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‘Unsustainable’ firms still attracting cash

Despite rising interest in sustainable investing, unsustainable companies have faced no obstacles in raising funds in public markets, according to research from Robeco. 

The report accepts that sustainable investing has gathered rapid momentum in recent years and that investors are increasingly looking for solutions that make an impact alongside financial returns.

But the asset manager argues that to deprive these businesses of fresh capital, sustainable investing needs to become ’business as usual’ in the investment community.

Asset managers and owners can reach these objectives through active ownership and capital allocation. With active ownership, they can pursue their sustainability goals by voting at shareholder meetings and engaging in constructive dialogue with firms to steer their behaviour. They can also vote with their feet, through their capital allocation choices.

Capital flows

Robecco’s analysis examined how sustainable investing has affected capital flows and the financing needs of companies.

“In principle, divestment would negatively affect the targeted firm, but this mechanism is actually not so clear-cut. Divesting results in a transfer of ownership from one investor to another, which has no direct impact on the firm.

“However, divestment may hurt companies indirectly by increasing their cost of capital. With this in mind, we argue that the ultimate impact of sustainable investing on listed companies is best evaluated by examining the primary market, ie new issues of bonds and stocks,” the report says.

In its study, Robeco considered all stocks in the MSCI All Countries World Index over the 2010-2019 period. It classified a company as an equity issuer if its number of shares outstanding increased by at least 10% over the year. Similarly, it categorised a company as a debt issuer if the book value of its debt increased by at least 10% over the year.

To distinguish between sustainable and unsustainable businesses, it used a broad range of metrics, namely ESG, carbon footprint and SDG dimensions.

David Blitz, chief researcher at Robeco explains the findings: “Our analysis showed no evidence that fresh capital flowed more towards sustainable firms than towards unsustainable ones. More specifically, it appears unsustainable companies faced no obstacles in raising funds in public markets. Indeed, the sustainability profile of equity issuers was generally similar to the broad market, while debt issuers even tended to have a below-average sustainability profile. Moreover, our results were stable over time. Capital did not flow more towards sustainable firms in recent years than before.”

Blitz says the results suggest that sustainable investing has not been able to starve unsustainable companies from fresh capital over the sample period. “We acknowledge that if sustainable investing continues to grow, it may become increasingly hard for unsustainable firms to obtain fresh funding in capital markets.”

He adds: “But how much growth would be needed for that, and whether such a scale is realistically attainable, remain open questions.”

To deprive unsustainable companies from fresh capital, sustainable investing needs to become ’business as usual’ in the investment community.

When it comes to investing globally, there are obvious headwinds for investors trying to push the ‘sustainability’ message. In growing economies like India, there are individuals owning 40­­­–50% stakes in large companies, so it can be extremely difficult for other shareholders to get their voices heard.

Exerting influence

That said, institutional investors can exert influence with such companies when these firms need to raise capital. Investment managers can include stewardship conditions before releasing any capital support. 

In such instances pressure from asset managers can have a meaningful impact.  New factors may also boost sustainable investment flows while conversely stemming the flow of capital into ‘unsustainable’ companies.

For instance, the new Sustainable Finance Disclosure Regulation (SFDR) aims to increase transparency on how financial market participants integrate sustainability into their investment decisions and recommendations. It introduces a classification system with new disclosure requirements for investment products.

What are the longer-term implications of SFDR and what can we expect to happen looking ahead? The view from NN IP is that it will be a gradual process, but we can expect to see further alignment and increased standardisation and harmonisation of financial products as more legislation comes into effect.

These developments will raise the bar for providers of sustainable investment solutions but also in a far broader sense for the corporate world as they influence selection criteria and make it easier to compare and select financial products and (crucially) evaluate individual companies. 

As Robeco stresses, the goal is to reach a point where capital is habitually allocated in a way that supports sustainable companies and hurts unsustainable ones. This approach incentivises the latter to improve their corporate behaviour or be weakened considerably as a business. It would seem from the report that we have not reached this inflection point yet.

The hope is that businesses deemed ‘unsustainable’ will soon be obliged to rethink how they operate – or the funding tap will run irrevocably dry.