Sustainable Investing Perspectives

This month we look at implementable investment takeaways from the initial developments from the COP26 climate meeting and the current landscape of workforce discrimination.

15 Nov 2021

Perspective 1

COP26: It will be all about the three ‘Ps’ – Pledges, Pots and Plumbing

Given this year’s COP is the first meeting for a five year review of the national contributions to the Paris Climate Agreement (PDF, 1 MB), expectations have been very high to receive increased verbal and financial commitments of governments to address global climate change issues. The International Panel for Climate Change (IPCC) report published earlier this year in August had set the scene for more urgent measures being needed.

For a breakdown of political and financial commitments— Pledges and Pots—from the conference so far, see the chart at the end of this report.[1]

Specific government commitments:

Halfway through the two-week meeting, we have seen a series of commitments from governments on topics such as deforestation, methane emission reduction and coalinvestments. For details, please refer to the table at the end of this publication. In addition, a few more individual pledges have been made focusing on specific industries and areas and topics, like agriculture and indigenous people.

Furthermore, the governments of the US, India, and Nigeria have come forward with new commitments:

The US rejoined the High Ambition Coalition (HAC), reaffirming the world’s second largest emitters’ commitment to the Paris Agreement and keeping the earth’s temperature rise within the 1.5 degrees Celsius limit.

The prime minister of India, Narendra Modi, announced his country’s pledge of reaching net zero emissions by 2070.

Nigeria’s President Muhammadu Buhari announced that Africa’s most populous country has developed an energy transition plan and roadmap to cut the country’s emissions to net zero by 2060.

However, all these pledges and commitments of additional funding will only bring results, if the ‘plumbing’ is ripe and the impact of introduced changes can be measured and accounted for and if additional funds will reach the right projects. As for the latter, particularly the funding of projects in emerging markets needs to be secured. In our view, currency risk is a major impediment to mobilizing the trillions of dollars needed to achieve the overall UN SDGs, which include a focus on climate change. In the context of investments in clean energy in EMs, private financing has become the main source of investments as a consultation paper by the Climate Finance Leadership Initiative from November 2020 indicates. Hence, more dedicated sustainable finance solutions that help to manage and absorb currency risks and stabilize EM exchange rates for the benefit of the respective lenders and borrowers are needed and may facilitate additional local currency financing and deliver attractive risk-adjusted returns to a sustainably managed portfolio.

Furthermore, any pledges and actual money flows must be accounted for, being measurable and comparable to steer funds to the right sources and to avoid greenwashing. Therefore, the announcement of the International Financial Reporting Standards Foundation (IFRS) of the formation of a new International Sustainability Standards Board (ISSB) to develop a comprehensive global baseline of high-quality sustainability disclosure standards is another important step to advance funding.

Last but not least, it is not only the pledges by governments itself that are important, but it is the greater momentum they create for everybody, including the public sector, corporations and individuals. For example, the transition to cleaner and more efficient energy sources continues, and is being accelerated by technological progress and declining costs for solar and wind energy, batteries and other clean technologies. This will reduce greenhouse gas emissions despite rising energy demand. Political support remains important but is no longer the driving force.

Takeaways for investors:

  • Environmental, social, and governance (ESG) leaders with more robust climate and transition policies are likely to prove more resilient amid both rising climate risks and potential regulatory tightening and new accounting rules in support of the energy transition.
  • We expect climate finance to accelerate, which is supportive of rising issuance of sustainable bonds. We prefer sustainable bonds on a pari passu basis.
  • Investing in solutions is an important part of the takeaways from the conference. The pace of renewables deployment will likely be further accelerated as renewables become increasingly attractive not only for the lower emission profile but as rising energy volatility lowers operating-expense visibility. Please refer to our “Greentech goes global” investment opportunities report, as well as our Longer Term Investments (LTI) themes “Clean air and carbon reduction” and “Smart mobility.”

 

Perspective 2

Workforce discrimination persists, increasing risk of employee attrition

Three in ten Black and Asian employees in the UK felt discriminated at work by their employer, according to a survey by analytics company Savanta, as reported by Euroactiv.[2] In addition, four in ten Black employees said that they had left a job due to lacking workplace diversity and inclusion. Of white employees, 25% reported to have experienced discrimination and 26% responded that they had left a job due to low levels of diversity.

The results of this survey are directionally consistent with other market research from a variety of organizations. For example, a 2019 study from Glassdoor found that 34% of employees in the US, UK, Germany and France have either witnessed or experienced discrimination based on age, gender, sexual orientation, or race/ethnicity at work. Over half of respondents in the US thought that their companies should do more to increase diversity and inclusion, even though 77% of them thought that their company employs a diverse workforce.[3]

There is a significant body of research which indicates that more diverse companies are more likely to be more innovative and more profitable. We see a longerterm societal shift that presents favorable conditions for companies with better gender, racial or other types of diversity to benefit relative to their peers due to potentially increased market share, and improved overall decisionmaking.

