Investing shouldn’t cost the Earth: the unprecedented transition to net zero

On Earth Day, we look at how the climate is changing for climate investing.

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By David Harris, head of sustainable business, LSEG

This year’s Earth Day, falling on April 22nd, provides a timely reminder of the crises of climate and nature we collectively face. As its convenors note, the “world needs transformational change” if we are to avert looming environmental disaster.

But Earth Day also provides an opportunity to recognise the signs that transformational change is underway. Within our part of the global economy – the financial sector – there is evidence of consciousness growing around sustainability issues, behaviours transforming and capital moving in ways that promise to deliver the change we need to see.

We would like to take the opportunity presented by Earth Day to point to five reasons to be optimistic that transformational change is taking place, with the financial sector helping to drive that change. 

1: The risk calculation has changed

Finance is all about balancing risk and reward. When it comes to climate change and sustainability, we are seeing policy, regulation, technological developments and consumer preferences all tilting the risk/reward calculation away from carbon-intensive companies and assets where there is no credible transition strategy.

These factors are working together to raise the risk that carbon-intensive assets will face higher costs, lower demand, and become worthless before the end of their natural life. This is raising their cost of capital, adding further pressure to high-carbon economic activity.

It’s important to note that this isn’t altruism or driven by ethical considerations: this is hard-nosed recognition by investors and lenders of the economic implications of the climate and sustainability megatrend.

2: Green industries outperforming global markets

Just as the market is recognising (and pricing) increasing climate risk, it is rewarding those investments that offer climate solutions. The chart shows the performance of the FTSE Environmental Opportunities All Share Index, which comprises companies with high levels of exposure to the green economy.

Since its launch in 2008, the index has returned over 300% – compared with 250% for the FTSE Global All Cap, whilst the oil and gas sector index has declined over the period, shrinking by 27%. The chart above includes the performance of the five year history prior to launch which accentuates this trend even further which green industries returning close to 1000% against 600% for global equities.

 

3: Sustainable fixed income issuance is booming

The world’s debt markets – three times the size of public equity markets– are also directing capital towards more sustainable issuers.

The latest analysis from the Refinitiv Deals Intelligence team finds that sustainable finance bonds totalled US$286.5billion during Q1 2021 and this figure far exceeds the previous years' Q1 figures which were under $100bn. Please see chart below for the huge annual growth since 2015.

Here too, investors are driven by changing calculations of risk and return. Some instruments offer exposure to green (or socially beneficial) assets or are linked to improved sustainability performance by their issuers.

4: Capital is flowing into green infrastructure

As governments plan to stimulate their post-COVID economies and meet carbon reduction targets in tandem, we are seeing a surge in ‘green’ infrastructure such as wind and solar power. Data from Refinitiv Infrastructure 360 shows a record US $272 billion in renewables projects announced in 2020 - 21% higher than in 2019, and 66% higher than in 2011.

President Biden’s $2.3 trillion climate-focused infrastructure plan, echoing the ambitions of other major economies such as the UK and Japan, is matched by growing interest from the fund management and pension fund industry. Indeed, in April 2021, BlackRock announced a $4.8 billion global renewable power fund—supported by over 100 institutional investors in more than 18 countries.

Europe is well advanced in decarbonising its power sector: emissions from power generation have fallen by an estimated 43.5% between 2012 and 2020, according to Sandbag, a think tank. President Joe Biden’s $2 Trillion Climate Plan significantly accelerate the penetration of clean energy in the transportation, electricity and building sectors.

For institutional investors seeking predictable, long-term returns, green infrastructure represents a compelling opportunity, and one that a growing number are embracing.

5: Regulators are helping to change the game, drive more disclosure/transparency and guard against greenwashing

From central bankers worrying about systemic climate risk, to the EU drawing up its Sustainable Finance Taxonomy, to the US Securities and Exchange Commission (SEC) putting its weight behind ESG disclosure, the regulatory landscape is helping to push sustainability issues up the agenda of the finance sector, and is creating consensus around definitions and measurement.

Significantly, IFRS – the body which develops a single set of accounting standards – has also made clear that the effects of climate related matters should appear on financial statements – in effect putting climate change on the balance sheet. IOSCO – the global standard setter for the securities sector – is also making steps to deliver globally consistent, comparable, and reliable sustainability disclosure. Climate is a material risk that is being priced in to valuations.

Regulators are also acting to ensure sustainable finance fair play. The EU is bringing in rules that will require financial products sold in its markets to validate their sustainability claims using measurable impartial data. In the US, the SEC has announced it will be shining a spotlight on “ESG-related misconduct” when it comes to corporate disclosure and the strategies pursued by investment advisors and fund managers.

There are increasing levels of collaboration across the market.  One of the most important of these is the Transition Pathway Initiative (TPI), a global initiative led by asset owners and supported by asset managers assesses companies preparedness for the transition to a low-carbon economy and is underpinned by academic research from the Grantham Institute at the London School of Economics. TPI and the inter-linked Climate Action 100+ initiative are providing  the go-to corporate climate action benchmark that provides a basis for global collaborative engagement. In response many of the world’s largest greenhouse gas emitters are making credible changes to strengthen their climate transition strategies.

These are encouraging developments that illustrate how the financial sector is recognising the sustainability challenges we face and is deploying capital towards the solutions. Could it happen faster? Of course. Many investors have not yet re-evaluated their investment strategies and integrated climate. Further, misdirected incentives  mean that plenty of unsustainable economic activity still gets financed, and still remains profitable. Nonetheless, the five trends we’ve identified above provide clear evidence of markets and the global economy moving in the right direction and are worth celebrating on Earth Day.

Subscribe to the blog or visit our Sustainable Investment Hub for more insights. Download our guide to climate initiatives here.

 

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