ARTICLE
23 April 2024

Responsible Investing And The WEF

KL
Kramer Levin Naftalis & Frankel LLP

Contributor

Kramer Levin provides its clients proactive, creative and pragmatic solutions that address today’s most challenging legal issues. The firm is headquartered in New York with offices in Silicon Valley and Paris and fosters a strong culture of involvement in public and community service. For more information, visit www.kramerlevin.com
Responsible investing (RI) has become a hot topic in private funds over the past few years.
United States Corporate/Commercial Law
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Responsible investing (RI) has become a hot topic in private funds over the past few years. The U.S. Sustainable Investment Forum reported that in 2020, $1 of every $3 professionally managed in the United States was invested in RI strategies, totaling $17.1 trillion. However, a similar report for 2022 saw the figures drop by more than half, to $1 of every $8, due to a narrowing in methodology excluding investors that fail to outline their RI criteria.

While RI has grown in prominence and popularity with investors, there are no clear criteria to define it. As a result, the concept itself has become somewhat nebulous, making it difficult for investors to determine whether the concept of RI even works. To that end, the World Economic Forum (WEF) recently published a paper proposing both a definition and a taxonomy to clarify the concept of RI and highlight the potential trade-offs between its varying objectives. The WEF is a significant platform for public-private cooperation, engaging leaders from various sectors to shape global agendas. This includes the formation of the Global AI Action Alliance, which currently includes more than 100 organizations across a variety of sectors to accelerate artificial intelligence adoption in the global public interest, and its Stakeholder Metrics Initiative, which has seen more than 150 companies implement sustainability reporting metrics. According to the WEF, RI is defined as:

The incorporation of environmental and social factors to achieve one or more of the following objectives: Financial returns, societal impact, and values alignment.

Further, the WEF identified fiveelements critical to its definition:

  1. Incorporation: RI must be meaningful, incorporating environmental and social factors rather than merely "considering" them. An investor may consider such factors, but they are often viewed as secondary to financial issues. Meanwhile, incorporation indicates that an investor will base changes in investment decisions on those factors.
  2. Environmental and Social: RI is often called environmental, social and governance (ESG). Nearly every investor pays close attention to governance, as it can have a direct internal impact on a company and its value. Meanwhile, environmental and social (ES) factors generally have an external effect, such as greenhouse emissions from factories or using forced labor to save on personnel costs. A responsible investor views ES factors either as an investment objective in and of themselves or as issues that will eventually be internalized and affect financial returns.
  3. Financial Returns: Responsible investors incorporate ES factors into investment decisions because they believe they will increase risk-adjusted returns. However, they won't automatically invest in companies with positive ES factors but will incorporate them into their valuations along with traditional drivers, comparing them with the current market price.
  4. Societal Impact: Another motive behind RI is positively impacting society in one of two ways. The first is investing in "green" stocks with a positive societal impact while disinvesting from stocks with a negative societal impact. The second way is by voting and actively engaging on ES issues to increase a company's positive impact or reduce its negative impact. Societal impact can often intersect with financial returns, as engaging with a company to bolster its ES performance can have both a positive societal impact and an increase in its financial returns.
  5. Values Alignment: A third motivation for RI is investing in companies that reflect the investor's values. Values alignment will frequently overlap with financial returns, particularly if the investment is in an underpriced company or stock. It can also overlap with societal impact if the investment in a company reduces its cost of capital, allowing for expansion.

The WEF views this definition as focused, involving ES factors and flexible, as it allows for a broad range of objectives. It will also enable researchers, practitioners and policymakers to be clear on which RI objectives are relevant to their activities, allowing them to consider whether they will help or hinder other objectives.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

ARTICLE
23 April 2024

Responsible Investing And The WEF

United States Corporate/Commercial Law

Contributor

Kramer Levin provides its clients proactive, creative and pragmatic solutions that address today’s most challenging legal issues. The firm is headquartered in New York with offices in Silicon Valley and Paris and fosters a strong culture of involvement in public and community service. For more information, visit www.kramerlevin.com
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