Changing views on climate change
The year looks likely to end in a major turning point for sustainability – in one way or the other. The 2023 United Nations Climate Change Conference or Conference of the Parties of the United Nations Framework Convention on Climate Change (UNFCCC), otherwise known as COP28, began convening in Dubai on November 30, extending over the next fortnight. With the signatory nations of the UNFCCC, as well as just about all interested parties meeting in one of the most climate-vulnerable states in the world at the end of the northern hemisphere’s hottest ever summer in recorded history, expectations were high for signs of how far global policymakers are prepared to go. In the run up to COP28, Asia Asset Management spoke to some key players to gauge their valuation of the current state of play in sustainable investing and the prospects ahead.
Backlash and basis
As well as extreme weather events, headlines worldwide have also been full of strident statements, mostly from populist politicians and incumbent petrochemicals groups, against the advent of ESG and sustainable investing, criticising both principles and performance. So how much effect does this noise seem to have on the sustainable investing universe, and what does it portend?
For Julie Moret, global head of sustainable investing integration at Northern Trust Asset Management, this has made very little difference. She says the firm’s investment priorities “remain focused on the long term and delivering risk adjusted returns for our clients. As such, we take an economic driven, risk-based approach to understanding the impact financially material ESG issues have on our investments".
The changing market dynamics following the war in Ukraine, rising inflation, and other new macroeconomic factors have made a big difference to the fashion-driven status of ESG investment. “Over the past decade, there has been a dramatic surge in demand for responsible investing and the asset management industry has been marketing itself as sustainable to attract investors”, notes an October 2023 report from Europe’s Centre for Economic Policy Research (CEPR), quoting predictions that “responsible firms are on track to manage a staggering US$53 trillion in assets by the conclusion of 2025”. Other commentators have remarked that the recent shifts in ESG popularity, and questions over its performance, have tended to separate the truly committed investors from those who simply jumped on the ESG bandwagon while it was still rolling.
The situation, and the noise around it, has very different ramifications inside and outside the US. Laura Kaliszewski, global head of client sustainable investing at Natixis Investment Managers, believes that the backlash shows how important the whole topic has become. She adds: “While it has become a polarised topic, which is unfortunate, in the US ESG/sustainable investment still accounts for a tiny part of the total AUM of $313 billion. This represents only 1% of total US AUM”, compared to 21% for Europe. Regarding continued appetite for ESG opportunities, Kaliszewski concedes that “asset managers may have toned down their marketing approaches, but there is still strong demand for these products”.
Asia, in general however, does not appear to be emulating the US approach. Mervyn Tang, head of sustainability, Asia Pacific at Schroders, points out that, when viewed from an Asian standpoint, the disparities in what constitutes desirable sustainable outcomes are not as pronounced as those in the US. Asset owners and policymakers, he adds, broadly accept “that a low-carbon transition is needed to fend off the worst impacts of climate change” and that investment portfolios should be aligned with the resulting shift.
Kaliszewski meanwhile insists that climate remains “top of our agenda and is fully part of the business conversation”. She adds that “hopefully the backlash will disappear, as we stay focused on the sustainable work that we do. Many investors want to have an impact on the climate, and the spread of such a movement in Europe seems unlikely given the regulatory framework in place and the numerous commitments made by companies”. Initiatives such as the European Union’s recently announced a 4 billion euro ($4.36 billion) Innovation Fund aimed at funding decarbonisation technologies and funded by revenues from the EU Emissions Trading System (EU ETS), bear out this conclusion.
The changing energy background
The global background in energy production and costing has shifted significantly over the past few years, with the impact of the war in Ukraine and energy sufficiency concerns increasingly affecting policymakers. But this can be overstated. The International Energy Agency’s World Energy Investment report from May 2023 estimated that some $2.8 trillion will be invested globally in energy in 2023, “of which more than $1.7 trillion is expected to go to clean technologies – including renewables, electric vehicles, nuclear power, grids, storage, low-emissions fuels, efficiency improvements and heat pumps.” Just over $1 trillion, meanwhile, will be invested in coal, gas and oil.
Short-term trends have rather made the case for those investment pundits who advise that commitments need to be made for fossil fuel businesses that are transitioning to low or zero carbon, rather than shunning the sector entirely. “The recent strong performance of fossil fuel investments relative to renewable investments has made it clear that sustainable investment cannot just be about picking the lowest carbon investments and avoiding the highest ones,” notes Tang.
Transition to low carbon energy currently accounts for up to $755 billion worldwide, while $2.1 trillion of investment is needed in the energy transition between 2022-25, Kaliszewski observes. The implication is that “there is still huge need and opportunities in the low carbon transition. Furthermore, compared to 2022, the short-term decline in the level of asset owners globally that are implementing and evaluating sustainable investment is due to high interest rates to combat inflation, and geopolitical volatility. In the long-term, sustainable investment appears to be continually maturing”.
Tang notes that climate change is “still a major driver of structural changes to the economy and the implications need to be considered to understand the viability of business models in the long term”, but that all of this “needs to be considered alongside risk/return considerations like valuation and other metrics”. Decarbonisation, he adds, is “one of the ‘three Ds’ or long-term structural trends that we’ve identified at Schroders which will reset the current investment landscape”.
