Responsible or sustainable investing is far from a new concept. The origins of what we might consider ‘modern’ responsible investing have been traced back as far as the beginning of the 19th Century; however, awareness and popularity of responsible investing has seen exponential growth in the last few years.
According to a recent report from the US Social Investment Forum (SIF) Foundation, at the beginning of 2018 US investors held US$11.6 trillion worth of assets which had been chosen according to Environmental, Social and Governance (ESG) criteria; this is an increase of over 40 per cent, from US$8.1 trillion in 2016. The report also identified that shareholder advocacy and overlapping strategies promoting ESG principles have risen apace with total assets under management. This recent surge has been driven, in part, by younger investors who want their finance and business practices to align with their personal values, as well as by a renewed awareness of global issues (such as climate change) among the general population, and the introduction of corresponding legislation, such as France’s radical mandatory reporting of climate risk. As such factors are set to become more influential and commonplace over the coming years, we can only expect ESG criteria to become an increasingly important and formalised aspect of global trading.
In order to keep up with the demands of stakeholders and any developing legislation, professionals at all levels of the financial services industry must be prepared to recalibrate their offerings around such principles in the near future. Stock markets, at the intersection between capital market participants and their increasing civil responsibilities to ensure responsible and sustainable business practices, are particularly well-positioned to catalyse the trend towards responsible investment. The Bermuda Stock Exchange (BSX), recognising its position as one of the world’s leading markets, has recently taken up this challenge, launching a new ESG initiative in line with World Federation of Exchanges’ (WFE) sustainability principles in May, and dedicating ESG as a priority for 2019.
ESG criteria, like any other investment criteria, are standards by which investors screen potential investments; however, while traditional criteria look to determine financial return above all else, ESG factors principally aim to measure the social sustainability of an asset’s business practices. Environmental criteria consider a company’s environmental impact; social criteria examine how companies interact with their employees, customers, and the communities in which they operate; and governance criteria seek to establish that a company’s leadership and corporate structure is operating in responsible and sustainable fashion. While the primary motivation for investors to consider such criteria is generally to ensure that they are not funding practices which may be socially and environmentally harmful, several recent studies have found that good ESG practices have a material impact on investment performance. Indeed, a 2015 study by Oxford University and Arabesque Partners reviewed over 200 sources to determine that “80% of studies demonstrate that prudent sustainability practices have a positive influence on investment performance.” Thus, evaluating the ESG practices of an asset is increasingly seen as a sensible method of assessing the potential risk and return of an investment, as well as its social impact.
As yet, there is no consistent global standard for ESG ratings but progress is being made. The WFE’s 2018 Sustainability Report found that 80 per cent of exchanges carried out ESG disclosure in markets where reporting is encouraged or required – and as global consensus on the importance of ESG continues to grow, so will the need for clear and standardised criteria. Nevertheless, despite the current lack of formalised global standards, the BSX has refused to adopt a wait-and-see approach. Rather, the BSX is determined to be at the forefront of encouraging and empowering sustainable growth for its member companies, listings, and the wider community, ensuring that all participants are better able to benefit from the ever-increasing flow of investment being directed towards the sustainable economy. In order to do so, the BSX has embraced the WFE’s five Sustainability Principles:
Sustainable Finance in Bermuda
While the BSX is still in the process of formalising its action plan to become a sustainable exchange, we already have much to offer the ESG investor. A recent review of our listings has demonstrated that many entities are already actively embracing ESG practices or moving towards incorporating them into their business model – often in the most innovative and insightful ways. Aurum Fund Management Ltd, for example, a Bermuda-based manager with several BSX-listed hedge funds, launched their embedded impact solution as early as 2002 – an initiative which has since generated approximately US$8.5 million for non-profit organisations across 40 countries.
The BSX has also long been a leading market for the listing of investment funds, debt and insurance related securities and small to medium enterprise companies; entities which already tend to perform well according to ESG criteria. Indeed, as the world leader in Insurance Linked Securities (ILS), Bermuda will play an increasingly important role in assisting communities around the world adapt and recover from natural disasters, climate change, and the resulting impact on vulnerable communities. And many of the BSX’s listings, especially in the ILS sector, are well advanced in developing products that move the sustainable finance agenda forward.
Embracing ESG principles is not only a priority for Bermuda Stock Exchange, however, but for the jurisdiction as a whole. Bermuda, as an island which is susceptible to natural disasters, is well aware of the importance of developing resilience to environmental upheaval. As a leading international financial centre, the jurisdiction also recognises the potential of the financial and business sectors to tackle such challenges. In June 2019, a special report published by Nephila Climate (an initiative of one of Bermuda’s earliest investment managers to specialise in reinsurance risk, Nephila Capital Ltd) detailed how risk transfer might be used to achieve climate resilience; concluding that, “risk transfer and catastrophe coverage can be successfully and cost-effectively used for climate change adaptation by a wide range of public and private organisations”. As a jurisdiction which understands both the financial and real-world impact of ESG principles, Bermuda is uniquely positioned to enhance dialogue on promoting sustainable products and services. While its status as a respected, well-regulated and dependable jurisdiction will ensure that this dialogue has a global impact.
In 2006, when the UN-backed Principles for Responsible Investment (PRI) was launched, the scheme had 63 investment companies, withUS$6.5 trillion assets under management, commit to incorporate ESG criteria into their assessment processes. By April 2018, the number of signatories had risen to 1,715 asset owners, asset managers and service providers, representing US$81.7 trillion assets under management. Needless to say, this represents a vast and growing commitment from the global wealth management industry toward tackling some of the most pressing environmental and social concerns globally.
In the coming years, capital markets will have a hugely important role in mitigating climate change, improving the social conditions of billions around the world, and ensuring that corporations are governed in a responsible and sustainable manner. The BSX is committed to developing its ESG offering and empowering sustainable investment for all its participants – not only to maintain its reputation as an innovative, world-class market, but also to advance ESG principles worldwide.
Insurance Linked Securities as an ESG-Compliant Asset Class
Insurance Linked Securities (ILS) is a non-correlated asset class which is recognised as a sustainable investment by the United Nations’ Sustainable Development Goals (SDGs) due to its role in helping private and public organisations to build resistance to natural disasters and climate change. Pension fund investors from several jurisdictions have repeatedly highlighted the ESG qualities of ILS investments and catastrophe bonds which provide essential financing and liquidity when natural disasters strike. Such investments not only have the potential to protect communities and infrastructure in times of emergency but also help reduce what is known as the ‘protection gap’ (uninsured or underinsured risks) and increase resilience to such risks generally, even in times of prosperity.
With such obvious ESG credentials, ILS investments are the ideal asset class for investors wishing to incorporate sustainable finance into their portfolios. The Bermuda Stock Exchange is the world’s leading exchange for the listing of ILS; of the 950 securities listed on the BSX, ILS comprises 349 listed issuers, with US$33.2 billion in market capital outstanding. Many of the BSX’s listings are particularly well-advanced in developing their ESG potential. Forward-thinking ILS fund managers, hedge funds and asset managers based in Bermuda have long embraced sustainable investment principles and offer the potential investor the confidence of cemented credentials, impressive track records, and an established commitment to ESG values.
Greg Wojciechowski is the President & Chief Executive Officer at the Bermuda Stock Exchange. He also serves as the Chairman of the Financial Intelligence Agency in Bermuda. Prior to joining the Bermuda Stock Exchange in 1993, he held management positions at three large US brokerage firms.