ESG | Raudline Etienne

Evolution and the capacity for innovation on a large scale are cornerstones of the CFA Institute’s Future of Finance report. Throughout the four possible scenarios that it envisions on the horizon for the worlds of finance and investment, the CFA predicts revolutionary developments in market forces, communication, social organization, and other areas. These themes of innovation and transformation reappear in the CFA’s fourth and final proposed outcome in which the rise of a new, purposeful capitalism reshapes finance along moral, ethical, and more client-centric lines.

As I discuss more thoroughly in a previous blog post, the CFA analyzes a series of megatrends and posits four scenarios to describe how the financial world would respond: fintech disruption, parallel worlds, “lower for longer,” and purposeful capitalism. In the latter, the CFA suggests that firms will become more conscious of all stakeholders and seek to redefine value propositions by placing more emphasis on trust and nonfinancial considerations.

The impetus for such soul-searching, according to the CFA, comes from a recognition of limits and changing forces. The report notes that as firms acknowledge the interconnected nature of finance—particularly when “viewed as an ecosystem”—they will stress the importance of trust in business and look for ways to demonstrate integrity. Additionally, concerns over systemic issues like resource scarcity and shifting demographics will prompt firms to operate via the principles of sustainable development.

Furthermore, as trust and sustainability come to play a larger role in the financial world, firms will need to find ways of aligning their investment strategies with these values. As a result, pursuing the greatest possible returns or profit maximization may no longer be the supreme goal for many firms who hope to make ethics a key element of their brand or strategy; the report points out the paradox of holding tobacco and health care stocks as an example of this. In fact, the CFA notes that these tradeoffs will represent a large part purposeful capitalism’s development.

Ultimately, firms that embrace purposeful capitalism will pay attention to the needs of broader constituencies that include clients as well as the public at large. Ethical business practices, like the adoption of corporate social responsibility (CSR) or ESG investing, will take center stage at financial institutions, which will also prioritize leadership and diversity initiatives.

To read the CFA’s full Future of Finance report, click here.

A recent Forbes article explored the opportunities that private equity (PE) firms could take advantage of by integrating environmental, social, and governance issues (ESG integration).

Considering the ideal position of PE firms to improve the world around us, it’s certainly an interesting suggestion that the writer makes about the role PE firms can take in developing ESG initiatives within the firm’s portfolio.

To explain how ESG integration could benefit PE firms, Forbes presents a compelling outline of the many social and financial boosts that could potentially happen. And there’s other research that suggests a similar positive influence.

According to this report, the PE industry possesses huge assets, somewhere around $2.4 trillion. Because of the size of the industry, it indicates the stage is set for PE firms to take a huge leadership role in ESG integration. Another reason PE firms are in such a good position to improve ESG integration is the most recent holding period for those companies in a PE firm’s portfolio. The holding period of a company’s stocks for a PE firm in 2015 was 5.5 years, while on Wall Street, it’s a mere 8.3 months. That short time period is not nearly long enough for a company to properly conduct ESG integration because it’s necessary to have a longer period of time to see concrete results.

Another possible benefit for PE firms? These entities are not held to many of the same regulations as listed companies, so PE firms can more freely check up on a portfolio company to ensure it’s being properly managed. In the case of evaluating ESG integration, this could mean determining how much value the company is creating, which could in turn influence future investment decisions.

Notably, a recent survey cited that businesses say risk management is their largest reason to begin ESG integration. Some experts argue that integrating ESG values is a first step to mitigating risk and helping companies appeal to their shareholders and potential investors who need greater assurances.

European PE firms are also honing their focus on ESG investments. In the last month, Invest Europe–a trade association for European PE, venture capital, and investors–published a due diligence questionnaire for private equity firms interested in ESG so that the firms can better assess potential ESG investments. That questionnaire is available here.