This article was first published in BDO Horizons 2020 - Issue 4
ESG is not new, but it’s now more important than ever. Material risks of a company are broadening and becoming more complex with the realities of climate change, global health pandemics and rising industrialisation.
Global economies and companies will have to adapt to the new systems which mandate more rigour and transparency around how a company behaves. Equally, the investment process is rapidly changing with ESG factors forming a core component when evaluating deal opportunities. Only this week, a large gold merger in Australia dedicated a considerable amount of the announcement to its ESG commitments and affiliations.
Blackrock have led the charge here stating that ‘climate change has become a defining factor in companies’ long-term prospects’ and is an investment risk. Larry Fink, in his open letter continues with ‘in the near future - and sooner than most anticipate – there will be a significant reallocation of capital.’
PUSH – PULL FACTORS AROUND ESG
Last month the New Zealand government announced that it will be mandatory for all financial institutions with $1billion in assets under management to report on climate related risk using the TCFD (Task Force for Climate Related Financial Disclosure) framework, which is being increasingly adopted around the world to enable financial markets to better understand and price climate-related risk.
In the same month the Chinese government announced a ‘jaw-dropping’ plan to be net-zero by 2060.
Whilst these are two vastly different countries, they are examples of governments now looking to take leadership positions, geopolitical or otherwise, in what could be a race to be green.
Up until now, the transition to low carbon has been predominately a ‘pull’ movement, led by various global institutions, NGO’s and community activists. However, there is now increasingly a ‘push’ factor evidenced by government policy and financial institutions raising the standards around who and where they invest. Stock exchanges have also taken note of the shift to sustainable financing; 24 of the main exchanges now require their listed companies to report on ESG issues.
The rise in engagement of investors has meant companies must be transparent around their conduct of operations and development and delivery of products/services in relation to providence of materials, ethical supply chains, modern slavery and impact on the environment and community, to name a few. Whether being ‘pushed’ or ‘pulled’ most companies will be discussing ESG at the boardroom, and if not, should be. The market and money are moving fast and, could catch companies out if they can’t respond clearly on their environmental, social and governance policy.
MOVING FASTER THAN PREDICTED
COVID-19, whilst arguably predictable, has been the Black Swan event of our lifetime and will ensue a number of unintentional consequences. It’s predicted that many government stimulus packages are being earmarked for the green economy which will help accelerate the transition to a low carbon economy. The stimulus will not only create much needed jobs but will create a step-change that will reshape economies, retiring certain sectors and turbo charging others. In good economic times, it can be difficult to retire un-productive industries, but the global health pandemic has provided an unprecedented, and perhaps timely opportunity to address another impending global crisis, climate change and the loss of the earth’s biodiversity.
Furthermore, the rise in energy nationalism will likely increase the speed in which renewables are deployed placing added urgency to the oil and gas and associated companies proposed transformation plans.
IT’S ALL ABOUT THE MONEY
Global ESG investment has doubled over the past four years and is not looking to slow down.
Sustainability-linked lending is also taking off. Borrowers are rewarded (or penalised) based on their performance against ESG metrics (e.g. carbon emissions). Investors, both big institutional investors and smaller, sustainability focused ones, love it. Green lending burnishes investors’ ESG credentials. And if the issuer misses the sustainability target the interest rate rises, the investor gets a higher return. In the two years to 2019, such issuances rose from virtually nothing to US$122bn (according to BloombergNEF, an energy consultancy). The single biggest issuer in 2019 was Shell, with US$10bn in capital linked to its carbon footprint.
WHY HAVE AN ESG FRAMEWORK
Right now, there are only upsides in adopting a globally recognised ESG framework. What can be measured, can be managed as they say.
Whilst the ESG alphabet soup (multiple classifications, metrics & providers) is still evolving, and common standards needed, certain evidence is pointing to those that do have ESG frameworks perform better than those that don’t. And it can attribute to higher valuations. Conversely, if a company lacks a clear ESG agenda and is looking for an investor/investment, a buyer may subscribe a discount to reflect the lack of long-term risk management and perceived risks. Increasingly so institutional investors are actively avoiding ‘sin industries’ and assets with poor ESG standards.
Singapore’s largest government sovereign wealth fund, GIC states “this relationship between sustainability and long-term returns will become stronger over time, as markets price in externalities such as a company’s environmental impact into valuations and as regulators, consumers, and businesses become more ESG-conscious.”
ESG is a tool for companies and investors. It’s to communicate on strategy, performance and disclosures around ESG brought on by climate risk and customers who want investments aligned to their values. Greenwashing, in short, a term used when a company spends more money on marketing their ‘green’ initiatives than actually investing and acting on change, will no longer cut it.
In much the same way the digital economy created ‘Kodak’ moments for companies, the energy transition will do the same for those unable to have a clear narrative on their ESG strategy.
Please do get in touch with us if you'd like to discuss your company's approach and strategy around ESG. You can also see our Energy in Transition website for more information about how we can help.
Feel free to download the BDO Horizons 2020, Issue 4 below.