The burden of sustainability reporting was a cause of consternation amongst investors gathered at Sustainability in Practice at Cambridge University, but new standards promise to streamline the process.

Set up last year, the International Sustainability Standards Board (ISSB) aims to achieve a single, global standard that sets out the risks and opportunities of investing in a company, said Sue Lloyd, vice chair of the ISSB which was set up by IFRS Foundation Trustees, the body responsible for international accounting standards.

Lloyd said that today’s confusing landscape needs to be replaced with transparent information on sustainable risks and opportunities that doesn’t preclude supporting impactful investment. “Things that a company does to the planet effect its value,” she said. “Corporate actions that effect value is information we are interested in.”

Lloyd stressed the importance of companies combining sustainable reporting in their financial statements because of sustainability’s link to financial outcomes. And she noted how ISSB standards have drawn a great deal on TCFD recommendations but also taken them up a notch, seeking more quantitative detail that explains different outcomes and impacts. Companies need to explain how they will achieve their carbon targets; how they will use offsets and the standards will detail what certification they require, she said.

Harmonisation

Lloyd also stressed the need for regulators to work across jurisdictions to coordinate legislation. The ISSB is working with the EU and the US’s SEC; although different regions are not on the same trajectory, harmonisation around mandatory requirements is important because it reduces the risk of greenwashing. “Markets are not served by having choices and alternatives,” she said. She added that from a cost and efficiency perspective, it is in the interests of investors to have a streamlined process; once standards are in place, the arguments can stop and the focus turn to solving the problem at hand.

PRI

Fellow panellist David Atkin, chief executive of the PRI, noted the reporting burden on PRI signatories did require revision. He told delegates the PRI plans to revise and reduce the workload for asset owners regarding their reporting requirements – releasing its findings on the issue shortly.

Investors face a myriad of challenges understanding new regulations and reporting standards; accessing data, shaping their net-zero commitments and holding corporates and fund managers to account in a bid to wipe out greenwashing. He noted how rules on climate related disclosure from the EU and US will bring down barriers to sustainable investment. “Our investors want the SEC to do more,” he said. Elsewhere, the UK’s Roadmap to Sustainable Investing that requires large pension funds to report in line with climate change regulations, is driving a new regulatory awareness.

Hélène Bussières, deputy head of unit at the European Commission, picked up on the importance of regulatory alignment. One of the main objectives of the sustainable working finance group is interoperability between jurisdictions, although she noted different regions have different priorities.

Cop 27: what to expect

Frances Way, executive director, Climate Champions team supporting the High-Level Champion for COP26, looked ahead to the expectations of COP27 in Egypt. She said the focus will be on the need to finance lower income countries, providing projects that can be scaled. Mobilization will be a key theme, focusing on how policy makers can unlock finance and solutions like, for example, using multilateral banks to catalyse private investment, a policy that has struggled. “If we don’t invest in [emerging economies] we all suffer and return to square one.”

The PRI’s Atkin noted the critical importance of a legal framework. He said that sustainable standards are a noisy and crowded field and that data needs streamlining. “This is something that will continue to be a major focus for the PRI. No one can solve it on their own,” he concluded.

CalSTRS, the $323.6 billion pension fund, is putting in place building bricks to meet its 2050 net zero pledge in a process that underscores the complexity and size of the task in hand. The pension fund won’t announce any firm commitments and targets until it has set up the governance structures; settled on the right incremental steps to net zero and understood how reducing emissions will impact its risk budget.

The pension fund is also looking at where it can invest in climate solutions in a total fund approach. It involves every asset class in a portfolio tasked with achieving a seven per cent annual return . “Getting the governance right really matters; we are spending a lot of time on this,” said Kirsty Jenkinson, director, sustainable investment and stewardship strategies, CalSTRS, speaking at Sustainability in Practice at Cambridge University.

That governance includes a leadership team setting targets, and an implementation team providing structured support with a private market and public market working group. Governance also prioritises next steps to maintain momentum. “With something this large, if you can’t break it down you lose traction and natural progress,” said Jenkinson. She noted a bigger challenge to measure and set base lines in private markets – although the majority of the pension fund’s assets are in public, passive allocations.

She added that CalSTRS net zero strategy also incorporates the influence the giant pension fund wields. This includes with policy makers; managing and shifting the portfolio around via active decisions and setting goals around what it can control. Where it has less active control, it will rely on market actors.

