Opinion – Rodrigo Tavares: What to expect from the ESG market in the next 3 years?

If, in 2021, the sustainability market faced the typical adolescent ups and downs, in the coming years it should enter a phase of greater maturity and circumspection. After listening to several experts, I highlight some trends:

1. Regulations, standards, certificates, tracking software, and all kinds of sustainability validation instruments will emerge. It will be a sphere dominated by ESGtechs and Big4 auditing. Organizations like Envizi or Project Canary will gain more and more latitude. In 2021, PwC and KPMG announced billion-dollar investments to prepare for the new world. Deloitte and EY are lagging further behind but are expected to catch up in the coming years.

2. The war for talent portrayed in this column will continue throughout 2021. As the demand for ESG specialists grows from companies and financial institutions, three trends will intensify: excessive wage compensation, hiring professionals with experience in finance (and not from NGOs) to occupy the most senior positions in sustainability and the emergence of professional makeup.

3. If 2021 was the year of net-zero goal announcements, from 2022 onwards these goals will be monitored more closely. Carbon offsetting will become commonplace and more sophisticated as it offers companies a short-term solution to reducing their emissions. Compensation will be carried out through participation in reforestation or forest conservation projects, methane capture, energy efficiency, among others.

4. Retail and investment banks will be increasingly relevant players in the market. The trend to incorporate ESG into debt strategies is irreversible. The various types of ESG bonds, sustainability-linked debt and the incorporation of ESG factors in risk modeling will continue to grow. This market doubled in size in 2021 and reached US$1 trillion (R$5.737 trillion).

5. ESG will become universal with expansion to Gulf countries and China. The sovereign wealth fund of Saudi Arabia (PIF), which this year hired a new head of resource allocation strategy with a mandate to prepare the country for decarbonisation, Bahrain’s banks, and the emirates of Abu Dhabi and Dubai will accelerate the pace towards sustainability. The UAE recently launched the UAE Sustainable Finance Framework 2021-2031 and the UAE Guiding Principles on Sustainable Finance to fertilize the land.

6. In Brazil, the government that will take office in 2023 will abandon the guerrilla and mindless stance against sustainability and will promote policies and rules that encourage and organize the market for sustainable finance and corporate sustainability. The country will gradually regain its status as a global power in environmental issues. It won’t be difficult to reoccupy your natural space.

7. In the area of ​​investments, the hyper-compartmentalization of different investment approaches with an ESG angle (positive filter, negative filter, “best-in-class”, ESG integration, etc.) will gradually fade away and give way to only two strategies umbrella: responsible investments (when systematically integrating ESG policies, practices and data to identify risk and opportunities) and sustainable investments (when the explicit objective is to generate positive social or environmental impact). Regulators in Brazil (ANBIMA), Germany, UK, Singapore, India and Switzerland will be the first to establish criteria and prerequisites for minting funds from these two angles. The much-desired standardization is getting closer.

8. Conviction will grow among investors that integrating ESG factors into company valuations enhances traditional analytics by identifying newly discovered risks and opportunities that go beyond fundamental metrics. Investors in equities and unlisted companies will calculate Discounted Cash Flows (DCFs) by incorporating the most material ESG data. The analysis of climate risks will be highlighted.

9. Sustainable funds (also called impact in Brazil) will continue to be a niche market, fueled mainly by generations under 40 and foundations in developed countries. They will be increasingly tailored to the interests and causes of each investor. Eventually, they will also be transported to the metaverse, a 3D virtual reality world that will enable an immersive online connection experience. Responsible investments, on the other hand, should become universal and cover the entire capital market. In the future, this modality will be synonymous with traditional investments.

10. Both types will have their impacts—both positive and adverse—constantly monitored and measured. A fixed income fund that invests in emerging market securities of all types of companies, even if not guided by any intention of social and environmental change, will be able to measure the consequences (voluntary or involuntary) of its capital allocation, such as the impacts on climate change or gender diversity.

11. This work will be done by the ESG rating agencies. If currently these companies (more than 100 in the market) operate under a logic of under-regulation and low transparency, soon we will have only 4 or 5 operating in a market with clear rules. Which? Centennial Standard & Poor’s (S&P) Moody’s and Fitch will incorporate ESG risks and dominate the market. Concomitantly, 2 or 3 agencies that exclusively measure the impact of investments will monopolize this submarket.

12. If currently the assessments of these agencies present a margin of subjectivity and volatility, their work will be facilitated once all companies are obliged to report ESG data and to do so following the same modeling. The entry of IFRS, which is now the main reporting format for financial data, in the ESG market will lead to the standardization of sustainability reporting. Eventually it will also lead to the merging of accounting data and ESG data. We will bury sustainability reporting and accountants will have to become experts in environmental, social and governance data.

The county of the prophets of doom who predicted that sustainability would be a ripple will have fewer and fewer inhabitants, but there will be many in the market who will become frustrated with ESG practices as they understand that the inclusion of these concepts is complex in the methods, long over time horizons and it depends on an internal transformation by each company. It’s either everything or nothing. The middle ground is not ESG.