Office of Strategic Environmental Management
Environmental Performance and Financial Markets
Note: EPA no longer updates this information, but it may be useful as a reference or resource.
"Climate change and other environmental and social issues pose bottom line risks, and investors have a right to know which businesses are best positioned to compete in the emerging low-carbon global economy."
Mindy S. Lubber, Director of the Investor Network on Climate Risk
"As we can see from the number of investors now actively seeking ESG information in order to help them base investment decisions, the dichotomy between sustainability and long-term business value is false."
Sean Gilbert, Sustainability Reporting Framework Director at the Global Reporting Initiative
"There is still insufficient recognition within the current debate on the fundamental role played by environmental, social, and governance factors in the creation of a recovery that is sustainable and capable of restoring societal confidence in the capital markets. Understanding the investment risks associated with environmental issues such as climate change, water scarcity, and energy security is crucial to the creation of a resilient, sustainable economic recovery."
Climate change, pollution, water quality, resource scarcity, and other global environmental threats are starting to transform the world's financial markets. A financial market is a mechanism that allows people to easily buy and sell financial assets, such as stocks, bonds, insurance, and commodities. Already, trillions of dollars, pounds, euros, and yen are being managed in the worlds financial markets with a view to environmental factors.
Driving this change are the significant risks and opportunities these global environmental threats represent. Some of them could have major financial consequences for companies. As a result, some financial services firms are rethinking the traditional ways they manage their portfolios. They are developing frameworks for incorporating environmental factors, usually integrated with social and governance factors, to identify better-managed, more forward-thinking companies with better long-term financial prospectsbefore the broader market recognizes them.
View and print presentation on corporate finance and governance (PDF) (101 pp, 12.4 MB)
A Competitive Advantage?
An integrated environmental, social, and governance (ESG) framework may enable financial services firms to achieve higher long-term returns and/or lower portfolio risk. This potential competitive advantage arises from several sources:
- Lower Risks. An environmental accident can wreck in hours a companys reputation, compounding exponentially an incidents direct financial costs. Even a relatively minor environmental incident can draw unwanted attention from regulators, courts, governments, community groups, and the media. A companys strong environmental management and performance, on the other hand, can lower or eliminate these risks.
- Reduced Cost of Capital. When financial market participants recognize companies with strong environmental management and performance as less risky, these companies pay less than their competitors do for insurance and debt and equity financing. At the same time, these strong environmental performers can be cheaper to run over time. These savings can come from lower energy, waste disposal, emissions, and water costs; lower operations and maintenance costs; and improved productivity and reduced absenteeism.
- Newly Identified Trends, Markets, and Revenue Streams. The need to address global environmental threats is boosting innovation in environmentally friendly and energy efficient ways of doing business. It is also creating new markets for environmentally friendly and energy efficient products and services. Companies with strong environmental management and performance will be in the best position to rise to the challenges (while avoiding related risks), provide solutions, and adapt profitably to coming changes. Environmental laggards, meanwhile, may be left behind.
- Greater Brand Loyalty. In crowded marketplaces, companies strive for a unique selling proposition that can separate them from their competition in the minds of their customers. Not only do loyal customers bring in repeat business, they also may be willing to pay higher prices, may cost less to serve, and may refer new customers. Going green can help build and maintain brand loyalty.
- Improved Employee Enthusiasm and Retention. A genuine and enduring commitment to going green can help with recruitment and retention, particularly among young people.
Barriers to Adoption
Several barriers are blocking many financial services firms from using environmental factors to manage their portfolios.
- Outdated Negative Perceptions. Historically, frameworks for considering environmental management and performance used negative screeningexcluding "sin stocks" and problematic industries from investment portfolios. Financial services firms often viewed negative screening as counter to their fiduciary duty to maximize returns. If you reduce the pool of available investments through screening, they reasoned, you reduce the ability to diversify and build a portfolio that can perform as well as conventional portfolios, let alone outperform them. Todays ESG frameworks, however, are defined positively. They focus on identifying companies that meet positive ESG criteria. They are about making better choices, not limiting choices.
- Inconsistent Information and terminology. State, regional, and national government offices often gather information on environmental management and performance in different ways. Similarly, companies usually self-report differently too, even ones following common ESG reporting frameworks, such as the Global Reporting Initiative. Not only does the usefulness and quality of available information differ, so does the terminology used for the same measures. Financial services firms want to make apples-to-apples comparisons but cannot when each investment, underwriting, and lending decision will be made on mismatched sets of information.
- Too New. Many financial services firms are not convinced there is enough empirical evidence linking environmental and financial performance. They want more proof that considering environmental management and performance (along with other non-financial factors) can help them outperform the markets. Still others buy into the link between going green and profitability but are stymied by the lack of a standardized set of quantitative measures that correlate environmental management and performance with financial performance.
- Short-Term Focus. Shareholder demands for strong short-term financial performance compete with the longer-term nature of ESG frameworks. As a result, some financial services firms fail to appreciate the longer-term value of superior environmental management and performance. Others recognize the longer-term value but are uncomfortable deviating from tried and true methods of meeting short-term earnings targets.
- Lack of Capacity. Many of the financial analysts making investing, underwriting, and lending decisions are primarily trained to assess financial information and are not fully equipped to analyze environmental management and performance.
Using environmental factors in investing, underwriting, and lending decision-making is a global phenomenon. The number of financial services firms using them to manage their portfolios is growing in the major international financial markets and even in developing countries. The ranks of socially conscious investors are also growing, particular among high net worth individuals, women, baby boomers, and foundations. Europe has been particularly innovative in making environmental considerations a more standard part of investment, underwriting, and lending decision-making.
View and print report on environmental investing in Europe (PDF) (97 pp, 1.14 MB)