Shedding assets

Portfolio implementation around net zero will lead to investors shedding assets, said Anne Simpson, global head of sustainability at Franklin Templeton. She explained how when one investor sells unsustainable assets another buys them in a process that often leads to assets going into private markets where there is less transparency and oversight. “Investors can have a pat on the back because they are decreasing ownership of emissions, but this is not the same as being on the right path,” she said.

Information remains an enduring barrier for investors aligning their portfolios to net zero targets. Investors rely on estimates without standardized mandatory reporting. Simpson urged investors to support the IFRS Foundation’s new standard-setting board the International Sustainability Standards Board, ISSB. Elsewhere she highlighted the need to end the subsidies still supporting fossil fuels and said that a price on carbon would enable investors to price risk accordingly. She also urged investors to focus on systemically important emitters in line with Climate Action 100+ and stressed the importance of climate competent boards.

Benchmarks

Benchmark providers play an important role supporting investors pathway to net zero. They give investors the ability to differentiate between assets on a high carbon business model and those delivering the low carbon solutions of the future. Tools – known as portfolio alignment metrics – enable investors to distinguish the leaders from the laggards as economies adjust to a net zero future, explained Sylvain Vanston, executive director, climate change investment research, MSCI.

He said it is easier to achieve long term targets if investors structure in short term targets on route. And noted pros and cons around temperature metrics, and reflected the different trajectory of a carbon intensive company with an ambitious target to cut emissions in the same sector as a company with no transition plan. Reflecting on the data challenge, he said the benchmark provider uses proxies based on other models when there is no data. MSCI is developing a new framework supporting accessibility of targets, creating new guidance and stronger models.

Data challenge

Jenkinson attributed CalSTRS ability to measure a large amount of the public market portfolio to MSCI data. In contrast, there is no similar plug and play in private markets like real estate and private equity where some of the most exciting opportunities exist to allocate capital to companies providing solutions. “[Data] is asset class specific and depends on what is available,” she said, noting an additional challenge of aggregating up to a total fund level.

Simpson flagged the ESG Data Convergence Project, an initiative by leading global GPs and LPs to align around a standardized set of ESG metrics and mechanism for comparative reporting in private equity. Private equity, attracting criticism for asset stripping and questions about whether it constitutes genuine value creation, will benefit from the transparency, she said.

Simpson stressed the need to move away from traditional discussions around ESG integration (and its fabled ability to cure all things) and change the narrative to one of sustainability of the financial system. The debate needs to be reframed to talk broadly about the purpose of the financial system – whether providing retirement income or mortgages – to ensure better management of the financial capital on which society relies.

 

 

 

When Kimberley Lewis (pictured above), head of active ownership at asset manager Schroders, used to work at Pfizer in the corporate responsibility department she was struck by how investor engagement with the drug company was often wide of the mark. Investors engaged on topics that weren’t the most material to the company; asking questions that Pfizer’s team knew weren’t particularly relevant to the company or sector.

“Do your research,” she urged investors gathered at Sustainability in Practice at Cambridge University in a panel session exploring the key characteristics of good active engagement. “You really need to think about the relevant issues for that company at that specific time,” she said, advising delegates to start comprehensively planning and researching 2023 engagement priorities now, ensuring cadence and materiality to increase the likelihood of success.

Successful active ownership requires investors to outline their expectations to corporate boards and clearly state their aims, she continued. Having set specific asks, she urged investors to track progress but with humility – neither assuming or projecting: investors should claim their stewardship role but balance that with demonstrating positive outcomes.

Active ownership involves clear intentionality, agreed fellow panellist Catherine Howarth, chief executive of ShareAction, the NGO that coordinates civil society activism.  Investors can’t stumble into meetings ill prepared; they need to know what companies should do better with clarity around their asks. Investors should also have a plan of what they will do if corporate behaviour doesn’t change – preferably in agreement with peers seeking change. “People have different appetites for collaboration so collectively ensure you know what you are doing so the group doesn’t fall apart when you run into the first hurdle,” she said.

Engagement at Railpen, guardian and administrator of the United Kingdom’s £35 billion ($47 billion) Railways Pension Scheme, is managed internally mirroring the asset managers own bias to internal asset management – and growth equity. “This is a ripe hunting ground for stewardship,” said Michael Marshall, head of sustainable ownership. Articulating the benefits of internal stewardship, he said it helps ensure alignment between stewardship aims and pension fund beneficiaries, allowing Railpen to tailor its engagement and escalate on a timeline of its own choice. “We care about the issues companies face,” he said.

