Our specialist ESG panel starts by discussing how key carbon-related companies, sectors and countries could be missed by climate-related finance, hindering the transition.
Seb Beloe, Partner and head of research, WHEB Asset Management
Annika Brouwer, Sustainability specialist, Ninety One
Chandra Gopinathan, Senior investment manager, Railpen
Myrna Ghanem, Senior sustainability specialist, S&P Global
Funds Europe – What are one or two of the main headwinds and tailwinds currently facing ESG climate-related investors and asset managers?
Annika Brouwer, Ninety One – From our view, as a global manager with roots and investments in emerging markets, a challenge facing our industry is that the net-zero movement is driving investors away from the problem, not allowing us to address it head-on. We need to go to where the carbon is, not turn our backs on it.
High-emitting sectors that are the source of 90% of global emissions are often the very types of companies we are pressurised to exclude through carbon budgets and decarbonisation targets. Similarly, emerging market countries which will be responsible for 90% of new emissions by 2030, are currently being excluded by global markets. The ESG movement doesn't incentivise investors to be investing in these regions and sectors. If we don’t invest to achieve net zero at the source of the problem, there is no net zero at all.
While we can acknowledge this problem, it doesn’t always translate into action. A separate but related headwind was that a recent study of ours showed only 19% of managers were investing in the actual decarbonisation of high emitters, while other ESG funds were really just focusing on not having high carbon footprints within their portfolios. Acknowledging the problem without putting finance to work behind the solution is a problem we see across the industry.
More positively, tailwinds include an area of ESG that has long been undefined: transition finance. This is a growing opportunity that’s now receiving much more attention and traction. There is a greater understanding that transition finance – in addition to green or sustainable finance – is a very meaningful way of contributing to net zero. Interesting and helpful guidance is being developed, such as the Sustainable Markets Initiative Transition Categorisation framework , as are innovative financing solutions, such as blended finance funds and a resurgence of public and private debt, which is critical to financing the transition.
Seb Beloe, WHEB – In developed markets, we find policy is both a tailwind and a headwind. There was a time when solar stocks would go up or down by 10-20% depending on the latest prognostications of the German government – and it was a nightmare. We have thankfully gotten beyond that. So, on the positive side, there is now much, much more momentum in the global economics of solar and it is a much bigger sector. There are just many more markets and more parts in the solar value chain that we can invest in.
The US Inflation Reduction Act has also been an enormously positive thing for a lot of the low-carbon and zero-carbon investments that we make. Energy security is the silver lining to the horrible Russian invasion of Ukraine, driving the deployment of, for example, heat pumps across Europe at a massively accelerated rate.
There are still policy issues, though. For example, obtaining planning permissions is a big problem for wind farms, particularly in Europe. Interest rates have also dampened the rapid deployment of renewable energy.
However, for decades economics was a headwind because solar and wind energy were more expensive than fossil fuels and electric vehicles more than petrol cars. These technologies are dramatically cheaper now – certainly in the case of solar and wind, and even electric vehicles, where in many markets on a total-lifecycle cost, they are cheaper than internal combustion-engine vehicles. The economics are now a tailwind.
"Emerging market countries are currently being excluded by global markets. The ESG movement doesn't incentivise investors to be investing in these regions and sectors. If we don’t invest to achieve net zero at the source of the problem, there is no net zero at all."
Chandra Gopinathan, Railpen – For the first time in history, there is a very strong alignment on decarbonisation and climate change between issuers, investors, collaboratives, policy-makers and governments. That is a big positive.
Universal ownership is not just a concept but a practice as well. Active ownership has been debated and implemented across asset classes – for example, engagement in public equity, along with voting and escalation through shareholder resolutions. Many investors have ramped up their activity in the last 5-10 years and disclosures in the industry are having an impact. The Task Force on Climate-related Financial Disclosures has been a big step and the International Sustainability Standards Board is coming. In the UK there is also the Transition Plan Taskforce for private sector climate transition plans.
There is a lot more activity now in the social space, such as the development of disclosures and taxonomies.
But some of these things have potential headwinds, too. Politics and government in some places are proving to be negative in terms of allowing the sustainability agenda to proceed. There are questions around definitions, goals and impact, and around success indicators across ESG. The industry has a lot of questions to answer about whether there is enough expertise to properly integrate ESG into investing. These current and emerging headwinds, whether perceived or real, do make ESG implementation difficult. However, it is a sign of maturation when difficult questions are being asked – and it’s an opportunity for ESG investors to introspect about what we are doing right and wrong.
