ESG and the SDGs: A perfect partnership?

Photo courtesy of Gail Hurley

How will the COVID-19 pandemic affect ESG investments? And is it possible to ensure that the current focus on ESG standards benefits low-income countries? Gail Hurley calls for more patient capital and a hands-on approach…

As published in the October 2020 issue of the OPEC Fund Quarterly.

The United Nations (UN) has warned that the COVID-19 pandemic threatens to reverse human development progress for the first time in over 15 years.

An estimated 71 million people will be pushed back into extreme poverty around the world with the poorest people and places hardest hit. This crisis has unleashed a development disaster just as the UN announced a ‘Decade of Action’ on its Sustainable Development Goals (SDGs).

The COVID-19 crisis has further worsened what were already high development financing gaps. Even prior to the crisis, the UN Conference on Trade and Development (UNCTAD) estimated SDG financing gaps to be in the range of US$2.5-3 trillion annually. As demand has fallen, revenues have declined. Remittances have also dropped sharply (by an estimated 20 percent in 2020, according to the World Bank). The African Development Bank has warned that 30 million jobs in Africa are at risk, and that private sector companies – large and small alike – face an unprecedented crisis.

Combined with high debt (and increasing borrowing costs), developing countries simply don’t have the fiscal space to respond as advanced economies have done with large economic stimulus packages. While multilateral financial institutions have pledged billions in economic aid, this is mostly loans and represents a fraction of the income countries have lost to the crisis. Development aid flows are also under pressure, as economic conditions remain difficult in key donor nations. Data from Development Initiatives shows that aid commitments from bilateral donors were almost 22 percent lower than expected in the first six months of 2020.

The investment environment has therefore become much more difficult and uncertain across the developing world. What does this mean for investments that take into account environmental, social, and corporate governance (ESG) factors in these same countries? Will the COVID-19 pandemic put a brake on ESG-aligned investment? Or could it be a catalyst for even more socially and environmentally-conscious investing in developing countries?

Over the last decade, ESG-aligned investments have grown rapidly in number, variety and size. Green bond issuance topped US$257 billion in 2019, up 50 percent on the previous year. While issuance has dipped in 2020, markets have instead seen a rise in ‘social’ and COVID-19 themed bonds – over US$65 billion this year so far. UNCTAD estimates that the total value of sustainability oriented bonds and funds is now between US$1.2 and 1.3 trillion worldwide. Since its launch 15 years ago, the UN’s Principles for Responsible Investment (PRI) initiative has become a dynamic community of almost 3,000 organizations and institutions around the world interested in responsible investment. Globally, there is an increasingly large and dedicated set of investors committed to ESG principles, in addition to financial return.

At the same time, the data shows that these growing markets are mainly concentrated in advanced economies, and largely bypass developing countries – in particular low-income countries. Europe, North America and other advanced economies account for around 90 percent of the sustainable investment market. Private finance is still not finding its way into investments in developing countries at the scale and speed needed to achieve the SDGs.

Investors and development finance institutions (DFIs) still struggle to source companies and projects that meet their stringent investment criteria, especially in the poorest countries and fragile states where capital needs are the highest. It is most often here that information and data flows are weak, and companies may have more difficulty in meeting certain standards. Added to this is the potential that public sector subsidies for blended finance approaches will fall, which may reduce attractive investment opportunities in developing countries further. These transactions also typically incorporate robust ESG-standards. Overall, there is a concern that the current uncertain market environment may encourage some investors to become more risk averse and adopt a ‘wait and see’ approach, especially in more difficult markets. And while ESG may be popular, there are also many people deeply sceptical about the extent to which ESG-metrics are robust or sufficient to catalyze a sea-change in the types of investments the world needs to see to meet the SDGs or reach the decarbonisation objectives of the Paris climate accord.

Long-term, there are no signs that investors’ commitment to ESG-alignment will wane due to COVID-19. On the contrary, citizens, business leaders, investors and policymakers alike have called for a ‘green recovery’ – one that places more emphasis on environmental conservation and puts people and planet at the center. The challenge is to ensure that this market momentum benefits the poorest people and places.

How can this be achieved? It calls for an increasingly active ‘hands-on’ approach from the development finance community. Development agencies, multilateral development banks, development finance institutions and foundations have a particular role to play over the next few years to nurture the project pipeline in the poorest and most vulnerable countries, and ensure high ESG standards. Investors also need to recognize that more patient capital is needed. Government regulations can also encourage private investors to finance ESG-related initiatives, and more countries may also focus their efforts here as they face an extra squeeze on their finances. These strategies will help lead private investors (back) into markets on the other side of the crisis.

The drive for more transparency and accountability in ESG is also critical. While it’s relatively easy to source a wealth of information on the performance of ESG-aligned instruments versus conventional funds or bonds, more information is needed on how investments advance sustainable development outcomes and make a positive impact on people’s lives and livelihoods.

The signs are positive that ESG-aligned investments will further accelerate. And COVID-19 has further strengthened the strategic importance of impactful investments in the developing world. More efforts are needed, however, to ensure that ESG tools also boost sustainable development in the countries furthest behind.

Gail Hurley is a senior advisor and researcher on development finance. She worked for the United Nations Development Programme (UNDP) for 10 years, and currently advises the UN, foundations, NGOs and governments on catalyzing financing for the SDGs.