Investors limited by lack of data and tools to incorporate social factors into sustainable finance strategies due to an “overwhelming focus” on environmental issues.
Experts have backed United Nations Development Programme’s (UNDP) call to recognise the interconnectedness of environmental and social-related issues in tackling climate change.
Delilah Rothenberg, Executive Director of the Predistribution Initiative (PDI), told ESG Investor that many institutional investors may “sense that inequality – like climate change and biodiversity loss – may pose system-level risks”. But there is currently “little understanding”, she added, about how such risks manifests in financial markets, what private sector activities contribute to inequality, and how and when inequality affects investors’ portfolios.
In a recent report, the UNDP remarked that the evolution of the global financial system has created “vast imbalances” that now “pose risks” to markets and economies, and that solely using sustainable finance strategies to address climate change will be “inadequate” if interrelated social issues are not addressed simultaneously.
In response, the UNDP has called for wider recognition of the “connections between social and environmental factors”, and for these considerations to be integrated into governance and asset allocation strategies by investors to “ensure their continued advancement”.
It also illustrated how social factors and systemic risks are interlinked and argued that tackling inequality is necessary for long-term market stability and a just transition to a climate-neutral economy.
The UNDP made eight key recommendations which include developing data analysis capabilities on socio-economic inequality, improving data, disclosure and transparency on social risks and impacts, and increasing efforts to “re-couple” climate and social risk and opportunity analysis.
The UNDP led the report, with contributions from the UK Financial Conduct Authority, research services firm ReGenerate, PDI, human rights innovation platform Rights CoLab, sustainability strategy and practice advisor JS Global Advisory and the UN Principles for Responsible Investment (PRI).
Environmental and social ties
The report noted that the interdependence of climate, biodiversity and social objectives is being “recognised more widely”, flagging the harm droughts can have on ecosystems, infrastructure, food production, human health and well-being.
It added that human health issues can “increase mortality and limit worker productivity”, which also impacts the availability of food and reduces access to goods and services.
Davide Cerrato, Senior Policy Specialist, Human Rights at the PRI, said that human rights and social issues are “gaining more relevance in the mind of investors and policymakers”.
“The climate crisis and growing inequalities are bound to have effects on our societies and our economic system,” he added. “Social issues must be at the centre of any policy intervention towards the economic transition, in order to ensure that they are effective and widely accepted.”
Marcos Neto, Director of the UNDP’s Sustainable Finance Hub, said that the organisation is calling for more research to be carried forward and is looking to understand the links of rising inequality to systemic market risks.
“More data and analysis to demonstrate this connection could really galvanise action from policymakers and investors, which is why disclosures, auditing, and assurance are a central piece of this report,” he added.
According to the report, investor mobilisation on social inequality has been stunted by factors including lack of comprehensive analysis of how social and inequality-related risks can manifest as material financial risks – both to individual enterprises and the health of the entire financial system.
It also pointed to a lack of tools for investors to integrate social issues into their investment strategies and an “overwhelming focus” from international bodies and investor initiatives on climate and nature-related issues.
Global index, data and analytics provider FTSE Russell recently published its annual Sustainable Investment Global Survey, which spotlighted a sharp fall in the priority of social themes for asset owners, dropping from 73% in 2022 to 37% in 2023.
For the survey, FTSE Russell spoke to 350 asset owners with AUM between US$7.9 trillion and US$14.2 trillion between 27 March and 28 April this year, with these owners citing data challenges as the biggest barrier to sustainable investment adoption.
Marina Zorila, Senior Research Officer at ShareAction, told ESG Investor that despite workforce-related risks having a “dampening effect” on company profits, human rights due diligence across supply chains remains a “blind spot” for investors.
“Investors must take the economic impact of social issues seriously by conducting more of their own research and then factoring it into their investment decisions,” she said, adding that regulation must also “catch up to ensure this happens quickly and across the board”.
The EU’s Corporate Sustainability Due Diligence Directive seeks to hold corporates and financial institutions accountable for their impacts on human rights and the environment throughout the value chain.
