New concepts of ESG are evolving
The biggest shift since the beginning of 2015 has been that the asset owner ideology has changed to involve concepts such as “Impact Investing”, “Natural Capital”, and “Universal Owner”. We have seen initiatives from pension investors that provoked a visible shift away from a purely financial viewpoint to one where longer-term stakeholder value is critical, for example:
- One of Sweden’s largest pension plans, AP4’s decarbonization strategy
- France’s public service pension scheme, ERAFP’s proactive ESG integration
- France’s public pension reserve fund, FRR’s tender for the asset manager who is able to deliver value from ESG, and
- Canada’s largest pension plan, CPPIB’s initiative to focus investment objectives entirely on long-term performance
In this model, more integrated approaches to ESG and better stewardship exercised over ownership will be present, as highlighted in the Towers Watson Report published in February 2015.
There are more and more investors who are actively considering ESG as a risk factor: reputational, as well as financial. Mercer European Study 2015 has stated that those who do not consider such risks now represent 36% versus 48% in 2014. And there is more evidence coming from index providers and their analytical partners showcasing that ESG has actually been able to deliver alpha. RobecoSAM has been able to identify these trends by quantifying the impact of ESG separately from all other factors (see their “Smart ESG Integration” whitepaper published in September).
Climate change talks dominated sustainability discussion in 2015 as COP21 approached
Finally, as we approached COP21 in Paris this year, the core of sustainability discussion was increasingly centered on climate change, which has received a consensus priority status as both the most important and the most pressing subject. The Montreal Carbon Pledge that was adopted in September 2014, whereby signatories agree to measure and publicly disclose the carbon footprint of investment portfolios annually, has reached $10 trillion of assets by the time of COP21, and the Portfolio Decarbonization Coalition whereby members will drive GHG emissions reductions on the ground by decarbonizing their portfolios has accumulated $600 billion. The Mercer report “Investing in the time of Climate Change” presented a very solid and quantified investment case, with Coal and Oil industries being the biggest losers under various climate scenarios and Renewable Energy being the only winner.
2015 saw investors divesting from fossil fuels and green projects were on the rise
Many asset owners have been divesting from fossil fuels, particularly coal. Coupled with the sinking oil prices, this has resulted in a decline of the S&P Global BMI Energy Index by more than 25% YTD.
In contrast, supported by the falling cost in the renewable energy sector and increased investor interest towards sustainability, we have seen a rise in the number and scope of green projects. The issuance of green bonds has grown to $41 billion dollars by early December (compared to $37 billion in FY2014), but what is more important, the unlabelled green climate-aligned projects have been growing in many parts of the world, starting from Californian solar farms to railways in China. Climate Bond Initiative calculated the size of climate-aligned bond-financed projects at $532 billion in their report “Bond and Climate change: State of the Market 2015” issued in July.
The impact of COP21 and beyond
COP21 brought a ray of hope to those who have been keen to minimize the carbon-related risks. Supported by the initiatives of public climate leaders, particularly the President of France, Francois Hollande, 195 nations’ delegations have been able to reach a legally binding and universal agreement targeting to get the climate change constrained within 2 degrees beyond the pre-industrial level and aiming to explore the possibility of 1.5 degrees. The agreement sets a coordination framework for individual governments, government and supranational agencies and NGOs in road mapping and implementing a transition to low carbon economy. This will require approximately $1 trillion dollars to be invested annually in low-carbon technologies and continued technological innovations, shift of funds from developed countries to developing countries. Part of the solution is in activating long-term and low cost financial solutions for public and private sector. Low carbon indices are clearly important part of this toolkit, as it helps the industry measure the performance of the low carbon market.
Among other positive news, 27 global investors representing over $11.2 trillion of total AUM issued the Paris Green Bonds Statement. Signatories have committed to support policies that drive the development of long term, sustainable global markets in green bonds as part of climate finance solutions. Furthermore, Climate Bonds Initiative (CBI) and UNEP Financial Inquiry Launch Green Bond Policy Report ‘Scaling Green Bond Markets – Guide for the Public Sector’, offer detailed action plans and best-practice examples from around the world for how to grow green bond markets.