Such predictions appear to be borne out by trends in the energy space. Solar module prices are now predicted to fall to $0.10/W by the end of 2024 or at the latest 2025, according to Australia-based think tank Climate Energy Finance (CEF). This will bring solar power well under the cost of energy generation by coal. Furthermore, China has immense capacity in solar panel manufacture, currently constrained by input tariffs on Chinese solar panels by the US and India of up to 40%.
The UAE, the host nation for COP28, has just brought online the world's largest single site solar power plant, the two gigawatt (GW) Al Dhafra solar farm. This will power nearly 200,000 homes and remove over 2.4 million tonnes of carbon emissions annually.
The implications of regulation
If nothing else, 2023 looks to have been a banner year for new climate and ESG-related investment regulations. The endorsement of the new International Sustainability Standards Board (ISSB) sustainability disclosure standards, backed by the International Financial Reporting Standards board (IFRS) by the International Organisation of Securities Commissions (IOSCO) in July 2023, looks likely to cement the acceptance of both the principle and the practice of sustainability reporting in public markets. Meanwhile, the US Securities and Exchange Commission looks ready to implement its proposed rule changes compelling climate-related disclosures in 2024, informed by the Task Force for Climate-Related Financial Disclosure (TCFD) framework.
Europe’s moves in this area have helped set these precedents, and in September 2023, the European Commission announced a review of Europe’s Sustainable Finance Disclosure Regulation (SFDR). Kaliszewski feels that the implementations of the various regulations around the world, led by the SFDR, “created real collective awareness, forcing the financial industry and companies to take into account ESG considerations into investments and processes”. She notes that “the long-awaited Corporate Sustainability Reporting Directive (CSRD), which is being implemented in January 2024, requires companies to report on the impact of corporate activities on the environment and society, and through an audited process”.
Asian regulators have been following and participating in these changes, and Asia Pacific institutional investors “are expecting climate policies to accelerate, even more so than investors in other regions”, Tang remarks. Almost 60% of institutions, he notes, expect a shift in climate legislation “to turn climate politics into concrete actions. This is driving how they think about their portfolios in identifying and allocating capital”.
The corollary of new regulation, of course, is actual enforcement. Kaliszewski notes that the SEC “has been active when it comes to ESG enforcement, with heavy fines against US financial firms”. The SEC, she confirms, is implementing new rules “that require funds with names that suggest an investment focus on ESG or sustainability-related factors to invest at least 80% of the value of assets in accordance with the ESG/sustainability factors”. The CEPR report observes that, while responsible investing does have its merits and can deliver positive impacts, “our research highlights the importance of scrutiny and regulation to disentangle true sustainability from greenwashing”. Both new rules and enforcement mechanisms are required to achieve this.
Regulation and internationally accepted standards “are both driving adoption of sustainability-related practices, such as environmental risk management, and enabling them by providing more information through improving corporate and investment product disclosures”, Tang emphasises. And he adds that more and more investors are seeking outside support from their asset managers and advisors “to navigate the evolving sustainable finance landscape”, not least the policy and regulatory factors. Most client investors, he notes, “look to build a decarbonisation pathway aligned with global and regional policy ambitions as well as their own”.
Kaliszewski cautions that “there is, however, need for more coordination, coherence and simplicity”, taking as an example, how to establish a link between SFDR sustainable investment (SI) definition and the taxonomy activities or the strict percentage of taxonomy alignment. “While regulation has led to huge progress, it is still very complex for investors to understand, and regulation remains silent on transition activities, which are a huge part of the economy”, she adds.
Client appetite for sustainability
Amid these shifts in policy and political background, how do investors themselves view the scene? In terms of Northern Trust Asset Management’s perspective, Moret reports that “we are seeing biodiversity and natural capital solutions rise up the agenda with clients”. More specifically, she adds, “clients are searching for solutions that take an interconnected approach to delivering not only Paris-aligned decarbonisation goals, but ones that also incorporate natural capital considerations such as water and green revenue tilts”. They are looking, she concludes, for efficient exposure to such themes in risk-controlled offerings.
“We still see strong demand from our clients and the market”, Kaliszewski confirms. She also sees especially strong interest in decarbonisation solutions aligned with the Paris agreement. “The top motivations to implement sustainable investment remain client demand, mitigation of long-term investment risk, avoiding reputational risk, and societal good”, she adds. In her view, the top-priority themes are climate/carbon and energy transition, water services and climate adaptation, with asset owners often addressing these through thematic approaches.
Other industry insights directly addressing Asian investor appetite tend to support this conclusion. Ocorian, a specialist provider of services to HNWs and family offices, financial institutions, asset managers and corporates, has just released the results of a survey of Asian wealth management professionals managing a total of some $15 billion in assets, showing that nearly nine out of ten believe that there will be an increased focus on ESG principles from a fiduciary perspective over the next three years and that 97% believe that ESG is “part of a family office’s fiduciary duty”.
Tang quotes the results of the latest Schroders Institutional Investor Study 2023. Most global and Asia Pacific investors, he observes, “continue to believe sustainability and impact strategies will support their objective of achieving long-term financial returns. However, investors’ approach to sustainability is evolving”.
Kaliszewski quotes some encouraging figures in terms of SFDR alignment to put alongside the alarming statistics around climate change: “Article 8 and Article 9 fund assets hit the 5 trillion euro mark for the first time [in 2022], and in European markets, 86% of ETF asset flows in 2022 went into sustainable funds”.