Part 6: Unlocking ESG – Navigating the Sustainability Ecosystem Series
Here are our key takeaways:
ESG: Estimating the cost to society
Richard Mattison co-founded Trucost 21 years ago “when nobody knew what a carbon footprint was” and says their approach takes into account the externalities associated with business activity. “There are costs borne by society that are not currently imposed on a company - but are nonetheless significant. The theory is that if a company is imposing a huge amount of costs on society that are unrecognized on its P&L today, these costs could be recognized in the future, representing a significant financial risk.” Addressing these costs might be less expensive than people think and Mattison cites China as an example. Trucost examined various sectors that generate air pollution in 19 different Chinese provinces, finding that the pollution results in a GDP loss of 5-10%. There is often hesitancy by policymakers to address such problems through a green plan, however, and in the case of China, the costs to address the problem would represent much less than the GDP loss.
Climate Risks are Increasing
According to Mattison, we have witnessed an exponential rise in the risks seen in the world, and as a result are seeing an exponential acceleration in business transition. The EU seeks to dedicate 30% of its EUR 750 Bn Recovery Fund to green and climate change projects, which will attract more capital. While he noted that over 1400 companies and about one hundred investors have committed to net zero by 2050, he also stressed that 60% S&P 500 companies face severe physical climate risks and 72% are a long way from meeting the goals of the Paris Agreement.
What’s important here is that these are essentially financial risks and this is not a 2050 problem according to Mattison. He states “the average tenure of a municipal bond is 17 years and when Trucost examined US municipalities, we found that 38% face severe water shortages in the next decade, so within the lifetime of the bonds being issued, you have very significant risks that will become evident.”
The Future Needs to be Addressed…Today
Roelfien Kuijpers has been working in responsible investing for over 25 years but believes we’re now at a tipping point in ESG. “DWS started with the G in ESG, looking at corporate governance in 1994, believing at that point that as active asset managers, we should also have an active voice when it comes to engaging with companies and voting at shareholders’ meetings. In 1997 DWS launched the industry’s first microfinance fund. Fast-forward to 2020 and the fund raised over $2 Bn in capital that has been extended as micro finance loans, particularly to create financial inclusion for women in emerging economies. In 2005, we strongly felt that climate change was going to be the defining issue of our time.” Kuijpers thinks that in the past year, we’ve reached a watershed moment in ESG investing now going more mainstream. “In 2021, the world has changed a lot, a pivotal moment and an eye opener for investors and corporations. The dialogue we have with companies has really changed,” she said.
Mattison said it is crucial to ‘understand’ the future as we face very volatile times, likely to be accelerated by the COVID pandemic. Companies looking to adapt to climate risks need to ask themselves fundamental questions about their business model in 2050. For long-term business strategy planning, a solid set of reliable and consistent forecasts and scenarios is required. “We have around 600 billion data points on physical climate risk so we can map out flood risk, sea level rise, wildfires, hurricanes, storms, heatwaves, cold waves, all sorts of different hazards presented by climate change over 3 core scenarios in the future.”
A key takeaway from Kuijpers was that there is a value in engaging credible, external experts to help define the future and shape the ESG agenda and priorities at a company or asset manager. As DWS began to evolve its ESG strategy two years ago, it focused on bringing in an outside view. DWS established the ESG Advisory Board, which provides guidance to the C-Suite and Board on all matters related to ESG. Experts on the ESG Advisory Board include representatives from the private and public sectors, such as Lisa Jackson, VP of Environment, Policy Social Initiatives at Apple and former Head of the US EPA under President Obama and Georg Kell, founding director of the UN Global Compact.
Investors are Placing more Scrutiny on Climate Disclosures and Targets
Investors are asking for more clarity and financial context when it comes to climate disclosures. Mattison advised companies to be specific as possible on their current emissions profile and the long-term modelling for the future. Modelling has to take into account a multi-decade approach, one that goes out to 2030 but also outlines the vision for emissions reduction to 2050. He cautions that if companies do not disclose that information on their own, they are at a disadvantage as others will calculate it on their behalf, often using inaccurate data that is without any additional strategic commentary or context.
Kuijpers added that going forward, as it relates to climate disclosure and strategy, merely putting out carbon reduction targets is not good enough for corporates. Rather, investors are looking for ambitious targets that are aligned to a science-based pathway that will meet the goals of the Paris Agreement. Expect more scrutiny on corporate carbon targets from investors in the next 12-18 months.
Carbon Pricing is not Working – and will Likely Change
“25% of the world’s carbon is actually priced in right now but the majority of this pricing is actually below the level that you need to achieve carbon reduction. It’s around $10 or less, while the IEA and OECD would say that it should look more like $120 per ton of Co2 by 2030. If you follow that thesis, there’s a big gap in carbon pricing today. In the future as countries seek to achieve their Paris Climate goals, they need to factor in a high-risk premium between what’s being paid today and what will have to be paid in the future,” stressed Mattison. “Capital is becoming cheaper if you can prove you can make a positive impact.” 96% US institutional investors and 91% across 6 global markets want to increase prioritization in ESG and the companies seeking positive change with their business models are achieving extremely high valuations right now, he said.
