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When is important not urgent?

20 Oct 2022 | Banks quiet quitting. Companies green hushing. Investors transitioning.

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🚧 Demand for sustainable funds is outstripping supply. The impact investment market recently hit the $1T mark, for which—according to analysts at Goldman Sachs—there’s no dearth of upside opportunity among the “under-appreciated” industries benefitting from the US climate bill. Of the institutional investors surveyed for the PwC Asset and Wealth Management Revolution 2022 report, 88% want more ESG products, for which 78% are willing to pay higher fees. So, why are 55% of asset managers dragging their feet? Fear of greenwash, apparently. Institutional investors tell PwC the answer is stricter regulation. For asset managers, it’s more complicated. “Rarely intentional,” mislabelling is attributed to insufficient regulation, unreliable disclosures, and inconsistent standards. But concrete regulation is no panacea: Given compliance costs are up 10% already, more rules could prove prohibitive for small providers. Not that they can afford inaction. Globally, 79% of investors plan to increase their allocation to sustainable products, while 90% have rejected or would reject an asset manager on the basis of product shortcomings.

⏮️ Institutional investors are doubling down. Half of those polled in the ISS 2022 Global Benchmark Policy Survey recommended voting against directors at fossil fuel companies without Scope 1 and 2 targets, while 79% said the same of directors failing to report in line with TCFD. That’s a lot of directors. In its 2022 Status Report, TCFD claims a mere 4% of companies meet all reporting requirements. Despite shareholder pressure, “green hushing” is driving data underground. Consultancy South Pole finds a quarter of companies are hiding climate targets to avoid scrutiny and greenwash allegations—as well they might, seeing as decarbonisation strategies are trailing pledges. The Climate Action 100+ Net Zero Company Benchmark reveals just 10% of target firms are Paris-aligned. Banks are “quiet quitting” net zero, says Bloomberg, their resolve weakened by the “revived fortunes of fossil fuels.” In the KPMG 2022 US CEO outlook, some 48% of CEOs plan to “pause or reconsider their ESG strategies” due to regulation and recession. “As focus shifts from words to deeds,” concludes the Economist, “the contradictions in ESG are becoming brutally clear.”

🇪🇺 Not to be left out, some governments are back-pedalling. It may be the mother of invention, but necessity has a complicated relationship with cooperation. “Record growth in wind and solar capacity” has powered a quarter of EU electricity since the outset of war, according to a study by E3G and Ember, wiping €11B from the EU’s gas bill. (Not just the EU: Ember finds global growth in electricity demand was met entirely by renewables in H2, amounting to $40B in fossil-fuel savings.) But with a winter (or two) coming, member states are considering “watering down” their REPowerEU target of 45% renewable energy by 2030, on which the European Council agreed just this month. The amendments could slow permits, which is something the EU can little afford. For context: It takes four and nine years to get a permit for solar and wind projects, respectively, according to Schroders. There’s growing fission on nuclear, too, with S&P projecting two years of disputes regarding its inclusion in the green taxonomy. One week before its World Energy Outlook 2022 goes to print, the IEA urges energy “solidarity.” The EU is finding theirs tested, reports CNBC.

When is important not urgent?

People overestimate the pace of change in the next two years and underestimate the pace of change in the next ten. The observation—attributed to Bill Gates, shared by LinkedIn influencers the world over—applies to many things. Technological innovation. Investment returns. The 2015 UK general election.

Our inability to conceptualise compound change, according to Gates (according to LinkedIn), lulls us into inaction. In financial terms, it leads to the type of short-termism associated with higher risk and lower returns. Systemic social and environmental risks, on the other hand, are long term. Inherently so. ‘Extra-financial’ factors tend to be extra-financial only in the sense that their financial effects have yet to be priced in, compounding over a timescale very different from the one against which S&P 500 performance is measured.

Dramatic as it is, climate risk can feel incremental relative to financial risk—which is why capital reallocation depends on frameworks imposed from the top, be it fiscal spending (US), energy regulation (EU), or blended finance solutions (World Bank, maybe). But although supportive frameworks are invaluable, their economic value, too, takes a while to materialise. High-impact projects are long-term investments. Renewable development spans the better half of a decade, and that’s before taking into account the time it takes to train a workforce big enough to meet demand.

Investors and businesses have short-term financial obligations. If those diverge from longer term considerations—say, when markets sour, inflation and interest rates rise, and energy gets expensive—it presents a dilemma. Investment firms may frame their U-turn on fossil fuels as a social imperative (it is); critics, decry it financial opportunism (it is); but, ultimately, the debate is meaningless—unless it’s one about the value of authentic communications. This, says Bloomberg, is Wall Street just doing its job: making money. Not just making money; making money now.

Tale of two investment approaches

One solution, outlined by Terrence Keeley of 1Point6—among many others—is for investors to “find value by turning ‘brown’ companies ‘green’.”

“Investors, asset managers, portfolio companies and policymakers have begun to draw distinctions between their short-term and long-term strategies for ESG. The shift in sentiment is reflected in the inclusion of nuclear power and natural gas in the EU Taxonomy and the increased allocation of oil and gas companies within a number of asset managers’ portfolios while, at the same time, these asset managers also work with energy providers to build efforts around a longer-term transition.” (PwC, Asset and Wealth Management Revolution 2022)

In theory, it sounds like having your cake and eating it. You get the short-term returns (and social points). You get the long-term returns (and environmental points, which are also social points). You could even get bigger bang and bigger buck if successful in steering the company from (A) to (B). See: Ørsted.

“The $40 billion Danish wind farm operator is a favourite of asset managers eager to swap their fossil fuel investments for more sustainable energy providers. But the really smart investors were those who owned DONG Energy, Orsted’s fossil fuel-burning predecessor, when it transitioned from oil and gas to renewable energy. Anyone who invested in DONG at the time of its 2016 listing, before it rebranded and sold its fossil fuel operations, would have made a total return of 200%. By contrast, investors who bought Orsted shares in early 2021, when they were trading at more than 40 times earnings, have lost money.” (Reuters)

Ørsted SDG impact, 2015
Ørsted SDG impact, 2021

There’s a case to be made for engagement over divestment. Theoretically, it makes sense that activism—not avoidance—is an effective way to capture returns and mitigate risks associated with the transition, while, at the same time, catalysing it. Too frequently, however, it fails in practice, when company actions—and asset management votes—fall short of ambitious pledges.

Institutional investors seeking transparency from transition plans might put the Gates Law in reverse: Put less store in pledges about tomorrow or absolute performance today; and more in the evidenced ability of an asset manager or business to deliver relative improvements over a meaningful timeframe.