Understand what ESG is, trend for investors in 2022

In the alphabet soup of the economy, one of the acronyms that will gain more relevance for investors this year is ESG. From English, the term means Environmental, Social and Governance, and is being adopted by companies around the world, including Brazil.

Knowing its meaning, its objectives and its importance can help investors to make decisions based on policies related to the environment, society and business ethics, as we will see below.

What is ESG?

To understand the acronym, created in 2004 by an initiative linked to the UN, it is necessary to look at each letter that composes it, understanding its meaning.

Environmental, or environmental, concerns corporate practices related to the environment. Discussions about climate change, reducing carbon emissions, waste management, use of renewable sources… all these attitudes fall into this category.

Social is related to the company’s responsibility and impact on the community in which it is inserted. It concerns human rights and labor laws, diversity and inclusion in the workplace, and creating a safe and healthy environment for employees and customers.

Already governanceor governance, is associated with the company’s ethics, and the structure created to efficiently meet the other two letters of the acronym.

This presupposes, among other initiatives, transparency in results and in relations with shareholders, formalization and structuring of policies and procedures for ESG topics, concern in the composition of the board and anti-corruption practices.

So what is ESG? “A lot of people like to say that ESG is a mindset, but I don’t like the term. For me, ESG is basically about aligning all this environmental, social and governance discourse with corporate practice”, says Caroline Palermo, a lawyer specializing in tax law.

In this way, ESG can be understood as a way of evaluating companies’ practices based on their environmental, social and governance policies. It can also be used for investments, as a kind of sustainability criterion: instead of looking only at financial ratios, investors can look at the ESG practices of companies they are interested in applying.

“What I think is important to say is that the ESG practice is not monothematic”, says Fabricio Soler, environmental lawyer and professor at PUC-SP and UFSCar.

“For example: ‘E’ refers to water use, emissions, carbon balance, biodiversity, land use. In the ‘S’, you have diversity, decent work, racial representation. The ‘G’ shows how that topic is internalized: ESG committees, the board implementing the topic, professionals specialized in the area. This is the difference of the term”, he adds.

How do you know if a company is ESG?

In Brazil, the ESG is not parameterized. The evaluation of these aspects in any company is still quite subjective and with variations. 24% of world exchanges place the regulation of sustainability reporting as mandatory — Brazil is among the 76% that do not foresee the initiative.

But this scenario must change. In December 2021, the CVM (Brazilian Securities and Exchange Commission) published an amendment to the rules of the Reference Form — a document that contains the main information about companies —, expanding the requirement for information on ESG aspects.

This is in line with the text sent by the CVM for public consultation a year ago, with occasional changes.

The document, however, has a market orientation character, not an obligation. For lawyer Caroline Palermo, this is a positive thing.

“I don’t know if the word would be to standardize — what we had here in Brazil was harmonization. Our system is very complex and peculiar, so it was necessary to harmonize international standards with our Brazilian system. It makes everyone else speaking the same language, and looking at the same metrics,” he points out.

The new provisions brought by the resolution will come into force as of January 2, 2023. Thus, publicly traded companies can adapt to the measures in the form.

Among the ESG criteria observed by the Commission are:

• Breakdown of “socio-environmental” risk factors into separate items for social, environmental and climate issues, in order to generate greater clarity on the need for all of them to be addressed;
• Requirement for the issuer to take a stand on whether or not to adopt a materiality matrix and key performance indicators for environmental and social issues;
• Requirement to position the issuer on which of the Sustainable Development Goals set out by the United Nations are relevant in the context of its business;
• Adoption of “practice-or-explain”, so that issuers that do not disclose sustainability reports or equivalent documents, or that do not have key performance indicators for environmental and social issues, explain why they do not.

The CVM also establishes that future more robust and prescriptive regulatory initiatives, focusing on sustainability issues, should not be ruled out. Although the Brazilian market does not have 100% clear and defined indicators on ESG, this is a concern of regulatory bodies around the world.

Still, some existing parameters work as a kind of “ESG Seal”. B3’s Corporate Sustainability Index (ISE) is one of them. A new methodology, approved on July 19, 2021, took effect in January of this year.

The changes aim to improve and increase the applicability of the index, which serves both as an ESG investment benchmark and an effective sustainability management tool for the market.

