, environmental and social factors along with financial factors. It can also be termed as ethical investing, green investing, socially responsible investment and triple-bottom-line. All these names are however focused on the same goal of long-term value creation. It is strategies aimed at generating sustainability and financial value. For responsible real and financial investments, banks should incorporate all forms of factors bound to lead them to profitability. Banking institutions are involved in real investments- investing in property or tangible assets as well as financial investments- investing in bonds; the strategies do not act only on economic value, but also on environmental sustainability, justice, and fairness.
Environmental factors cover environmental issues such as climate change and raw material depletion that affect the choices of investment. In other words, environmental factors analyze how a company is performing as a steward of the natural environment. This criterion examines the environmental risks that affect profitability in terms of investment return and how companies can mitigate the risk (Scott-Quinn & Cano, 2018). For example, a company may face risks related to hazardous waste disposal and environmental regulations which deal with toxic substance emission and contamination of the natural environment. These issues have pressured the investors to adopt sustainability covers. This factor acts as externalities which affect revenues and functioning of the company. For instance, companies investing in nuclear energy are bound to gain more profits as they escape governments’ regulations legal suits and protect the environment through limiting the emission of carbon dioxide.
Social factors evaluate the company business relationship in regards to its daily operations. These factors show the recruitment policies of the company and the degree of diversity in the workforce. Diversity optimizes agility and innovation by ensuring the company focuses on the importance of having a diverse workforce with different talents and abilities. Subsequently, social factors tie the social responsibilities, and human rights concern welfare to the financial capabilities of the organization. For example by ensuring employees welfare leads to increased profitability and by appreciating the local communities which build a positive perception of the company. Effective social relations with the public and company attract a wide range of investors who in turn increase the company profitability. For instance, a company that ensures that their clients
Regarding governance factors, investors are mainly focused on how the company handles important issues and the stockholders’ role in decision making. Additionally, corporate governance entails the use and accurate accounting methods. The governance factors highlight if there is a conflict of interest between shareholders and the company in choosing board members. For instance, investors will not prefer to invest in a company which does not consider their opinion in electing board members. In relevance to profitability, these factors prevent fraud and ensure transparency in its operations.
In summary, ESG factors impact a company operations and investment decisions in terms of financials on the basis of cost, revenue and the cost of finance. Companies that incorporate these ESG factors can take advantage of generating profits in terms of profit margin growth. These factors enable companies to generate profits through ensuring a constant return on investment and effective and efficient operation. These factors also ensure effective management hence attracting a wide market and an increase in price share of the company. Ultimately, the ESG factors enable companies to escape cases of value-destroying reputational risk from issues such as climate change, pollution, working conditions, employee diversity, corruption and aggressive tax strategies which affect the company share price, profitability, social perception and overall decision making.
Based ESG factors which dictate the concept of responsible investment the bank should reject the investment proposals from the new potential borrowers and the existing clients. While maximizing the long-term risks involved in carbon emission utilities the bank should reconsider its decision in lending these companies since they depend on carbon-based fuels, and hence their demand for their output will fall, and in turn, their assets will end up losing value. In consideration of responsible investment, the bank policy should include several investment strategies which include positive selection, exclusion, Activism engagement, and integration.
Activism ensures that there is shareholders support for the investment proposal. Considering the bank situation, the investment should be rejected even if the shareholders will vote in favor of the investment. Since in the long term; the investment will have drastic implications on the shareholders’ value. The board should advise the shareholders against these investments by laying the financial implication of such entities in the next three to four years considering the factor that the world is changing towards “green energy.” Even though the shareholder’s value will be maximized initially, it will be a short-term effect and shareholders should opt against this kind of investment. Sustainable finance for bankers is a controversial topic based on carbon-heavy assets since they are associated with advance climatic change.
As stated by Caplen (2018) banks should take climate change seriously and input commitment measures to combat climate change. Positive selection strategy ensures that the investment portfolio chosen adheres to all ESG criterions. The companies in question are opposed to the environmental factors which can result to collapse of the businesses. According to Caplen (2018) banks should consider environmental criteria and focus their investments in promoting high to low carbon economy transition. These will result in a mutual outcome both for the bankers and the society as a whole. In this essence, supporting investment in co2 emitting processes, coal and oil miners will negatively impact the company later on through posing them into risks of environmental degradation. Lending to such polluting companies involves a great financial risk as well as creating a negative reputational risk to the lending company.
The exclusion investment strategy based on ESG criteria, the bank should remove the companies from consideration based on the environmental factors criteria. This move will benefit the stakeholders capital by ensuring that their capital is not exposed to risks which can result in significant loses (Scott-Quinn & Cano, 2018). Through the act of refusing to lend money to such companies which pose a greater risk to the environment and the society, the companies have since transformed and most of them have started to invest in green energy and more renewables while de-investing from carbon-producing processes.
According to the Boston Common Asset manager survey, 59 banks do not provide climate-related risks on their investment choices. Based on this assumption, the bank should measure their carbon-related assets and exclude finance utilities which have 5% carbon-related utilities and emissions (Caplen, 2018). Having a balance sheet which is majorly financed by carbon depended entities will result to the Bank having a financial crisis in the near future because the entities that the Bank have leased finances will not be able to cover loan installments. These will have an adverse effect on the shareholder’s returns since the bank will be unable to pay dividends due to the shareholders due to lack of funds. In conclusion, does not meet the social factors criteria, or address the environmental concerns and it is against ethical corporate governance. Therefore, the investment is irrelevant based on the ESG factors and should be rejected to protect the shareholder’s interest, while also upholding the Bank investment options.
Caplen, B. (2018, February 20). How fast can banks be ‘climate change ready’?. Retrieved from http://www.thebanker.com/Comment-Profiles/Editor-s-Blog/How-fast-can-banks-be-climate-change-ready
Scott-Quinn, B., & Cano, D. (2018). Financing the Energy Transition. In More on Risk and Energy Infrastructure. Globe Law and Business Publishers.