According to Zorila, ShareAction research has found that most large asset managers continue to invest in companies that breach human and labour rights, and only exclude investments in these companies for specific ESG funds. “[Asset managers] also rarely use their influence to tackle issues such as indigenous rights and public health problems,” she added.
Peter Webster, CEO at the EIRIS Foundation, said that as investors increasingly prioritise social issues, and as reporting requirements increase, there will be “greater opportunities for investors to consider them in tandem” with environmental issues.
Co-ordinating international integration
The UNDP report calls on governments, regulators and financial institutions to support advances in research and data on the systemic risk of socio-economic inequality, adopt and improve social standards, disclosures and tools, and to “rethink the macroeconomic determinants of sustainable finance scenarios”.
Neto said that there has been “less of an incentive for the wealthy to focus on inequality” but stressed that the UNDP report highlights that in the long run, it will be “impossible to ‘save the planet’ without rebalancing resource distribution and consumption”.
The PRI’s Cerrato said that human rights and other social issues should be fully integrated into a whole-of-government approach to the economic transition, which goes beyond financial policy to include a wider range of policy tools.
“We can see governments taking action in trade policy, corporates taxes, restrictions on business, discussions about international financial architecture reform, as well as with incentives and stimulus,” he said.
“All of these interventions are designed to influence distributions of risk and return and therefore inequality,” the PDI’s Rothenberg added. “Yet there is no coordinated effort to understand inequality as a systemic financial risk.”
Webster said that while reporting on social risks is “improving” it remains fragmented and “a long way behind” climate reporting. He added that the UNDP report is “right to focus on the need for integrating these social considerations with the E and G of ESG”.
An example of the present degree of “un-connectedness” flagged by Webster was the International Sustainability Standards Board (ISSB) pressing ahead with climate reporting while not yet being clear whether social factors will be taken forward in their next work programme, as well as the postponement of the EU’s social taxonomy.
“These are both cases of prioritising between the S and the E rather than succeeding in integrating them,” Webster added.
The ISSB recently consulted on its priorities for its next two-year work plan, with respondents largely underscoring the importance of an increased focus on biodiversity and nature. NGO Reclaim Finance warned about the “major social risks” that increasing water stress and drought threats could pose.
The European Security Markets Authority (ESMA) said that the ISSB should also make a start on social and human rights-related reporting standards which are “as important and pressing as environmental standards”. ESMA also noted that the priority placed on biodiversity “should not undermine the importance of work on social and human rights matters”.
Sovereign wealth fund Temasek has also stressed that human capital and human rights are “inherently linked” and should be viewed as two “important elements of the broader social domain of sustainability”.
Initiatives to improve transparency of social risks to investors have gained momentum this year. The Taskforce on Inequality-related Financial Disclosures (TIFD) and the emerging Taskforce on Social-related Financial Disclosures (TSFD) recently merged to form the TISFD.
The newly formed taskforce is currently developing a global framework for risk management and disclosures that encompasses social- and inequality-related risks and opportunities affecting financial stability and long-term value creation, which will be interoperable with the Taskforce on Climate-related Financial Disclosures and the Taskforce on Nature-related Financial Disclosures (TNFD). The TNFD published its final recommendations on nature-related risks and disclosures at New York Climate Week, with the aim of providing a foundation for preserving the planet and financial market stability.
The UNDP report noted that more action is needed to “support investors in understanding the financial materiality of social and inequality-related risks – as well as opportunities for investing in solutions”.
It added that policymakers have a “critical role” in making the data available by mandating corporate and investor disclosures, as well as recommending increasing transparency on social and inequality risks to “induce market discipline”.
It flagged that there is currently no global framework to “guide companies and investors in measuring, managing, and mitigating the risks to financial stability (or even enterprise value) generated by inequality and social issues”.
“Little work has been done to identify the key issues to be disclosed when it comes to the system-level risk of inequality, as well as the relationships between single financial materiality, impact materiality, and system-level materiality issues,” Rothenberg said.
“This is why the idea of a TISFD is so compelling.”