As these survey results begin to highlight, higher levels of diversity are only a starting point, inclusion–or the presence of policies and practices that enable diverse employees to contribute fully and effectively–also matters. In the context of labor market tightness, this becomes even more material to company’s longer-term performance. A recent McKinsey study found that 40% of US employees stated that they are somewhat likely to leave their job in the next 3-6 months. In our view, companies that have stronger human capital policies that favor diversity and inclusion are more likely to mitigate the impact of the overall high level of employee turnover, and attract and retain the right talent.

Investor takeaways:

  • Companies that are more diverse are more likely to be more innovative, and are better positioned for the longer-term given societal shifts. Yet, having higher diversity at the board, senior leadership or even workforce is not sufficient; inclusion–and leading human capital policies–are also important to longer-term success. We see longer-term opportunities related to the "Diversity and Equality" theme relative to their peers.
  • Relative lack of disclosure of diversity and human capitalrelated data poses a challenge for investors looking to identify relative leaders on this topic. ESG Engagement strategies may present investment opportunities for investors looking to drive positive impact on company management of diversity issues.

Perspective 3

Transport electrification offers upside potential but comes with labor risks of its own

Workforce considerations span beyond discrimination — employee safety is an important factor for corporations. Unsafe labor practices can open a company up to regulatory and reputational risks, and rising wages increases the cost of attrition. For sustainable investors, one industry of particular complexity is the market for electric vehicles. In a thematic sense, the market for electric vehicles offers significant growth opportunities across the entire supply chain, and we expect growth to be exponential rather than linear. By 2025, we estimate around 25% of new cars globally could be electrified, from low levels of penetration today. Still, electric vehicles require a significant amount of input materials that aren’t completely “green.” Mining for these critical input materials, such as lithium and copper, comes with a number of humans rights and labor force considerations. The usage of child and unpaid labor, the displacement of communities, and serious workplace safety violations are all potential risks inherent in the electric vehicle supply chain.

We see the value and the investment opportunity in the materials necessary for electrification, but sustainable investors should be mindful of the related risks. Engagement or ESG leader strategies that consider a company’s controversies can help put these risks into a relative context. Technological advances in the years ahead could also help to mitigate some of these issues. For example, the auto industry is taking a closer look at adequate sourcing, the use of sustainable materials, and recycling via circular raw material usage at the end of vehicles’ life cycles. Lithium-based batteries appear to have a first mover advantage for the time being, but further down the road, solid-state batteries could provide greater energy density, higher safety, and more appealing recycling characteristics. While workplace safety and recyclability considerations bear monitoring, we see significant potential in the path to electrification nonetheless. A continued push for supply chain transparency, and a proliferation of data to aid analysts in assessing ESG risks should help to provide investors with more context on these issues as we forge a path towards net zero economies in the years ahead.

Investor takeaways:

  • Opportunity exists throughout the electric vehicle supply chain, but challenges remain before electrification can fully take hold.
  • Integrating sustainability considerations into the investment process can aid investors in identifying key risks and ongoing controversies related to materials mining.
  • Battery recycling and the use of more sustainable materials are likely to remain in focus moving forward.

"Pledges and Pots": Initial list of commitments at COP26

Initiative

What is the goal?

Who signed it?

Who's missing?

Deforestation Pledge[4]

Ending deforestation by 2030, and restoring damaged land in developing countries. Reversing forest loss, developing sustainable agriculture for rural communities, and reaffirming financial commitments towards Indigenous peoples.

Countries that account for 90% of the world's forests, including: Brazil, China, Canada, Indonesia, the Democratic Republic of Congo, Russia, Australia, United Kingdom, United States, and more.

Various South (East) Asian countries, such as India, Thailand, and Malaysia.

Global Methane Pledge

Cutting methane emissions by 30% by 2030, relative to 2020 outputs.

More than 100 countries, including some of the highest methane emitters: South Korea, Canada, and Brazil.

Half of the top 30 methane emitters (with large agricultural interests), including: Australia, India, China, Russia

Glasgow Financial Alliance for Net Zero (GFANZ)

Mobilizing private capital to transition the global economy to net zero by 2050.

Banks, investors, stock exchanges, and various other financial firms, representing over $130 trillion in private capital.

 

Coal Phase-Out Pledge[5]

Phase out coal-powered electricity in the 2030s for larger economies, and 2040s for smaller economies.

More than 40 countries, including some of the most coal-reliant nations such as Canada, Poland, Ukraine, Indonesia, and Vietnam.

China and India (accounting for over 60% of global coal consumption), United States, Australia, and others.

Stop of Foreign Investments in Fossil Fuels

Stopping foreign investments in fossil fuels (including coal, oil, and gas) by the end of 2022. Putting an end to public finance for the international, unabated fossil fuel energy sector.

Over 20 countries, including the United States, Canada, and Denmark. Five development banks such as the European Investment Bank and East-African Development Bank.

Various big fossil fuel funders, including: China, Japan, and South Korea.

EU-US Cross-Border Steel and Aluminum DecarbonizationUnder negotiation[6]

Achieve the decarbonization of the global steel and aluminum industries, encourage low-carbon intensity steel and aluminum production and trade.

The partnership is currently under negotiation, but would apply to the United States and European Union aluminum and steel markets.

Countries outside of the US and EU are encouraged to join. Industries beyond steel and aluminum are not impacted.


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