We're in the midst of an ESG investment moment (ESG=Environmental, Social and Governance). In the U.S. alone, sustainable investment funds attracted $51.2 billion in 2020, more than double the previous record set in 2019. But to make ESGs more of a mandate than a moment, these investments need to be able to track and verify their impact, particularly for climate-related investments.

The Paris Climate Agreement represents a global policy mandate to significantly reduce greenhouse gas emissions; similarly, the money pouring into ESG funds should be seen as an investment mandate for climate change. Unlike the Paris Agreement, however, ESG investments have no agreed upon framework to report, track or measure how effective and impactful they are. In particular, the degree to which the scale of environmental investments will actually reduce carbon dioxide (the main contributor of climate change) is not built into climate-related investment decisions — which is what the "E" in ESG needs to be all about.

One challenge is that a significant amount of ESG money is flowing into index funds and ETFs (Exchange Traded Funds) which are removed from where CO2 reductions happen. This diversified approach can be dilutive and not maximize or capitalize on investments that achieve near-term reductions in carbon emissions. Further, these investments often have no verifiable, ongoing measurement of performance, which opens the door to greenwashing.

Until the environmental (carbon reduction) and financial value of an investment can be clearly measured and tracked, the speed and scale of this opportunity cannot be fully attained.

Taking a bottom-up approach

The renewable energy and energy efficiency industries have spent decades proving the value of climate-positive investments. These industries know how to measure, account for and finance energy savings, and ESGs would be well served by incorporating these mechanisms and established standards.

Measure it. The International Performance Measurement & Verification Protocol (IPMVP) was created in 1994 in an effort spearheaded by the U.S. Department of Energy. Its goal was to provide a common standard to measure energy savings from energy efficiency upgrades and technologies sufficiently rigorous to create energy efficiency as an asset class and enable off-balance sheet project financing. IPMVP lays out measurement approaches based on technology and savings scale to consistently calculate energy savings which, in turn, can be used to quantify CO2 reductions by using regionally-specific emission factors like EPA's eGrid.    

Account for it. Separately, in the mid-1990s, a consortium led by the World Resources Institute (WRI) developed Greenhouse Gas (GHG) protocols — a comprehensive global framework that standardizes the way in which corporations, cities and countries account for their carbon emissions. These protocols establish a common methodology to quantify both direct (Scope 1) and indirect (Scope 2 and 3) emissions generated by business activities. WRI's GHG Protocol is now playing a critical role as the leading accounting system for carbon registries. It is used as the basis for the Science Based Targets Initiative (SBTi) that companies are using as the basis for their Net Zero commitments and countries are using for their national targets.

Finance it. The market for third-party project finance for renewable energy and energy efficiency projects, which Guidehouse expects to reach $278 billion by 2028, is scaling decarbonization in the built environment — spurred in part by measurement platforms like IPMVP and the GHG protocols. Pay-for-performance financing structures like power purchase agreements (PPAs) and sustainable energy service agreements (SESAs) clearly map dollars invested to annual carbon reduction throughout the life of an investment. Performance — both financial and environmental — is embedded in the underlying contract from the outset of an investment through monitoring of renewable energy output and standardized measurement and verification protocols for energy efficiency.

Top-down meets bottom-up

The urgency and global focus on climate change has also led to increased efforts to define climate disclosure standards, including by the International Financial Reporting Standards (IFRS) and the Securities and Exchange Commission's (SEC). This indicates a dramatic shift that will result in closer scrutiny of the actual environmental impact of sustainable investments. These top-down approaches to shape investment policy are important but they need to incorporate the nuts and bolts, which includes the following:

1. Prioritize investments with the greatest CO2 reduction per dollar invested. CarbonCount® is a good example of a clear quantitative metric that investors can use to score and measure carbon savings for each ESG investment dollar.
2. Ensure that qualified climate-related ESG investments monitor and report on ongoing emissions reductions using Science Based Targets that pull in IPMVP and WRI's GHG protocols. 
3. Build environmental performance into the financing itself. If an investment is billed as climate-related, it should include upfront targets and built-in annual measurements of carbon reductions alongside its return.

If money talks, ESGs have a mandate and momentum. It's time the financial services industry listens and seizes this once-in-a-lifetime moment.