Myrna Ghanem, S&P Global – One tailwind is data, which is definitely improving and now makes it possible to do historical analysis and gauge the effectiveness of ESG projects. This shows the importance of the educational aspect of ESG, and/or sustainability are not carried out in isolation but is an additional layer to normal business activities. Confusion is also another headwind.
Brouwer – If we were to address the carbon problem as opposed to avoid it, we would have to go to five sectors that are responsible for 90% of emissions – power, mobility, buildings, heavy industry and agriculture. These are the hardest sectors to abate, but many of these companies are committed to net zero and have robust transition plans. For some of these companies, a science-based transition pathway that is in line with a 1.5o world does not yet exist.
For example, we don’t yet know what a 1.5o trajectory looks like for an oil and gas company. We have to make a judgement call about whether the data or targets they present to us are credible – because our judgement of that credibility is effectively our clients’ judgement, too. Data is critical for short-term credibility and driving long-term change.
Beloe – For an oil or gas company that doesn't have a credible strategy for net-zero emissions, at some point, that must undermine the investment case for that business because if the business does not have a credible strategy, in the longer term, they won’t have a business.
Often climate change is considered a risk, but this is only half the story. For companies producing low-carbon technologies, it is also an opportunity. There’s a whole new economy that’s growing, and it’s important to see both sides of this conversation.
"For the first time in history there is very strong alignment on decarbonisation and climate change between issuers, investors, collaboratives, policy-makers and governments. That is a big positive."
Brouwer – I think you are completely right in saying that if there is no credible transition plan, not only does that potentially undermine or pose a risk to the investor in the long term, it also says something about the ‘G’ – the governance – of the company.
Holding high emitters that have credible transition plans is critical to actually building towards solutions. For example, cement is responsible for 7% of the world’s emissions. It’s a huge footprint, and it’s not going anywhere. Cemex, one of the world’s leading cement companies, has reinvested revenue back into a climate-aligned transition technology. It has developed the first green clinker – a material created in the cement production process. Cemex is effectively removing the high-emission portion of the cement process through a blast furnace and utilising renewable energy to create the first green clinker ever invented.
In the next 20 years, the hope is that Cemex not only scales green clinker but also that there will be wider adoption in the industry.
Were we to exclude Cemex from our portfolio, the company would be starved of the very capital needed to invest in the solution in the first place. So decarbonising key sectors requires credible plans that allow for the development of solutions.
Gopinathan – Not having a credible transition plan does not singularly provide a reason to divest. As commendable as Cemex’s efforts are, not every company is a Cemex and a Cemex cannot populate an entire portfolio by itself.
The thing to bear in mind is that first and foremost, as an asset owner, is our fiduciary duty to our members, which both internal investment teams and external managers must prioritise. We are essentially saying investment returns are key, and that climate and ESG risks are a key part of the risk assessment and opportunity set. To ensure member outcomes are better in the longer term, sustainability is integrated overall.
We would engage with a company whether they have a credible transition plan or not. If they do not have one, then the engagement will attempt to steer them to have one. If they have a transition plan, then it is about how credible the transition plan is and the level of progress.
There are a number of things we need to be cautious about when assessing credibility of a transition plan, including the decarbonisation pathway and climate solutions. There is significant emphasis on certain technologies where the scalability and investment case have not been proven yet. While climate technology is a key solution for decarbonisation and innovation absolutely needs to be supported, we need to be very clear about the investment risks and returns of these technologies, the need for associated infrastructure and investment needed there, and also focus on the low-hanging fruit as well, like methane emissions.
The approach is not of divestment but is balanced appropriately between strategy and capital allocation to existing solutions, new technologies and milestones to monitor progress. At the end of year three, there is a point where we determine whether a company is a laggard or even not moving forward at all, and if this impacts portfolios. That’s the moment to decide about divestment but it’s really the last option.
Funds Europe – When Vanguard departed from the Net Zero Asset Management Initiative last year, the reason given was confusion about the views of individual investment firms. How does the panel interpret this and what challenge does it point to in the asset management industry?