External benefits

The Universities Superannuation Scheme, USS,  divides its stewardship of investee companies between internal and external management. External stewardship is delegated to carefully selected and monitored managers, explained Phil Edwards, head of manager selection at the pension fund. USS requires managers take clear ownership of stewardship priorities at a senior level and demands transparent reporting so the pension fund can see managers are doing what they say – along with compulsory PRI membership. Managers are selected according to their approach on stewardship and engagement; voting and transparency and the ability to work with others and lead, he listed.

The pension fund also checks managers voting record is aligned with its own principles and seeks relationships from which its own internal stewardship practices can also grow and evolve. “We assess every manager on these issues and the degree of alignment with our own approach,” he said.

Elsewhere USS investment managers can expect an escalation process. For instance, the pension fund recently voiced its concerns about one manager’s stewardship strategy, leading to the manager appointing a new head of stewardship. “We are encouraged – and now want to see changes,” said Edwards. “Escalation with our managers is a serious conversation that can ultimately lead to taking away some or all of our assets. We haven’t don’t this yet, but we would if we felt a manager was not taking action in a way we would like.”

Skills shortage

Panellists also noted the workload ESG teams face meeting disclosure and internal stewardship requirements. Investors are buying-in and developing internal stewardship skills, but recruitment is hard in the current market as the race for sustainability talent increases. “If you are going to do stewardship internally, prepare to be patient and pay,” warned Marshall.

Make it matter

Pension funds should ground stewardship programmes in the key interests of their own beneficiaries. Outside climate (in everybody’s interest) ShareAction’s Howarth noted health was a priority for many beneficiaries. “When you ask people what matters, health comes above income,” she said. This could lead to pension funds engaging on issues like a sugar tax. She also noted how more investors are engaging on biodiversity where strategies could focus on the agro-chemical industry.

Her point was echoed by Railpen’s Marshall, who noted that stewardship at the pension fund chimes with issues close to its beneficiaries like workplace rights. “Members views are reflected in the themes we adopt,” he said.

Collaboration

Howarth stressed the importance of collaborating with groups, citing ShareAction’s engagement on the living wage with the supermarket Sainsbury’s, working alongside NEST and Fidelity International. Elsewhere, engagement is best focused on sectors because it leads to whole industries moving forward. Panellists concluded with a nod to encouraging signs of investors getting more assertive and intentional about what they want to achieve, as well as a growing number of collaborations between asset owners and managers.

 

 

United States policy has quietly encouraged India and other countries in Asia to buy Russian hydrocarbons to avoid a global recession, driven by energy and food shortages, according to US government adviser and Russia expert Stephen Kotkin.

While “no one wants Russia to get away with” invading Ukraine, an energy supply shock prompted by sanctions on Russian oil and gas by the US, Europe, Australia and others, would punish poor people in developing countries, he said.

Speaking at the Sustainability in Practice conference in Cambridge University this week, Kotkin said India, the world’s third largest buyer of oil, has taken advantage of cheaper Urals crude oil prices in March and April, buying more than its annual intake in what has been described as a large uptick in imports.

“If all Russian supplies were immediately taken off the market we would have that global recession,” the Professor in History and International Affairs at Princeton University said.

“Europe is immediately susceptible (and while the) US is trying to punish Russia with sanctions, we don’t want to hurt everyone including those poorer countries by inducing a global recession when there’s a possibility it might be avoided.

“(By the US) encouraging India to buy Russian hydrocarbons, Asian markets might pick up the slack of Russian supply and avoid a global recession,’’ Kotkin told the Sustainability in Practice, forum for investment leaders, organised for Investment Magazine’s sister publication Top1000Funds, in Cambridge, UK.

The problem with sanctions

While sanctions “felt good” as a punishment on Russia, there was nothing to gain by destroying commodity and food markets for many countries, he said.

In a scenario where Saudi oil supply faltered, the world would not be able to make up Russian supplies and this would halt manufacturing.

“German industry is dependent on Russian natural gas to power it. Fertilizer, for example, which is usually important, if you lose that, your yields go way down on your crops,’’ Kotkin said.

“There’s so much risk involved here to manage. No one wants Russia to get away with it but, on the other hand, we don’t want to punish innocent countries.”

Commodity supply issues

He said Russia’s commodity supply extended to palladium, titanium, neon, as well as “green” commodities cobalt, zinc and lithium used to make batteries and electric vehicles.

Kotkin quoted the late and former US Secretary of State, George Shultz, who said energy policies had to balance economic feasibility, environmental impact and national security.

