There is a sense of inevitability in the air. Ambitious climate change objectives and well-crafted slogans have yet to be translated into real action, until now.
In 2021, we expect to see a seismic change for the environmental, social and governance (ESG) agenda catalysed by a) the Blue Wave in the US; b) global climate change regulations and c) investment-led green initiatives which kick in this year. These three factors will act as the transmission mechanism for vision to become reality.
Blue Wave – Green Agenda
The Blue Wave scenario in the US is a catalyst for the global green agenda.
Incoming US President Joe Biden’s “Build Back Better” environmental agenda advocates international cooperation and articulates key goals such as re-joining the Paris Agreement and a USD2 trillion federal spending package on infrastructure and clean energy to boost research and development into renewable energy technologies.
The Biden-Harris administration also vouched to reverse the Trump administration’s dilution of environmental standards in the areas of climate policies on clean air, water, wildlife and toxic chemicals. Enhanced disclosure, reporting requirements and adoption of ESG regulations in investing can be expected in the US over the next four years.
Another dimension is the role of Janet Yellen, the incoming US Treasury Secretary who is a strong advocate for a carbon tax. Ms Yellen is a key member of the Climate Leadership council, a bipartisan group of business leaders and influential economists (including 28 Nobel Laureates) that mooted a carbon tax proposal in the Bipartisan Climate Roadmap in Oct 2020.
“Rarely have I seen this level of consensus in the economics field around a specific policy. That is because our carbon dividends plan offers the most cost-effective, fair and environmentally significant climate solution,” said Ms. Yellen.
The Race to Zero – Top-down initiatives:
Leaders around the world are in a green race to meet environmental goals set out in the Paris Agreement and the United Nations Sustainable Development Goals (SDGs). The Paris Agreement commits the US to a net-zero emissions target for 2050.
In Europe, the EU Commission adopted the ambitious European Green Deal action plan in December 2019 with medium- and long-term sustainability-related goals for all sectors of its economy: energy, buildings, industry, mobility, and agriculture.
The plan also laid out financing mechanisms and a roadmap of legislative and non-legislative proposals.
Chinese President Xi Jinping pledged at the UN General Assembly last year that China will achieve peak carbon emissions before 2030 and carbon neutrality by 2060. China’s 14th Five-Year Plan also featured environmental protection as a key agenda, as well as the dual circulation policy which focused on energy security.
Putting money where the mouth is
When the term environmental, social and governance (ESG) was first introduced to the financial industry in the “Who Cares Wins” publication, the endorsing institutions believed that ESG factors would ultimately contribute to stronger and more resilient investment markets and contribute to the sustainable development of societies.
As the ESG investment agenda evolves, investors are moving from exclusion policies, to transition and ESG integration into investment process and portfolios.
Changes in the regulatory framework for the sustainable finance and investment eco-system (from asset owners, pension funds, institutional investors, private wealth to retail investors) is gathering momentum. This is the “transmission mechanism” for capital to be deployed globally into sustainable causes which support the global climate change agenda.
The Institutional Investor Group on Climate Change (IIGCC) launched a net zero framework, while the Asset Owners' Net Zero Alliance set out protocols for consultation last year.
According to United Nations Principles for Responsible Investment (UN PRI), the number of investor signatories increased by 29%, to 2,701, while the number of asset owner signatories increased by 21% to reach 521, and their collective assets under management (AUM) increased by 20% to USD103.4 trillion as of 31 March 2020.
The EU has already had a head-start in implementation of its sustainable finance action place in relation to sustainable benchmarks, disclosure requirements and corporate governance standards.
Establishing the EU taxonomy for sustainability this year will help overcome a major hurdle in the variability in ESG definitions, as part of the wider EU Renewed Sustainable Finance Strategy that is due to be published in Q1 2021.
In Asia, the Hong Kong Monetary Authority adopted a phased approach last year to introduce its green and sustainable banking framework; adopt a responsible investment philosophy; and establish the Centre for Green Finance.
In December, the Monetary Authority of Singapore (MAS) issued guidelines on Environmental Risk Management for banks, asset managers and insurers with an 18-month timeline for implementation.
Asset managers are required to embed relevant environmental risk considerations in their research and portfolio construction processes, evaluate potential impact of relevant environmental risk on investment returns and establish processes and monitoring of environmental risks.
Key challenges
For many investors, concerns remain regarding:
1. Lack of consistency in ESG definitions,standards and benchmarks.
To address this, the adoption of a sustainability frameworks by multilateral agencies will align definitions.
Starting March 2021 in Europe, the Sustainable Finance Disclosure Requirement(SFDR) sets out common criteria for definitions and measurement of economic activities relating to environmental objectives, while the Non-Financial Reporting Directive (NFRD) provides stringent and standardised requirements for how companies report non-financial information and ESG-related disclosures.
2. Limited availability of green investments infixed income.
Green bond issuance by developed and emerging market sovereign and corporate issuers continue to rise.
According to the Climate Bonds Initiative, global green bond and loan issuance accounted for close to 75.2% of overall labelled bond issuance in 2019, reaching are cord USD 257.7 billion last year. Issuance of sustainability and social bonds has also risen across Europe, North America and Asia-Pacific. According to an Amundi/IFC report, Emerging market green bond issuance increased by 21% to USD52 billion in 2019 (of which China accounted for USD34.3 billion),reaching a cumulative USD 168 billion at the end of 2019.
3. Concerns over “green-washing”
While ESG integration incorporates financially material ESG factors into the investment process, there is increased focus on active ownership, which involves engagement on the sustainability performance of investee firms.
How should investors respond?
The Covid-19 pandemic and the ensuing shock to economies and societies has cast the spotlight on the urgency to address risks in climate change, social integration and governance issues.
We witness renewed urgency by governments, regulators, asset owners and individual investors to re-evaluate the value of sustainable investing as a means to strengthen long-term portfolios.
Companies capable of broadening their agenda from maximising shareholder value to engaging with stakeholders (e.g. customers, employees and society), contributing to the climate change agenda and aligning to ESG principles will likely attract valuation premiums over time.
We believe sustainable investing will become mainstream and ESG factors will become ubiquitous means of assessing risk-reward for investments. With the weight of national and multi-lateral policies behind the ESG agenda and the liquidity of capital markets directed at ESG investments, it is timely for investors to adjust portfolios to align profitability with purpose.
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