The ESG investment balancing act
There is a fundamental challenge at the heart of sustainable investing: investors are increasingly alert to navigating the risks, but companies are under more pressure than ever to set ambitious sustainability targets.
At the same time, policymakers and regulators are trying to ensure that all parties do what they claim. In Australia, the Australian Sustainability Reporting Standards (ASRS) were introduced at the start of 2025.1
The need for a credible approach has never been greater. The emissions gap – the difference between actual emissions and the levels that would comply with targets – remains high.
Countries’ current climate change mitigation plans imply an emissions gap in 2030 of 22 gigatons of CO2-equivalent above what would be needed to limit warming to 1.5 degrees above pre-industrial levels.2 That gap widens to 29 in 2035 and 36 in 2050.
Tough, but achievable
How do companies go about setting targets, and what do investors think of them? Investors want tough, science-based targets that are for companies to meet through business-as-usual. But companies want targets to be achievable.
“With any transition plan we are expecting a focus on what is within a company’s control and what they are doing to tackle those,” says Kate Turner, global head of responsible investment at First Sentier Investors. “For those things that are outside a company’s control, we want to understand what they are doing to influence, and so indirectly play a role in reducing emissions.”
In the past many companies set targets because rivals did. Today there is more attention paid to the detail, and even those working hard to reduce their impact are finding that they must adjust their expectations.
“ESG commitments have in the last five years gone from being non-material to being material financial information, shifting them from the sustainability report to the financial report,” says Zoe Whitton, head of strategy and impact at Pollination, a climate change investment and advisory firm. “That means we will get an array of targets being reset because the standards of evidence are going up.”
Seen through that lens, changes are less about backsliding and more about getting closer to a real trajectory. The new generation of targets are likely more realistic than before. A recent example is Unilever’s revision of its 2025 virgin plastic use target, with the company explaining why it needed more time and a systemic shift.3
The long green
The market for debt issued in the context of these targets continues to develop. As of the end of September 2024, cumulative issuance of green, social, sustainability and sustainability-linked (GSS+) bonds had reached USD6.6 trillion.4
Explicitly ‘labelled’ bonds have made life easier and more difficult for the investor. On the one hand, they provide disclosures to support their claims; on the other, analysing those disclosures has added to investors’ workloads.
One of the biggest challenges for investors interested in sustainability remains the data. Adrian David, director at Macquarie Asset Management, says the labelled market has helped with standardisation, but also notes there is still much manual work.
“One challenge for a credit investor is that a lot of issuers are private companies, and data disclosure is very different to listed companies,” he says. “Sometimes it feels like we are living 20 years ago from a data perspective.”
As data becomes more available, the focus will shift to the ability to process it. Artificial intelligence (AI) is expected to help.
“We are in the early days of using AI,” says Turner. “But we are hopeful that it will help ease the pain of the regulatory burden and being able to use it to manipulate all the data we will need to gather will be very useful.”
Returns, meet integrity
For as long as there have been sustainability-related financial instruments, there has been the question of whether investors should accept a trade-off between returns and integrity. If reducing emissions means reducing consumption, this raises the fear of falling growth, for example.
“In the context of the Australian bond market, a good proportion of the widest trading bonds in the investment-grade universe are wide because they have ESG risks,” says David. “A company that has a particularly large emissions footprint or has had governance missteps will trade wider than another of similar credit risk.”
The question of returns is often one of perspective. Many companies are transferring their future operational expenditure to today’s capital expenditure – for instance, by saving fuel expenses by switching to an electric fleet. Dynamics like these drive ‘greenflation’. But a focus on the costs of transition ignores the impact of inaction.
“We were visiting investors in Canberra recently and one equity manager said that their modelling suggests a 10% hit to GDP by 2050 if we do nothing,” says Whitton. And physical climate change is inflationary because it erodes the productivity of assets.
The growth and inflation challenge exists whether the world acts or does not act. But over the longer term, only one option is sustainable.
1. https://treasury.gov.au/consultation/c2022-340878
2. https://www.unep.org/resources/emissions-gap-report-2023
3. https://www.unilever.com/news/news-search/2024/how-were-aiming-for-greater-impact-with-updated-plastic-goals/
4. https://www.climatebonds.net/files/reports/cbi_mr_q3_2024_01c.pdf