Gopinathan – Asset managers have the choice to either join initiatives or set their own goals. They also have the fiduciary duty to clients – but one client’s goals might differ from another.
Companies that have made statements about this show that firms are following what it is their clients want – and that is hard to argue with. It might be disappointing or inadequate for some, but it is a challenge for the asset management industry as it entails litigation, regulatory and political risks.
Having said that, we don’t see this as a reason to slow down the impetus for climate-related engagement with companies. Railpen encourages stewardship and engagement. It is part of the trustee investment beliefs and in our ESG practices. We also conduct stewardship on our own as well as part of investment collaboratives like Climate Action 100.
Beloe – It’s important to not to see ESG as some kind of political or moral issue. One approach I’ve heard is to not talk of ESG risk, but of ‘360-degrees risk management’ that takes into account the long-term issues around environment and human rights, and diversity. Who would argue against companies doing that?
Climate change should not be political because it has a scientific basis. Science is telling us that we need to reduce carbon emissions if we want a liveable planet. That’s not a political issue. But how we deal with it is political – the question of which technologies we choose and how we prioritise different communities.
This is all in the interests of a fiduciary’s long-term capital preservation and is not a moral crusade.
"Climate change should not be political because it has a scientific basis. Science is telling us that we need to reduce carbon emissions if we want a liveable planet. That’s not a political issue. But how we deal with it is political."
Brouwer – There’s a political divide on ESG in the US, while in the UK and Europe the issue is more bipartisan. Our fiduciary duty spans all our clients’ needs, and that is to invest on their behalf for a world for change. Clients in the Global North versus Global South view the problem, and solutions, differently.
In the Global South, for instance, the ‘S’ is more in focus. It means our work on climate and net zero has to include people at the core of the objectives. We cannot, and should not, promote planet over people. For example, the coal value chain in South Africa provides 125,000 jobs. A transition away from coal presents a direct risk to those livelihoods and all that depend on them. This is the real-world just transition dilemma that we need to be at the heart of solving for. However, this distinction rings more true for our African clients and investee companies versus those in the Global North.
Similarly, how we position the green transition as an opportunity changes based on who we speak to. For instance, renewable energy for South Africa is not just about greener investments, it is in fact a more affordable, more accessible form of energy and therefore should be positioned as a social and economic solution, not simply a climate solution.
Gopinathan – The Vanguard statement said the decision to leave the Net Zero Asset Managers initiative would not affect its commitment to helping investors navigate the risk that climate change poses for long-term returns and that will still be provided with the use of information and products needed in order to make sound investment choices, including products designed to meet net-zero objectives.
Everybody wants to be a pioneer, but we all work under certain pressures. In the case of asset managers, these pressures are commercial. From an asset owner’s perspective, the pressures are about responsibility to our members.
Even data providers have disclaimers about non-liability if Scope 3 emissions data is wrong!
People do have their commercial considerations – data providers do, asset managers do, in some cases, asset owners might do as well, and even governments. Like we said, some governments focus on social impact more than they do on environmental impact because they need to feed their people. So, let’s balance that out a little bit when we have this discussion, let’s have the bandwidth for the nuance and not just for the headlines. Let’s appreciate that and find positive ground from where we can move forwards.
Funds Europe – At Davos earlier this year, Bank of America CEO Brian Moynihan called for a set of global ESG standards “to align capitalism with what society wants from it”. Would such standards be either desirable or achievable?
Beloe – I think it’s difficult, isn't it, to argue against? Don’t we all want capitalism to be aligned with what society wants and not what it doesn’t want?!
Capitalism needs to meet the needs of society, but it’s about whether global ESG standards are going to help that.
The European Commission’s SFDR framework puts an awful lot of emphasis on the role of investors without actually putting in place the underlying industrial policy that changes incentives in the economy. What’s great about the Inflation Reduction Act is the Americans haven’t really bothered yet with labelling funds as sustainable or not. They’ve just changed the industrial logic by massively supporting the technologies that they want to see develop. That’s where we really need the policy, too, to change economic incentives and then investors will follow that. I think trying to change the economy through ESG standards on finance is the wrong way around.
Brouwer – I know what Brian is trying to say here; he wants consistency. But there are two issues with the statement that I think miss the complexity of the problem. First, an assumption that there is one society and, therefore, one voice; and second, that one ESG standard fits all.
