ESG investing - a recap for the Life Sciences and Healthcare sector

ESG considerations have become increasingly important in recent years, as a result of both market demand and increasing regulatory pressures, with the Life Sciences & Healthcare (“LSHC”) sector being a key focus for investors focussed on ESG. At a high level, investors may choose to invest in LSHC companies that provide  obvious positive ESG outcomes, such as organisations committed to developing treatments for diseases that disproportionately affect marginalized communities, such as HIV/AIDS or diabetes. However, it is also key to ensure that such companies also do no significant harm to other ESG outcomes and, as such, investors are increasingly likely to avoid investing in companies that produce or sell harmful products, or that have a history of unethical business practices. An informed choice will often require a deeper dive into a company’s business practices.  

ESG factors are relevant throughout the value chain of LSHC companies, from development and testing to the production and marketing of medical and healthcare products. Supply chains within the sector are often complex and far-reaching, making the application of an ESG investment strategy nuanced. ESG factors to consider may impact upon the quality and diversity of clinical trials, the safety of employees, the efficacy of products, or the environmental impact of the production process. Investors should also consider issues after the production process as well as the broader ethical implications of the products and services in which they are investing once they have reached the market. For example, the social impact of the products and services or accessibility and affordability. Companies may have an end product that may be assessed as “good” socially, but there may be issues relating to parts of its production process, supply chain, environmental impact, or governance. 

Governments around the world are introducing regulations and policies that require companies to provide detailed reporting on ESG practices throughout the supply chain and to disclose risks associated with ESG issues. While there remains a lack of international consistency, and issues with reliable data, the impact of regulatory requirements should over time make it easier for investors to understand the sustainability risks and opportunities of companies across all sectors. 

Investors are considering a number of factors within their ESG investing strategies in the LSHC sector. These include:

1. The growing reputational risk of not investing sustainably. There is now a more sophisticated awareness of the need, amongst both investors and consumers, to consider the long-term sustainability of companies in terms of both their products and practices. In the LSHC sector, this demand is particularly high as investors seek to support companies that are making a positive impact on society and the environment while  taking greater care to identify and analyse companies with poor ESG performance – either to exclude the possibility of investment or to seek to make positive change. The reputational impact of not taking these factors into consideration is increasingly evident in both the media and in shareholder activism.
2. Positive financial returns. Studies have shown that companies with a strong ESG profile tend to outperform those with a weaker ESG profile, making ESG investing an attractive option for investors seeking to generate positive financial returns over the long-term.
3. Mitigating risk. By considering ESG factors when investing in the LSHC sector, investors can mitigate risk and reduce the potential impact of negative events, such as product recalls or environmental disasters.
4. Supporting innovation. Investing in the LSHC sector can support the development of new and innovative products and services, such as breakthrough treatments for diseases, more accessible healthcare, or more advanced medical technology. This can lead to improved health outcomes and increased social and environmental benefits.

ESG metrics are assessed through various methods relying both on independent rating agencies and self-reporting. ESG rating agencies evaluate companies based on their ESG performance and assign them a score or rating. The agencies use a variety of criteria to assess a company's ESG performance, including environmental impact, social responsibility, governance structure, and risk management,. Companies also report, either on a voluntary or mandated basis, on their ESG practices through sustainability reports or other disclosures. 

Regulation in this area has been increasing at a frantic speed. In the EU, the Corporate Sustainability Reporting Directive (“CSRD”) expands the previous corporate EU ESG reporting obligations by replacing the narrower Non-Financial Reporting Directive.. CSRD enforces more stringent reporting standards, which must be adhered to using compulsory EU sustainability reporting criteria. It is the third pillar in the EU's sustainability reporting framework along with the Taxonomy Regulation and the Sustainable Finance Disclosure Regulation (“SFDR”). Combined, these three pillars are intended to drive capital allocations towards more sustainable investment and to improve the disclosure and transparency of ESG reporting across all sectors. The investment community is at the forefront of the EU’s commitment to sustainability, with the obligation on investment houses to provide detailed reporting across their assets under management increasing the pressure on companies to comply.. Regulations in the UK and US are yet to be fully implemented (with the UK currently focussing on climate related disclosures) but change is certainly coming. 

Nevertheless, as regulations will take time to be embedded there will remain a lack of reliable data and investors should take care when both analysing and reporting to ensure that any data gaps are taken into consideration and reported. 

It is important to note that while investing in companies with good ESG practices has been shown to have positive financial performance, the focus of ESG investing is not solely on financial returns but more so on promoting positive social and environmental impact. Further, there is no standard definition of what constitutes a “good” ESG profile. Investors should conduct their own research and due diligence to determine which companies align with their values.