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This year has been off to a tough start for sustainable investments: The Ukraine-Russia conflict, the energy super cycle, and the green premium have put significant pressure on sustainable investing. Still, it’s not all bad: Multiple taxonomies are introducing new frameworks through which we can establish, build, and regulate sustainable activities; An ever-increasing list of companies, organisations and governments are committing to Net Zero; and a combination of engagement and divestment could effectively guide the biggest emitters towards greener pastures. Let’s have a look at the major developments in the field of sustainability and discuss what we can expect in the coming months.
AMBITIOUSLY COMPLEX REGULATION
In the last couple of years, regulation on sustainability has undergone a veritable revolution. So too has sustainable investing. Europe in particular has taken the forefront with its ‘EU Green Deal’, and has introduced a slew of proposals, guidelines and regulations to kickstart, coordinate and supervise the transition to a green and carbon-neutral future. While this increased legal pressure can appear complex and even downright confusing at times, it is still one of the most efficient tools to redirect much-needed capital flows towards sustainable and inclusive growth.
At the heart of all the Green Deal’s regulation lies the ‘EU Taxonomy’, a classification system that clarifies which investments are environmentally sustainable. Even though it among the most well-known examples today, this is far from the only ‘sustainable taxonomy’: In fact, existing and upcoming taxonomies will soon cover and regulate nearly half of the globe: a veritable ‘Taxonomania’.
However, we should not forget that effective regulation goes hand in hand with ‘clear, high-quality and comparable data’. Sustainable objectives oftentimes appear qualitative in nature, and are inherently hard to measure. Today, the large number of different benchmarks, goals and definitions form a major stumbling block and only add confusion to an already difficult subject. Clearly, the increasing lack of conformity and complexity when it comes to data is something to keep an eye on, as it could easily be exploited to promote greenwashing and avoid real commitments to change. On the bright side, the Corporate Sustainability Reporting Directive – an amendment to the already-existing Non-Financial Reporting Directive – will go some way toward tackling these data challenges. Additionally, the International Sustainability Standards Board will also deliver a global baseline of sustainability-related disclosure standards, and offer objective information about companies’ sustainability-related risks.
WINDING DOWN THE ENERGY SUPER CYCLE
A super cycle is defined as a sustained period of expansion, usually driven by robust growth in demand for products and services. In this case, the energy super cycle specifically refers to the continued growth in demand for energy from fossil fuel sources. According to the latest report from the IPCC, greenhouse gas emissions have not gone down yet— quite the contrary in fact. And while renewables have experienced tremendous growth in recent years, as of today, global energy demand is still greater than the total supply of renewable energy.
Thankfully, there is a green light at the end of the tunnel: Firstly, the recent hike in energy prices has been a great incentive to further accelerate the transition towards renewable energy sources. Next, the increasing pressure from regulation and reporting requirements (i.e., ‘double materiality’) will also continue to drive this green transformation. Finally, in the long run, as an ever-increasing share of the world commits to Net Zero, the fossil fuel industry will have to dramatically adapt its approach to sustainability, or disappear entirely.
DIVESTMENT VERSUS ENGAGEMENT: THE FALSE DILEMMA
This brings us to our next point: How can we best lower our dependence on carbon-intensive means of energy generation? Many are in favour of simply cutting off financial support from fossil fuel companies through divestment, as this would automatically resolve the matter. Others prefer a method of engagement to guide these energy providers towards more sustainable energy generation, and limit the risk of stranded assets. While both sides seem to hold fundamentally opposing views, the middle ground is not that hard to reach: By finding a happy medium between the two, and relying on a combination of divestment and engagement, we can potentially have the best of both worlds.
But fossil fuel companies have not been standing idle and have been preparing their own transition for quite some time. The example of TotalEnergies comes to mind: The company, previously known as a French multinational oil and gas titan, decided to fully overhaul its business model. It has reengineered its strategies, projects and future activities to make sure that sustainable development is at the heart of it all. This turnaround is not only based on empty promises either, as TotalEnergies has already become one of the biggest solar players in the world.
Still, we are definitely not out of the woods yet. According to the international organisation ‘‘Transition Path Initiative’ only three big energy providers (namely, TotalEnergies, ENI and Occidental) are currently aligned with a 1.5°C scenario as set out in the Paris agreements. Even though TotalEnergies seems to be heading in the right direction, its current strategy does not consider so-called ‘Scope 3’ emissions (i.e., the consequence of company’s activities that occur from sources not owned or controlled by it). This specific shortcoming has led to a significant amount of pushback from institutional investors during the company’s latest annual general meeting. We clearly have to remain selective and critical when it comes to big promises from big oil.
BEYOND DATA WITH ACTIVE ENGAGEMENT
The so-called ‘Green Premium’ refers to the extra cost you end up paying for a clean technology, compared to one that emits a greater amount of greenhouse gasses. It can also be the result of regulation that initially directs investments towards obvious green companies (‘the usual suspects’). However, as the EU Taxonomy broadens its scope and includes other objectives, the investable universe will also increase, sectors biases will shrink, and green premia will decrease.
To limit the impact of the green premium and go past the usual suspects, it is key to look ‘beyond the data’. ESG data in particular tend to focus on past developments without sufficiently considering future potential and momentum. This can be partially offset by focusing on measures such as a company’s Capital expenditure for example, which is more forward-looking.
To conclude, our convictions are clear: A combination of active engagement with companies or governments, as well as strong qualitative and fundamental research are key to any investor who wants to go beyond ‘the usual suspects’.