Sindhu Krishna: When we talk about sustainability considerations, we’re talking about Environmental, Social and Governance factors. The financial materiality associated with these factors is important to investors, especially for the insurance or pension sectors, as long-term investors with fiduciary obligations.
When we say ‘integrating sustainability considerations’, we’re looking at materiality and the impact of these factors on the risk and returns of investment portfolios. Examples of this could be - Climate change, pollution, waste management, and biodiversity on the environmental side. On the social factors, it could be health and safety policies, human rights and the risks stemming from regulatory non-compliance with standards. Governance factors are broad and could be corporate governance, executive compensation, and Board composition, among others.
"As the understanding of ESG risks and opportunities continues to evolve,
so too does the approach to embedding these factors."
Integration of these factors within investment decision-making is something that is well underway, from both a UK and European context. As the understanding of ESG risks and opportunities continues to evolve, so too does the approach to embedding these factors within investment frameworks.
Sindhu: From an investor perspective, the sustainability considerations and what they mean to risk and opportunity are interrelated. If we talk about climate and other environmental factors, they are linked- whether purely approaching it with an environmental lens or through Just transition and other associated social factors.
For us as investors, it is important to see the overall impact on the investment portfolio. Climate change is an area that has seen significant evolution when it comes to the quantification of impacts, quality and quantity of data. It has also influenced how capital is allocated across portfolios. Many institutional investors are now explicitly considering these factors in their investment decision-making.
On the second part of the question, it's a journey, and this is an area that is evolving not only in terms of our understanding of the risks/data and the way we integrate it, but also the wider environment in which we live is itself constantly evolving.
It's hard to miss the headline recently that the UK has seen the hottest summer on record. When you look at a statistic like this, for sectors like insurance, it has wide-ranging implications. But it also raises questions for investors: how do we address these realities within investment strategies?
"Understanding potential financial implications, including long-term
costs and who bears them, is critical."
When we talk about climate change, we often reference mitigation and adaptation. At a high level, the former looks at avoiding and reducing emissions to prevent the planet from warming to more extreme temperatures, and the latter is about managing the effects in today's world, which means altering our behaviour, systems, and, in some cases, our way of life. We need both, and they need to go hand in hand. Whichever part of the world you’re in, headlines such as these are quite common, so there will be adaptation by people living in that area, the businesses operating in the region and the infrastructure, among other changes. This impacts many sectors, from housing to agriculture to transport and others.
When investing in these assets or sectors, it’s essential to consider how the sustainability risks and trends may impact performance. This includes transition risks, such as emissions intensity and physical risks like flooding or rising temperatures. Other key factors include the use of sustainable materials, water management, and the broader environmental and social impacts across the investment horizon. Understanding potential financial implications, including long-term costs and who bears them, is critical. These considerations feed directly into the investment process, informing asset selection, valuation, and long-term risk management.
Sindhu: Businesses increasingly recognise the importance of proactively managing sustainability-related risks. The insurance industry is systemically important to the economy, so effective management of these risks is vital.
In real terms, the first step to managing the risk is identifying and understanding the risk. We've made much progress in terms of our understanding and appreciation of these risks and what it does on the asset as well as the liability side, but that's not a ‘one and done’ situation. It requires constant learning and recalibration.
When we talk about physical, transition, and litigation risks, for example, it's important to contextualise them for the business that we're talking about, as well as its customers and their requirements. While this conversation focuses on the asset side, we must acknowledge that risk management is a cross-cutting concern that spans the entire enterprise.
"When it comes to assets, it's important to integrate them
into investment decisions."
On the asset side, once risks, both current and emerging, are identified, they need to be assessed against a risk maturity model. This helps determine risk appetite and guides integration into the broader enterprise risk management (ERM) framework.
Key enablers would be data and modelling, tools for scenario analysis. As discussed previously, there is an evolution in terms of the sophistication and understanding in these areas, which could impact decision-making across many aspects of business, whether investment decisions, underwriting decisions or others.
When it comes to assets, it's important to integrate them into investment decisions. It's about asking “what’s changed as a consequence of our understanding of these risks and opportunities? If nothing changes, is that right?”. It is an additional lens that we're using when it comes to making investment decisions or reshaping the existing portfolios.
Sindhu: From a regulatory side, we've been through a period where regulations were on the rise at a global level. We've seen this in Europe and the UK, and also in Asia, and there has been a lot to grasp for investors.
We are now going through a phase of streamlining, evolution of these regulations and attempts for standardisation at a global level. That's good in terms of bringing consistency and making sure we're capturing the right data at the right level of detail. It always has to be a learning curve because as you introduce new requirements, you receive insights and feedback, which leads to the evolution of those requirements.
"Organisations must disclose what they are doing. Providing the
evidence and transparency is paramount."
Regulation must not be approached merely as a compliance or a reporting obligation. The objective is to give the responsibility/accountability to senior members of the organisation and to put it on the Board's radar. Therefore, the “what do we do about it” question is important for organisations. There is also a need for a cultural shift. We're seeing many organisations employ this and integrate sustainability factors within Board/Investment Committee MI, balance scorecards at the executive level, etc. It requires continuous focus.
It is also important for organisations to make sure that there is no over or understatement of their activities. Organisations must disclose what they are doing. Providing the evidence and transparency is paramount. It is essential to protect the market integrity.
Sindhu: When you look at emerging markets, there are several regions, and they have a range of maturity in terms of regulations in force, data and reporting.
The good news is that there is recognition of the importance and need for standardisation. Initiatives such as the International Sustainability Standards Board (ISSB) reflect a global move toward aligning on consistent sustainability disclosure standards.
"Assessing the double materiality of the investment is also important.
This is the case across developed and emerging markets."
As an investor, you are always cautious of the different regulations and market conditions. This is the case for matters not related to sustainability considerations, too. Most investors use third-party asset managers, so it's important to make sure the right partner is chosen to get the appropriate data, including information on the sustainability regulations, in addition to overall due diligence and analysis of the transactions/investments. Assessing the double materiality of the investment is also important. This is the case across developed and emerging markets.
Despite the challenges, there is a strong case for investment in emerging markets, particularly when viewed through the dual lens of sustainable development and long-term returns. I am doing a piece of work for the Emerging Markets and Developing Economies (EMDE) Investor Taskforce, which is an industry-led initiative convened by UK Government Ministers. It brings together leaders from across the UK investment community.
The task force is looking to develop practical solutions, such as capacity building and product innovation, to overcome barriers that currently constrain long-term private capital from investing at scale in the region. The report and further areas of work will be published in Q4 this year.
