Until very recently, the overarching objective of a company was to maximise its profits with a view to maximising the wealth of its shareholders. In pursuing that objective, a company's impact on the wider community was a matter of peripheral importance. However, the adverse effects of climate change, increased awareness of environmental risks, ethics and human rights led to the emergence of what is now known as ESG – an umbrella term that covers a wide spectrum of environmental, social and governance factors which investors are able to use to assess a company's day-to-day activities and its current and prospective financial performance.

What are the three pillars of ESG?

Environmental

The environmental part of ESG covers a company's business activities. This includes considering a company's impact on the natural environment, on climate change, its gas emissions and reductions, and its water and energy efficiency and carbon footprint.

Social

The social aspect of ESG examines how a business manages its relationship with its employees, suppliers, and customers; its compliance with labour standards and health and safety regulations; and its commitment to equal opportunities.

Governance

The governance area of ESG considers management of the company and audits that deal with tax transparency and anti-corruption measures as well as shareholders' rights.

ESG and investment

With the increasing awareness of ESG, investors have shown interest in putting their money into ESG compliant businesses. Although there are no agreed standards for evaluating ESG performance and a company may not pass every test available in every category, investors have recently begun to decide what is most important to them and to invest accordingly.

ESG factors can have a material impact on the value of companies and securities. Environmental, social, and governance factors are becoming increasingly important to companies worldwide as they seek to strike a balance between achieving organisational goals and fulfilling the expectations of their stakeholders in an increasingly complex operating environment. When companies manage stakeholder relationships effectively, they can be more successful at managing risks and seizing opportunities.

ESG refers to the environmental, social, and governance practices of an investment that may have a material impact on the performance of that investment. The integration of ESG factors is used to enhance traditional financial analysis by identifying potential risks and opportunities beyond technical valuations. In other words, analysts study a company's ESG metrics and present a framework that reflects the company's growth opportunities and potential risks which are not typical for a regular traditional financial reporting. Since these ESG factors are generating transparency and raise consciousness, they have become an essential component of the investment process to both consumers and investors alike. That is why more and more companies around the world are making ESG disclosures in their annual reports. These disclosures have shown that investing in sustainable businesses offer lower market risk. It has been shown that ESG funds have outperformed their traditional peers. Funds that have better ESG practices are monitored through the company's stewardship policies as well as external ESG ratings. Becoming ESG-compliant will enable businesses to make positive impact on the society at large. While consciousness towards responsible investing is growing as more and more companies tend to regulate their strategies and establish good corporate social responsibility that reflects the investors' standards and ethics while providing profit. In recent years it has been seen that ESG oriented funds and businesses outperformed their traditional peers. Considering the rise of ESG and awareness of responsible investment, there may soon come a time when non-sustainable companies may have to pay additional taxes or their non-sustainability may become an entry barrier to some markets in many countries. Companies will therefore need to shift their strategies and business approaches if they are to maintain their financial assets or to be able to get credits in order to compete in the market. Financial institutions and markets as the primary financing source of companies have become one of the pioneers of ESG transformation in this regard. As a borrower in the international markets where ESG compliance is already developed (or ahead in the process) and as a creditor in the local market, motivate companies (borrowers) to better manage the ESG risks.

ESG metrics can be very effective on financial instruments like Sustainability-linked bonds ("SLBs"). The SLBs are mainly meant to enable debt markets to play a role in funding as well as encouraging companies to contribute to sustainability in the context of ESG factors. SLBs provide an investment opportunity with transparent sustainability credentials. These bonds are any type of bond instrument whose financial and/or structural characteristics can vary depending on whether the issuer achieves predefined Sustainability/ESG objectives. These bonds work by aligning the loan terms with borrower's performance which is evaluated against ESG scores or other equivalent metrics that look at the borrower's performance vis-à-vis their sustainability profile. The sustainability linked loan market is based on improvements in the overall sustainability profile of the borrower. Sustainability linked loans provide a direct financial incentive for the borrower. A company that issues SLBs should raise its ESG scores in order to have lower interest rates when borrowing.

Turkey's Status

As a developing country, an emerging market, and a geography which recently faced severe natural disasters (floods and wildfires) Turkey has taken some important steps about sustainability and ESG. The steps taken by Turkey include most notably the ratification of the Paris Agreement on climate change. The Paris Agreement seeks to strengthen the global response to the threat of climate change by limiting global temperature rise by 1.5 degrees Celsius by halving emissions by 2030 and reaching net zero emissions by 2050. Although Turkey signed the agreement in 2016, it had not ratified it until November 2021. Now as a G20 country that has ratified the agreement, Turkey should reduce its dependence on fossil fuels and increase its investment in clean energy sources and should encourage the private sector towards environmental awareness and sustainability.

Ratification of the Paris Agreement was not the only step taken by Turkey towards sustainability, Turkey had already taken some regulatory actions against climate change and other pillars of sustainability such as corporate governance. The process of regulating this area is ongoing and some of the actions Turkey has taken are as follows:

  • Borsa Istanbul's corporate governance index which includes companies that implement the Corporate Governance Principals is already being circulated. This has encouraged the sustainability journey of public companies in 2007.
  • Several years thereafter, Borsa Istanbul published a Sustainability Guide for companies and ever since sustainability index of companies are being published and taken into consideration by the investors.
  • On 3 January 2014, Capital Markets Board of Turkey began regulating the corporate governance practices of public companies and published a recently amended Communiqué on corporate governance. This provides that public companies are subject to sustainability principles, and that corporate governance compliance reports of such companies shall include explanations on the sustainability principles and compliance. This was a powerful indication of Turkey's regulatory authorities' approach to global sustainability trends and how they will be taken into consideration for Turkish companies.
  • On 3 November 2021, a draft guideline on Green Debt Instruments and Green Lease Certificates (Sukuk) based on Green Bond Principles of the International Capital Markets Association ("ICMA") was published for public consultation. Capital Markets Board of Turkey ("CMB") emphasised the need for long-term financings to fund the investments required for the transition to a low-carbon economy and, at the same time, the importance of capital markets as a potential contributor through different financial instruments. The Draft Guideline sets forth the required qualifications and obligations of issuers as well as the minimum requirements and criteria for domestic and international issuances in accordance with international standards.
  • It was further announced by the Ministry of Treasury on 12 November 2021 that preparation of 'Sustainable Finance Framework Document' has been completed and the Ministry intends to use this Framework as the basis for issuing debt instruments such as green, social or sustainability bonds or sukuks in the international capital markets.

Second opinion on the credibility, effectiveness and compatibility with the International Capital Market Association (ICMA) Sustainability Bond Guidelines 2021, ICMA Green Bond Principles 2021, ICMA Social Bond Principles 2021, Loan Market Association (LMA) Green Loan Principles 2021, and LMA Social Loan Principles 2021 has also been obtained.

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.