In the last few years before Schultz’ death, in 2021 at age 100, environmental impact had been allowed to trump national security but with Russia’s invasion, national security might be allowed to trump environmental impact, he said.

Without a carbon price, which Australia had briefly legislated for, there had been a slow transition to renewable energy around the world as well as a slowdown in nuclear power plant rollouts which meant the world needed to invest in hydrocarbons in the short to medium term to avoid significant global food shortages.

Reducing reliance

Reducing Europe’s reliance on Russian oil and gas could see a “massive redirection” of liquid natural gas (LNG) from Asian markets to Europe building out LNG infrastructure in Europe in 18 months to two years instead of the usual five years, Kotkin said.

“If you’re optimistic you’d say it could be done without as much disruption as if it had to happen overnight,’’ he said.

“The move from Russian hydrocarbons is underway… you see the resolve and ingenuity of Europe and that’s cause for optimism.

“Europe has returned to the idea of being a buyer’s cartel, using its incredible purchasing power to form a cartel of buyers the way that OPEC Plus is a cartel of sellers.’’

Squandered recovery

But the Princeton professor said the world had squandered the Covid-19 recovery and an opportunity to transition faster to a greener energy supply.

“We have another opportunity again. Will we squander or take advantage of the invasion to change our behaviour and enact that successful management of the carbon market place?’’ he asked.

Kotkin closed his presentation by saying there were some challenges to a transition with stranded assets particularly with the need to invest in hydrocarbon infrastructure in the short term.

“If we’re making a transition, who’s going to invest in assets like LNG terminals that are significant in scale and capital, if those are going to be taken offline because of decarbonisation, how do markets manage investment in new assets designed to be obsolete at some point,’’ he said.

He suggested the trend towards deglobalisation would see countries work towards national solutions to decarbonise which were “piecemeal” but likely to work.

Investors struggle to influence sustainability in the trillion-dollar sovereign debt market. There is little evidence to suggest sustainability is important when it comes to pricing sovereign issuance, and investors that do prioritise sustainable sovereign investment are not sending a particularly strong message to the market, said expert panellists speaking at Sustainability in Practice at the University of Cambridge.

Moreover, many UK pension funds will continue to invest in UK sovereign debt to match their liabilities even if the country goes off track with its transition to net zero, said Will Martindale, group head of sustainability at Cardano, the pensions advisory and investment specialist which manages over £15 billion in DC assets across the UK and the Netherlands including operating the United Kingdom’s NOW: Pensions.

Martindale noted little attempt from sovereign governments to issue social bonds or bonds linked to sustainable KPIs, while fellow panellist Ella Hoxha, senior investment manager, global bonds at Pictet Asset Management (as pictured above), said there are inherent complexities for investors when it comes to “telling governments what to do” particularly in markets governed by undemocratic regimes or where sustainability has little traction.

Despite the challenges, panellists outlined the steps they are taking. Investors can invest in sovereigns that have committed to cutting emissions and meeting the Paris goals. “Investors can look at signatories to the Paris agreement; you can be an active allocator of capital on this basis,” Hoxha told delegates.

In developed markets this will incur a European bias and exclude the US, which will come in and out of sovereign debt portfolios depending on the US administration’s progress and commitment to lowering emissions. “This is a bias you can manage,” she said. Regarding the European bias, forming objective decisions on the different sustainable paths of, say, Germany and France is challenging for investors.

Understanding policy

Trying to understand sovereign sustainability policy exposes many complications. For example, emissions in Brazil could fall but on the policy side commitment to lower emissions or protect the Amazon remain weak. “The nuance behind the policy is important,” said Hoxha. She also noted that incumbent governments will prioritise elections over climate policy and that during elections, sustainable commitments may slip. She noted the importance of looking to governments future policies, a pertinent point in growing economies where GDP is rising and emissions creeping up. “We like to see an improvement in emissions for GDP reflected in policy,” she said.

Measurement

Accurately measuring sovereign emissions is another minefield for pension schemes. For example, investors need to consider whether they count state-owned companies only, or if they should count emissions of the country as a whole. Should they include a country’s exports and Scope 3 emissions, or just look at the issued debt of an economy?

Martindale added that when investors try and measure social issues in their sovereign sustainability calculations it gets even more complicated – particularly when policies run counter to factors going into that measurement like the United Kingdom’s 2021 decision to cut overseas aid.

