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Supplements » ESG Report Spring 2020

ESG roundtable: One shot at refinancing a fit-for-purpose economy

Funds Europe – We’ve seen growing emphasis on the aviation industry and to a degree, maritime. When it comes to cars, momentum is building around the idea that we are on the cusp of an inflection point in the electric vehicle market – carbon prices have increased and there is excitement around the opportunities. On the other hand, we also have industries such as fashion and textiles, which are bigger contributors to greenhouse gas (GHG) emissions than international aviation and maritime combined, so how important is it that we go even further and even quicker?

Eric Pedersen, Nordea Asset Management – There are some pockets of CO2 emissions and climate stress contributors that we don’t necessarily catch in the standard filters, and some sectors that are not really in focus, and fashion is clearly one of them. Another one we’ve recently started looking at is companies that supply or build new coal capacity, but don’t actually run it. So, you catch coal producers and utility companies, but you don’t necessarily catch the construction companies that build new turnkey coal plants. This goes to show that you need to be much more granular in the way that you filter, for the type of ESG approach where you really want to keep GHG drivers out. 

Then there’s the part of seeking out investment opportunities that are climate-positive but not so obvious, for instance, there are smart grid companies that make software to optimise electricity grid flow. This Chinese company which we’ve been looking at, Glodon, makes software that helps construction companies build in a more climate-neutral way. You can have a strong carbon handprint where you help other industries. For instance, there is a US company, Hexcel, which makes lighter airplane wings or parts for airplanes that reduce fuel consumption and thereby also CO2 emissions per passenger mile. Opportunities like that are worth looking at.

So there’s that on the one side, and then like you said, there are ones that we miss where typically, if you look at a clothing company, what is obviously material is labour standards, the risk of child labour, the supply chain, water use and things like that. But there is also the GHG part that needs to be taken into account, which in some cases was not in focus in the past for that particular industry.

Tomi Nummela, Mercer – From my perspective, being an investment consultant and working with boards of asset owners, the opportunity is to understand the crisis and systemic impact and increase governance around this issue. We have lots of known unknowns that can then be managed, and boards and trustees do know what to do with them and they have built a governance network and chain of expertise around them to look at those issues. From that perspective, it’s to have bolder governance that is future-ready and can look at strategic asset allocation and opportunities, build scenario analysis and stress-testing, whether that’s climate or broader. For example, understanding the speed of transition, how is that coming in and how do you respond to that? Obviously stock selection is important, but even bigger moves are done at the strategic level. 

When everything is discounted and bought almost at zero rates, there’s a lot which looks attractive, but we need to understand through that strategic discussion what is cheap and whether it is good value. For example, fossil fuels may look cheap at the moment, but they may turn out to be lemons relatively quickly in energy transition, so it is that conversation around bringing an increased understanding of climate-related/ESG-related [issues] to the board based on what a systematic crisis means. What is really important is taking the time not to be derailed by having a limited governance budget and only looking at the fashionable letter of the day but expanding the ability to look at the social and environmental aspects and how fundamentally important they are going forward.

Patrick O’Hara, USS – It is true that certain industries are not necessarily identified and scrutinised in the same way as oil and gas and mining. They aren’t recognised as significant contributors to climate change. We analyse, then, for other ESG impacts. One way to address this is through precise portfolio analysis, so analysis that shows alignment with net zero will help investors recognise where their exposures are, where they need to be focusing their attention in terms of reducing either their transition risk or physical risk. We’ve done some scenario analysis and stress-testing and the next real threshold is to push that up the organisation. We’ve done a lot of work doing bottom-up ESG analysis, stock-picking, even sectorial and thematic work and that needs to be pushed up to asset allocation decisions within organisations. 

There are still some weaknesses in the analysis. Assumptions need to be made and this makes it difficult to make precise decisions off the back of the results. This is still a maturing field and data is improving – and so is the analysis. Efforts are being made to assess risks arising out of scope 3 emissions, the impact of carbon pricing on a company’s business model such as their ability to pass on a carbon price, mapping corporate supply chains, physical risk exposure to those supply chains and asset location. Investors need to know not only the physical location, but how important those assets are to revenues. They are all data points that will bring precision to carbon analysis which will help to drive the flow of capital to companies and sectors that are well positioned, or at least less threatened by the coming transition.

Ultimately investors, in the first instance at least, must think about their portfolio positioning in terms of risk mitigation and upside opportunities. Broader engagement with governments and regulators is also important. The first duty is to make sure that your portfolios are positioned in a sensible and intelligent way for the coming transition. In the UK’s case, investors viewing this in terms of net zero through the same lens as the UK government appears to be a sensible basis on which to perform portfolio analysis.