If you’re not capturing the nuance or embracing the diversification of investing in different parts of the world and different asset classes, using different instruments, if you can’t acknowledge the nuance of all of those points of differentiation, you will never understand what the risks and opportunities are. You will also never develop satisfactory ESG metrics and/or identify the impact we should be seeking. East Asian society has a very different value system from American society, and therefore when we invest in a company in East Asia, we need to have a framework that acknowledges different governance structures in the region and different hierarchical relationships with employees – and a different perspective on net zero and climate. Without this, you risk squeezing out ‘the other’.
Gopinathan – I think both the points made are absolutely relevant. The statement lacks nuance. For example, would Basel III – the regulations for banks in Europe – work for US banks? If not, how can we expect a one-size-fits-all approach whereby we take the Paris climate goals to South Africa, or to India or Indonesia, and expect them to work?
Funds Europe – The US is perceived to lag Europe in its enthusiasm for ESG. Do the challenges facing ESG managers in the US present an opportunity for their European counterparts?
Brouwer – This links back to that original point of how ESG is sold and raises the opportunity of selling positive ESG outcomes without using terminology that creates bifurcation. Effectively, if you have credibility in what you’re doing, if it’s fundamentally baked into your processes and your decision-making and the way that you structure your business, you will drive change. With that integrity, you don’t need to change what you sell, you just need to change how you sell.
Going back to renewable energy as an example, whether you’re a red state or a blue state, whether you’re pro- or anti-ESG, the facts are the same: jobs get created from the building, maintenance and scaling of renewable energy, new renewable energy is 40% cheaper than new coal, and the investment remains a profitable one.
Beloe – Maybe culturally, there’s more of an affinity with ESG in Europe. But I would point to the saying that ‘America leads on innovation and Europe leads on regulation’. This resonates with me. The Inflation Reduction Act in the US is very crisp and goes straight to companies, who get a tax credit when building a new factory, manufacturing electric vehicles or creating low-carbon technologies. The Act goes straight to the industrial logic of it and will absolutely turbocharge US innovation.
In Europe, we have a load of regulation and it’s a more bureaucratic response. Give it three years, and I think the US will be ahead in these technologies. Culturally, we may be more inclined to think about these things in Europe, but I think the machine of American capitalism will drive it ahead pretty quickly.
Funds Europe – What are the panellists’ closing thoughts on how climate investing will evolve over the next one to two years and what needs to be done to further its evolution?
Ghanem – To echo what was just said, I could see the US playing a much bigger role, even overtaking Europe in terms of ESG evolution, just because there’s so much opportunity there. However, clearer guidelines are needed – but not necessarily at the global level. We’ve heard in this discussion that standards don’t necessarily work for industries on a global level, for example, in Europe, the same as in Africa.
But ESG needs to be simplified and there needs to be more education around it for climate and ESG integration to be seen more like business as usual.
Gopinathan – Incentives are important and the US Inflation Reduction Act has taught us that incentives make and provide change. Positive incentives help accelerate change and bring in capital and technology.
Obstacles that do need to be removed include permissions, particularly for renewables infrastructure.
"Sometimes ESG is seen as a socialist move by critics. But ESG and sustainability are not about telling the rich they cannot get more rich, but saying they can increase wealth but not at the expense of developing countries or future generations."
And third but not least are workforce improvements, by which I mean upskilling, apprenticeships, resourcing. All of those things need to improve in order to confront the hurdle of scalability for climate solutions.
Brouwer – In the next two to three years, I think general ESG investing should really become the new norm, and what will differentiate funds is what they aim to invest in and what they aim to drive. I think with climate specifically, it’s going to be about balancing green solutions and transitioning the source of the problem. This implies transition finance becoming a key lever for change and a normalised financial instrument for the private sector.
A lot of the reason why we’re in the situation we’re in is because finance isn’t flowing into the right types of investments and into the right regions, and this is because of the perceived risk of it. We need to be able to de-risk private capital using more catalytic public capital in order to unlock committed capital into emerging market countries. As an asset manager, we want to be able to deploy our clients’ capital into regions where it matters most, but that often needs to be done in combination with the types of finance that can de-risk those investments, and so working together with other parts of the system will really be critical in enabling that future.
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