Measuring commitments has also been complicated by war in Ukraine where Hoxha noted the resulting energy crisis will impact sovereign net zero pledges, many of which are now optimistic. Although on one hand governments need for energy security away from Russia will speed up investment in green energy, in the short-term, reliance on fossil fuels will grow. She also questioned investors ability to influence policy.  “The transition will take longer than we assume,” she said.

Counselling a realistic and practical approach, Hoxha said investors should look at sovereign policies, set their metrics and then “draw a line.” She added that investors are “not NGOs” and need to balance generating returns with prioritising sustainability.

The future

“We have more barriers than solutions,” concluded Martindale who also noted that investing in higher impact, sustainable sovereign assets can incur higher fees, liquidity issues and requires the support of trustees.

However, although engagement with sovereigns is still in its infancy the size of the government debt market means it will have a significant role to play in achieving the transition. Martindale also outlined his believe in the power of collaborative engagement to influence frameworks, policy, and behaviour.  Positively, sovereign sustainability could also become more of an investor focus given the challenging macro backdrop for fixed income as interest rates and inflation rise.

 

In today’s hot inflationary environment and where prices are forecast to rise further still,  the commodity markets (excluding oil and gas) could offer returns, inflation protection and impact, argued Carsten Stendevad, co-chief investment officer for sustainability at Bridgewater Associates, the world’s biggest hedge fund.

Speaking at Sustainability in Practice at Cambridge University, Stendevad said demand for inflation-proof commodities like copper, aluminium and nickel will grow given these metals’ role powering the energy transition, the essential components in building the renewable future from electric cars to offshore wind farms. Investing in these kinds of commodities also fits into Bridgewater’s 3D investment lens that focuses on impact as deeply and rigorously as risk and return.

Moreover, for the last decade investment in commodities has steadily fallen.

“Across all commodities there is a supply demand imbalance that will be exaggerated by the loss of Russian supply and the invasion of Ukraine,” he said. “It is very difficult to get to net zero without leaning into commodity production.”

Inflation on the rise

Stendevad argued that inflation is set to rise much more ahead.

“There is a market expectation that this is transitory and that after a tough environment, we will return to normal life. We don’t think this is realistic.”

Inflation will be fuelled further by the cost of financing the transition. Green public spending on renewables will fuel inflation further while supply and pricing of both fossil fuels and renewables will impact the macro environment. He noted however that advances in technology will have a disinflationary impact.

For the past four years, Bridgewater has been building out its sustainable assessment of individual metals and mining securities, exploring what different commodity companies are producing and how they are producing it. Stendevad advised investors to dig deep into individual companies to ascertain ESG integration in their production process like labour rights and the use of fossil fuels in extraction, as well as their products Scope 3 emissions.

He estimated that only around a quarter of the world’s companies have mapped their revenues, services and production processes to the SDGs in which cohort, listed metals and miners are few. While it is important to support mining companies on their transition journey, he noted that many mining groups are uncertain of their own transition path and don’t have a forward-looking carbon plan.

“It is too early for us to say that if we engage with companies, they will improve. It is really hard to assess most companies transition path.”

Still, Stendevad noted that some companies are doing better than others. A handful of mining companies provide increasingly valuable and granular data on their operations spanning water use, labour practices and community engagement.

“In the last year we have been surprised by the amount of information companies are starting to release,” he said. “It is about drilling into individual securities, and putting it into a portfolio that will be resilient in a tough economic environment. It is a complex task.”

3D approach

Stendevad said that the compulsion to invest for risk, return and impact is growing.

“Truly sustainable portfolios have an objective on carbon and financials,” he said. He noted that some investors find impact “a step too far” and that there are still asset owners who feel sustainability is not their responsibility. Yet he argued it is liberating to put sustainable investment through the lens of risk and return.  He reiterated the importance of investors understanding the goal of their portfolios and a systemic approach to define what they mean by sustainability.

“You have to own the concept and define what it means to be sustainable,” he said.

Different industries have different challenges. For instance the auto industry faces the challenge of shifting to electric vehicles. In the case of metals and mining, the challenge is less about the product and more about how it is produced. In the mining industry, core business will need to be transformed with KPIs around operating practices; investors will need to take a view on the key items that companies need to address and the credibility of those plans.

“Are they spending money to make the changes required?” he asked. “There are a whole set of things you need to look at to give you confidence.”

He warned investors to not be too reliant on commitments but look for signs of action and real transition.

“Companies know they need to change; when we speak to companies, we see a level [of commitment] we didn’t see before,” he concluded.