Editing IPCC:AR6/WGIII/Chapter-15 (section)

=== Box 15.7 | Impact of ESG and Sustainable Finance Products and Strategies ===

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While scaling up climate finance remains a challenge ( [[#15.3.2|Section 15.3.2]] ),there is consensus that investments that are managed taking into account broader sustainability criteria have increased consistently and ESG integration into sustainable investment is increasingly being mainstreamed by the financial sector over recent years ( [[#Maiti--2021|Maiti 2021]] ). The United Nations Principles for Responsible Investment (PRI) grew to over 3000 signatories in 2020, representing over USD100 trillion in assets under management ( [[#UN%20PRI--2020|UN PRI 2020]] ). And according to the 2018 biennial assessment by Global Sustainable Investment Alliance, [[#footnote-002|15]] sustainable investments in five major developed economies grew by 34% in the two-year period following the 2016 assessment. The primary ESG approaches leveraged were exclusion criteria and ESG integration, which together amounted to over USD37 trillion, accounting for two-thirds of the assessed sustainable investments, with novel strategies such as best-in class screening and sustainability-themed investing showing significant growth, although together they accounted for around 6% of these investments ( [[#GSIA--2019|GSIA 2019]] ). Shareholder activism or corporate engagement is the other key approach, which has been well established and continued to grow to nearly USD10 trillion ( [[#GSIA--2019|GSIA 2019]] ).

However, research indicates that ESG strategies by themselves do not yield meaningful social or environmental outcomes ( [[#Kölbel--2020|Kölbel et al. 2020]] ). When it comes to the tangible impact of the financial sector on addressing climate change and sustainable development, there remains ambiguity. There is a growing need for more robust assessment of ESG scores, including establishing higher standardisation of scoring processes and a common understanding of the different ESG criteria and their tangible impact on addressing climate change. The issue was highlighted in an assessment of six of the leading ESG rating agencies’ company ratings under the MIT Aggregate Confusion Project, which found the correlation among them to be 0.61, leading them to conclude that available ESG data was ‘noisy and unreliable’ ( [[#Berg--2020|Berg et al. 2020]] ). This need is reaffirmed by [[#Drempetic--2020|Drempetic et al. (2020)]] , who claim that a thorough investigation of ESG scores remains a relatively neglected topic, with extraneous factors, such as firm size, influencing the score ( [[#Drempetic--2020|Drempetic et al. 2020]] ).

There continues to be a research gap in assessing the direct impact of ESG and sustainable investments on climate change indicators, with most existing studies assessing the co-relation between either the factors driving the sustainable finance trends and the impact on sustainable investments, or sustainable investments and the impact on corporate financial performance. Nevertheless, since the post-SDG adoption period, there has been a notable uptake on research linking sustainable business practices and financial performance ( [[#Muhmad--2020|Muhmad and Muhamad 2020]] ). This research shows that there is a growing business case for ESG investing, with evidence increasingly indicating a non-negative co-relation between ESG, SDG adoption and corporate financial performance ( [[#Friede--2015|Friede et al. 2015]] ; [[#Muhmad--2020|Muhmad and Muhamad 2020]] ), and ESG performance having a positive relation with stock returns ( [[#Consolandi--2020|Consolandi et al. 2020]] ). Research focused on developed economies also indicates towards a positive relation between ESG criteria and disclosure, and economic sustainability of a firm ( [[#Giese--2019|Giese et al. 2019]] ; [[#Alsayegh--2020|Alsayegh et al. 2020]] ) and allays investor fears by showing that sustainable finance initiatives, such as divestment, do not adversely impact investment portfolio performance ( [[#Henriques--2018|Henriques and Sadorsky 2018]] ; [[#Trinks--2018|Trinks et al. 2018]] ). It should be reiterated that this research assesses the co-relation between ESG criteria and corporate financial performance, with the researchers in some cases, such as [[#Friede--2015|Friede et al. (2015)]] , including disclaimers of the results being inconclusive and highlighting the need for a deeper assessment for linking ESG criteria with impact on financial performance.

On the other hand, there is growing evidence for a sustainable investment lens having a broader positive impact on creating an enabling environment and strengthening the case for such investments. For instance, corporate social responsibility (CSR) activities and investments on the environment dimension, specifically in the areas of emission and resource reduction, were found to be profitable and a predictor of future abnormal returns in the longer term, from additional cash flow and additional demand ( [[#Dorfleitner--2018|Dorfleitner et al. 2018]] ). These factors could be contributing to the increasing trend of sustainable and green investments, and can be said to be further reiterated by the spate of investor-led collaborative initiatives and recent announcements by leading finance institutes in the developed economies, which is well recorded in a range of recent grey literature, including new climate-aligned investment strategies and ambition towards net zero targets.

Yet there is also a risk of companies announcing projected sustainability or net zerotargets and claiming the associated positive reputational impact, while having no clear action plan in place to achieve these. The lack of mandatory reporting frameworks, which results in an over-reliance on self-reported carbon data by companies for ESG assessments, can be a primary contributor ( [[#In--2021|In and Schumacher 2021]] ).

While there is a lack of research on the impactof sustainable finance products, divestment impact has been assessed in more detail. Although the research here also points towards the ambiguous direct impact of divestment on reducing GHG emissions or on the financial performance of fossil fuel companies, its indirect impact on framing the narrative around sustainable finance decisions (Bergman 2018), and the inherent potential of the divestment movement for building awareness and mobilising broader public support for effective climate policies, have been better researched and could be considered to be the more relevant outcomes ( [[#Braungardt--2019|Braungardt et al. 2019]] ). Arguments against divestment point to its largely symbolic nature, but [[#Braungardt--2019|Braungardt et al. (2019)]] elaborate on the broader positive impacts of divestment, which include its ability to spur climate action as a moral imperative and stigmatise and reduce the power of the fossil fuel lobby, and the potential of the approach to mitigate systemic financial risks arising due to climate change and address the legal responsibilities of investors merging in this regard.

Challenges remain with regards to overlapping definitions of sustainable and ESG investment opportunities, which also vary depending on social norms and pathways. There is also a general need for more extensive ESG disclosure at a corporate level, against the background of emerging mandatory impact reporting for asset managers in some regions. A movement is building towards sustainable investment strategies and increased sustainable development awareness in the financial sector ( [[#Muhmad--2020|Muhmad and Muhamad 2020]] ; [[#Maiti--2021|Maiti 2021]] ), which points to the ability of civil society movements, such as divestment campaigns, to have some influence on investor behaviour, although there are other influences such as climate risk disclosure initiatives and regulations.

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