CFI.co – ESG – Business | Finance

What is ESG?

Environmental, Social & Governance

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Sustainability or ‘ESG’ (Environmental, Social and Corporate Governance) concerns are becoming increasingly widespread among global capital market participants. Such issues are clearly starting to have an important impact on investors’ decisions. Exchanges, situated as they are - at the sharp edge of change due to their critical infrastructure role for the financing of the real economy, can help promote responsible business and investment behaviour and so facilitate sustainable development and transparent ESG policies and practices.

Exchanges in recent years have received a number of questions from investors relating to their sustainability practices. Thirty nine percent (22) of the respondents to the World Federation of Exchanges Sustainability Working Group Survey (SWG Survey) said they had been approach regarding sustainability and ESG issues, with 10 saying that the number of inquiries on these topics has been rising (see sidebar).

Exchanges need to respond to this heightened investor awareness of sustainability issues by ensuring the stability, fairness and transparency of their markets and at the same time nurture investor confidence by the provision of information. A number of possible ways have been suggested through which exchanges can contribute to addressing sustainability and ESG issues (UNCTAD 2014).

1. Conditional on regional and/or regulatory requirements, exchanges can encourage the disclosure of ESG information by the companies listed on their markets, whether on a mandatory or voluntary basis.
2. Exchanges or regulators can directly gather and/or compile ESG metrics submitted by listed companies.
3. Sustainability-themed financial products can provide incentives to issuers and create opportunities for capital allocation to ESG leaders or appropriate projects.
4. As companies themselves, individual exchanges should themselves consider producing a sustainability report.
5. Participation in sustainability-related initiatives and events, relevant engagements with stakeholders and collaboration with sustainability experts in their markets.

This report sets the scene for the further work which the WFE Sustainability Working Group (SWG) intends to undertake by examining the extent to which WFE members already engage with sustainability initiatives or not and what the prospects are for closer involvement by the exchanges with such projects in the near future.

This report takes into account the diverse economic and regulatory environments in which exchanges operate and takes into account that a ‘one-size-fits-all’ approach will neither be possible nor effective. In spite of this, most exchanges are keen on pushing for better ESG practices in their markets while recognising the importance of protecting these markets from inappropriate or overly burdensome regulation.

Most of the data and graphs cited in this report have been taken from a recent survey of WFE member exchanges prepared by the SWG. Selective reference is made to reports and literature on the issue, although this does not reflect the full range of the literature that now exists on the topic.

This report will be split into three sections: an introduction and consideration of the importance of ESG issues for exchanges; an analysis of survey responses and concluding remarks and potential further steps.

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Increasing Number
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General Inquiries
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Small Number
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Why are ESG issues so important to exchanges?

The increased focus on sustainability and ESG issues clearly has its roots in now widespread perceptions of long-term climate change, increasing economic instability and poverty (UNCTAD, 2014). The prevalence of such views have persuaded some investors to make environmental impact, social sustainability and corporate governance key criteria in guiding their decisions. This has led to increased pressure on firms to make a habit of disclosing such information. Research by CK Capital highlights seven of the most broadly disclosed sustainability-performance metrics: energy, greenhouse gas (GHG) emissions, water, waste, lost-time due to injuries, payroll costs and employee turnover rates (Capital, 2012). That said, there is a range of additional factors across the ESG spectrum.

Sustainability and good stewardship are essential to continuing prosperity in the years to come. This is obvious in terms of environmental sustainability, natural resources are finite and will need to be carefully managed.

Social and governance issues also affect corporate sustainability and other potential investments. Issues such as fair pay and employee turnover have a significant impact on the social environment in which potential investments are situated. The social environment can be degraded if pay structures are inequitable and/or employee turnover is high and this can undermine the operational stability of companies and so the potential for growth and more inclusive wealth creation.

For the above reasons, and many more not discussed here, there has been increased demand for sustainability disclosure (UNCTAD, 2014). Disclosure allows for more informed decision making on investments and facilitates more accurate assessment of long-term investment potential. Research suggests a positive relationship between ESG disclosure and a company’s share price (Z. Zuraidaa, M. Nurul Houqeb & T. van Zijlc;, 2014). Despite these increasingly clear bottom-line benefits of disclosure, one study shows “only 3% of the world’s large companies … and 0.04% of the world’s small companies” provide complete first generation sustainability disclosure to their stakeholders (Capital, 2013).

Exchanges are well-placed to encourage sustainability and ESG disclosure. Stock exchanges, although diverse in terms of their legal status and revenue streams (Research, 2012), provide the infrastructure for markets and as such are, in most instances, able to influence the behaviour of market participants via rule-making, implementation of national legislation, policies and regulations (Research, 2012) or by the use of other tools and incentives as may be appropriate.

The following report is based on a survey of the World Federation of Exchanges (WFE) members. The WFE has a membership of 64 exchanges of differing sizes and structure from around the globe. The results of the survey therefore cover a wide range of regulatory situations and highlight the breadth and diversity in the disclosure of sustainability and ESG metrics.

ESG Initiatives Survey

Read full survey results

It is clear from our analysis of the survey results that many exchanges are eager to learn more about—and play a role in the promotion of—sustainability and transparency on ESG issues. Most stock exchanges, well beyond the examples provided in this report, could testify to the shifts that are being experienced in their various markets in terms of the growing awareness of the sustainability imperative and the need for greater availability of information. The WFE and its member exchanges stand ready to respond.

Despite this affirmation, a lot of work remains to be done. Over the past year the SWG has sought to forge an industry-wide consensus on the role exchanges should play in this regard. Given there is a large degree of support for such a consensus, we should now go further. It is our task to advise on the range of approaches that could be pursued at industry level. WFE SWG members will work together to present the broader WFE membership with such an industry-level view and intends to play catalysing role in the implementation which should follow.

After publication of this paper, the SWG will turn its attention to a detailed ESG recommendation. We expect to present this document to the WFE board, and the entire WFE membership, this year. This recommendation will consist of 4 parts:

An “exchange-level” materiality assessment of ESG data;
An overview of the expected business impacts of exchange involvement in this space;
A list (with explanations) of core ESG metrics essential to understanding a listed company’s strategy, structure, and sustainability; and
Other methods of achieving more sustainable capital markets, including indices, financial products, and data transparency.

The recommendation will not, by design, make any recommendations regarding how the data should be acquired and whether this should be an obligatory requirement on companies. The latter will be left to the discretion of individual exchanges and their regulators. Exchanges will not be obliged to enact a program or plan based on WFE’s recommendation; it merely serves as a benchmark of best practice, should they wish to follow it.

Finally, the SWG and its leadership intends to make a transition to an active reference body for WFE members. We will assist exchanges directly (and privately) on specific market or regulatory issues related to ESG. If necessary, we will provide talking points, undertake original research, or facilitate conversations between investors, exchanges, and other stakeholders. These stakeholders include both large investment firms, agenda-based investors (SRI), and retail investors.

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