This year, 46 companies were added to the ISE’s theoretical portfolio. Meet the companies that make up the index:

‘Profit with purpose’

After all, why invest in ESG? According to professor and environmental lawyer Fabricio Soler, currently, money is being backed by these practices. For the specialist, both for companies and for investors, there are more and more incentives within the financial market to prioritize these conducts.

He explains that “today, there are differentiated rates in the market for behaviors linked to social, environmental and governance aspects.”

This is because signs are growing that sustainable debt is coming out cheaper for issuers than traditional debt. It’s the call greeniuma term that links ‘premium’ to ‘green’.

Although traditional and ESG bonds from the same issuers, in theory, do not have a price difference —after all, both incur the same credit risk —, research released by Amundi, a French manager that is a reference in sustainable investments, found that, even with limited amplitude, , there is evidence of greenium in the market.

Here in Brazil, there are examples of this: Suzano, a pulp and paper manufacturer, issued, at the end of 2020, US$ 750 million in sustainability-linked bonds maturing in 10 years, which came out with a yield below conventional bonds of the same type. in the market, at the lowest rate in its history.

Klabin, in turn, raised US$500 million for a 10-year term at a yield of 3.2%, the lowest for a Brazilian company at its rating level.

This in companies. But what about investors? The professor says he believes that their movement occurs in sync with the companies: “ESG practices affect companies’ pockets and, consequently, investors’ pockets. There are studies that point to the perpetuity of investments when there are criteria: greater appreciation, less loss, all in line with good practices. These regulations can no longer be ignored.”

Marcella Ungaretti, Head of ESG Research at XP, calls investing in ESG companies “profit with purpose”.

It also provides evidence of this return: XP made a graph comparing the performance of the Bovespa Index and the Sustainability Index from 2006 to January 25, 2002, and found that, in the analyzed period, the ISE outperformed the Ibovespa.

beware of the greenwashing

THE greenwashing it is the practice of false sustainability. The literal translation of the term is “green wash” or “green bath”, and defines the action of a company to spread sustainability in its products and services, but not actually exercise it.

“The company can no longer position itself only in marketing. ESG is not that”, explains Fabricio Soler.

So, how can the investor who is starting to look at this market differentiate a company that is genuinely engaged in ESG guidelines, from one that only uses it for advertising?

According to Ungaretti, it is a sum of factors. The expert recommends paying attention to companies “that are being vocal on the subject and, in addition to that, that have sustainability reports, have been implementing initiatives that corroborate and justify the reference position they claim to assume.”

“The divergence between discourse and practice is worrying. The company is being vocal, while lacking initiatives.”

In addition, analyzing companies, whether they are ESG-linked or not, is a key step before putting your money anywhere. When the president of a company says on his social networks that the company prioritizes sustainability, a consultation of company reports and available indices in the market may be enough to debunk or confirm the speech.

Therefore, the secret to not falling into any kind of washing, according to Marcella, is to look critically at information. Marketing is important for companies because it helps to get the word out about exciting ESG-related projects, but achievements need to come before announcements.

ESG in 2022

For the XP specialist, there are 5 trends that investors need to be aware of regarding the ESG agenda this year. Are they:

• Climate issues linked to the emission of greenhouse gases: the discussion gained strength at COP26, held at the end of 2021, and will be at the center of ESG debates;
• Carbon Credits: especially in Brazil, a bill (PL No. 528/21) aimed at regulating the carbon credits market can be approved. The Chamber of Deputies approved the project in November 2021, and it is awaiting analysis by the Plenary. The date, however, has not yet been set.
• Diversity and Inclusion: the ‘S’ pillar of the acronym should gain strength;
• Advances in regulation: the initiatives promoted by the CVM are moving in this direction, but new actions must still take place on the subject;
• Standardization of regulation: whether on its own or through the new regulations, parameters defined with greater clarity and cohesion are a goal for 2022.

Ungaretti adds a sixth trend: data privacy and security. With the recent attacks on the Ministry of Health system, this is an especially important topic for the country.

For experts, in general, ESG will gain strength this year. And the numbers prove it: an annual survey carried out by Deloitte and
Brazilian Institute of Investor Relations (IBRI), in 2021, showed that 74% of publicly traded companies plan to increase their ESG budget in 2022.

Ungaretti warns: “ESG is neither binary nor stationary. It’s a journey, a process.”

For the specialist, in the long term, this trend will dictate which companies will prosper. “The winning companies will be those that prioritize ESG. Those who do not take the topic seriously will be left behind.”

* Under supervision of Deise de Oliveira