The changing climate for sustainable investment

This Decade of Transition content series looks at how environmental, social and governance (ESG) investment will play a fundamental role in achieving a more sustainable future. Part 1 focuses on the “E”—the environment—as the need to proactively tackle climate change becomes increasingly evident.

If the first two decades of the 21st century were about awareness, the next 10 years will be marked by transition. The impact of the changes made over the next decade, in human consumption patterns and how we maintain the planet’s resources, will define our future. Ten years remain to achieve the U.N. Sustainable Development Goals, the blueprint for “peace and prosperity for people and the planet, now and into the future.”

The good news is that numerous global economies are signing up to be carbon net zero. According to the Climate Action Tracker, 126 countries responsible for 51% of global emissions have set decarbonization goals. Significantly, climate change commitments are coming from all regions, including nations that have not previously embraced the green transition.

AXA Investment Managers (AXA IM) Clean Economy strategy manager, Amanda O’Toole, says, “It shows that this is happening globally and it makes it much more difficult for companies and investors to ignore the changes underway.”

It’s not just governments—at national, regional and city levels—embracing the net zero ethos. “2020 has been remarkable for the breadth of mainstream corporates that have announced net zero targets,” O’Toole adds.

"AXA Group has committed to a 20% CO2 emissions reduction target in its investments by 2025."

Bloomberg reports that investments that take into account ESG are set to comprise more than one-third of the market by 2025, with assets under management of more than $53 trillion.

AXA Group’s Chief Economist, Gilles Moëc, notes that this increase in investment is expected despite the economic slowdown caused by the coronavirus pandemic, in sharp contrast to the way the world emerged from the 2008 financial crisis.

“In 2008–2009, we saw a temporary drop in emissions, but the minute the recovery started, we returned to business as usual,” he explains. “What is reassuring this time is that the urgency of fighting climate change has not been sacrificed to the focus on restarting the economy. Instead of seeing the green transition as reducing economic growth, now, with its need for large-scale investments in infrastructure and renewable energy, it is seen as one of the tools for that growth.”

Johann Plé, AXA IM’s global green bonds strategy manager adds: “Covid has made both companies and investors realize that non-financial risks matter, and climate change is one of the biggest of those risks.”

The Companies Committed to 100% Renewable Power
RE100 is a global initiative bringing together influential businesses committed to 100% renewable power.
RE100 has commitments from 280+ members in 140 markets worldwide, consuming 320+ terawatt hours (TWh) of renewable energy a year.
Source: RE100

As governments seek to bolster their economies, stimulus initiatives such as Europe’s Recovery and Resilience Facility will increase the amount of green assets available, while the green bond market continues to set new records for issuance each year.

“Many of the projects that we need are very large-scale infrastructure. We need to invest close to 1% of GDP every year to 2030. If you want to raise that kind of money, the green bond market is the place to be,” says Plé.

Key areas of ESG investment include well-established and fast-growing sectors, such as renewable energy, electric vehicles and efficiency technologies, and emerging fields including smart energy and hydrogen. Another focus is the food and agriculture sector. Here, digital solutions can help reduce the amount of water needed, as well as reduce the massive amount of food that currently goes to waste.

There have been a number of encouraging regulatory moves in recent months, in Europe, the U.S. and Asia that further reinforce the rationale for investing in clean tech, O’Toole says. This on its own, though, is not enough. “Where investment strategies target emissions reductions, we often need greater disclosure from companies about their ESG risks, particularly their carbon emissions,” she adds.

“Often there are limitations when it comes to creating portfolios because the emissions information doesn’t exist,” Moëc says. “We’re looking for more disclosure, and standardized data. When we have this information, it will be much easier to include companies in our portfolios. That will increase pressure on companies to publish the information.”

Yet there is still no industry-wide consensus on how to measure and report on these metrics, O’Toole adds. “Consistency across corporate disclosure on ESG issues is essential because it allows us to compare company performance, as we can with financial reporting.”

Five key standards bodies—the Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), International Integrated Reporting Council (IIRC), Climate Disclosure Standards Board (CDSB) and CDP (formerly the Carbon Disclosure Project)—recently announced that they will work together on aligning standards. This has already resulted in the merger of SASB and IIRC to form the Value Reporting Foundation, and more consolidation may follow.

The green bond market faces similar issues because only voluntary guidelines exist, which increases the danger of greenwashing. “If we really want to grow the market, we need some regulation and common standards,” asserts Plé.

The European Union’s Green Taxonomy environmentally sustainable activity classification system will play an important role for both equity and debt investments. It will define what qualifies as a green investment and create a standard approach to ESG risks, and decarbonization in particular.

Encouraging signs are appearing elsewhere, too, with recent net zero announcements from China, Japan and South Korea, and Joe Biden’s victory in the U.S. presidential election is resulting in a significant change in sentiment. “The U.S. election result was clearly a game changer for green finance,” says Plé. “Biden has committed to spend $2 trillion to finance environmental projects. That’s a huge boost to the sector.”

Carbon prices will be a key tool to encourage investors to fund decarbonization initiatives, but they cannot be expected to work in isolation. “If you just let the price of carbon rise to the level needed to cut emissions, you may meet significant social and political resistance. It needs to be combined with policies to mitigate that higher cost of carbon,” Moëc says. “You cannot move towards net zero if you don’t also accommodate the needs of communities that will be affected by the change. Essentially, this is about reconciling the ‘E’ and the ‘S’ of ESG.”

A growing number of investors are decarbonizing their portfolios. AXA Group has committed to a 20% CO2 emissions reduction target in its investments by 2025. AXA was one of the first signatories to the Net-Zero Asset Owner Alliance, with AXA IM joining the Net Zero Asset Managers initiative in December 2020; both are commitments to making the assets they manage net zero by 2050.The latter initiative now has 30 signatories and covers $9 trillion in assets under management, sending a clear message. “This is real. Asset managers across the world are ready to make this commitment. It is not a niche area,” Moëc adds.

As the standard of disclosure improves, and it becomes clearer both what companies must do to aid the green transition and what constitutes a green investment, the market for green solutions will be a key source of growth over the next few decades. This will be complemented by significant political momentum and tightening regulation. The days when investing in environmental issues was seen as an impediment to growth are over, Moëc believes. “This is a reality. There’s no point trying to ignore the issue.”

“We’re right at the start of a transition that will take beyond this decade to complete,” says O’Toole. “There are huge opportunities for companies and investors, and already, it is possible to build a genuinely diverse portfolio without compromising on quality.”