In the opening session of the second day of Sustainability in Practice, Stephen Kotkin, Professor in History and International Affairs, Princeton University warned that the sustainability debate needs to become less ideological and more practical. He added that policy on a carbon price would do more to counter climate change than Biden’s huge infrastructure spend.

Expect little progress at this November’s COP26 unless governments are held accountable for their promises. Looking back over progress in the wake of previous UN climate change conferences, Stephen Kotkin, Professor in History and International Affairs at Princeton University warned the lack of enforcement mechanism means that few government pledges and ever implemented.

Promises amount to a goodwill pledge that few governments, rarely in power at future meeting or when deadlines come due, see through. Even progress around implementation in France, home to the Paris Accords, has stalled in the face of political protest by the Yellow Vests, he said.

“The current path is not working,” he said, urging for a more consultative and less ideological process – and the ability to force governments to comply.

“When something is not working trying harder at the same thing is often not successful. It is better to change the terms of the debate.”

Ideology

He said the climate change conversation needs to lose its ideological zeal, noting how a backlash in the political space typically follows ideologically driven activity in the area of sustainability. Key policy areas to focus on include the carbon price and building a new electricity grid.

“If you look at Biden’s stimulus, the one thing not in there is a carbon price,” he said, noting that today’s ideological politics makes introducing a carbon price difficult.

Moreover, despite pledges to build out renewables, without grid transformation progress will stall. By introducing a carbon price and a new grid leaders could achieve more than they can by going to international meetings “to make pledges they won’t be around to see fulfilled.”

The climate debate can become less ideological if the conversation becomes more practical, he said. He said people didn’t want to be forced to make uncomfortable decisions; the solution is compromise and managing change in a sustainable way. He said people needed to be able to compare a cost benefit calculation of action (to counter climate risk) versus a cost benefit calculation of inaction.

Reflecting on the possibilities for compromise and practical thinking over ideological mantra, he said “ironically” big advocates of carbon pricing include carbon producers. A carbon price would allow them to calculate the cost into their operations without outlawing their business in a compromise that caters to interests on both sides.

Encouragingly, Kotkin said that debate about climate change had been won.

Moreover, huge consumer demand and changing behaviour is radically altering industries. For example, the rise of the meat-free sector and electric cars is indicative of big industries turning on their head because of changes in consumer behaviour.

Despite this, he noted pervasive greenwashing, stimulated by our approach to sustainability. However, he said that greenwashing would become more challenging when greenwashed portfolios performed worse than portfolios that measured climate risk properly.

Sustainable accounting

Elsewhere, encouraging signs of change include new international reporting standards for sustainability.

The IFRS Foundation, the body that oversees the work of the International Accounting Standards Board, IASB, in setting financial reporting requirements for most companies in the world outside the US (where these requirements are set by the Financial Accounting Standards Board) is on track to launch a Sustainability Standards Board, SSB, at the UN’s COP26 climate summit in November.

Kotkin warned that adoption will be a difficult process, but voiced his confidence in the foundation.

He said that new standards would be “worth their weight in gold” for investors and would herald a bonanza for potential investment.

“It is only investment that can get us where we need to get,” he concluded.

The climate challenge requires new investment on a staggering scale: new generating capacity, the electrification of everything, emissions-free fuel, carbon capture and sequestration, new supply chains and infrastructure, plus the building of negative emissions technologies. Stanford’s Dr Arun Majumdar explores the opportunities for new investment, the risk return trade-off and how investors should approach the opportunities.

The world has two decades to find the solutions to keep warming to below two degrees, said Dr Arun Majumdar, Professor of Mechanical Engineering at Stanford University and former Acting Undersecretary for Energy at the US Department of Energy.

“If we can’t get our act together in the next two decades, we are likely to cross two degrees and need to plan for risk associated with 2.5 or 3 degrees,” he said, calling it the “defining challenge and opportunity” of the 21st Century. Majumdar noted how Europe and the US have set bold goals, particularly within the vast US infrastructure spend.

He said the number of corporate commitments to tackle climate change will increase in line with customer demand for more action. Here he noted retail giant Amazon, poised to introduce its first electric van, developed by EV start-up Rivian.

“Consumer demand is at a tipping point,” he said. “Consumers are willing to pay a premium for clean brands.” He noted that this in turn is set to make sustainable goods more affordable.

He said companies will be able to meet targets around decarbonisation with renewable energy, energy storage and electrification. Innovation like AI and cloud computing will stoke innovation further.

“We have to innovate our way out of it,” he said.

On one hand, innovation will comprise “sustained innovation” of existing technology. Charting sustained innovation in the car industry over the last century illustrates how products can evolve, scale and change with the times. In contrast, “disruptive innovation” in the same industry – like Tesla – comprises new technology that is initially expensive but then becomes cheaper.

“Battery costs will come down over the next few years. Tesla has moved the needle on this one.”

Innovation easier with existing infrastructure and supply chains

Innovation also depends on companies being able to tap the infrastructure and supply chains they need to thrive. Electric cars will need a new supply chain in a different model that will influence the growth rate of innovative companies.

In early-stage investment, the focus is on feasibility and the extent to which a new product is cost effective or competitive, he said. In the next stage, access to a supply chain and infrastructure becomes a priority.

“If you can use existing infrastructure, it’s much better than being dependent on a new infrastructure and supply chain,” he said.

Regulation also plays a part in corporate innovation as does access to low-cost capital. It is important to think where there are things down the line that could hurt you, he warned. “What is coming down the pipeline, so you are not disrupted in the future? Take a systems view on this.”

Majumdar also espoused the potential of hydrogen to meet sustainability goals. Success depends on putting the infrastructure and regulation in place, but he noted that electrolysis (a promising option for carbon-free hydrogen production) wouldn’t necessarily require new infrastructure platforms.

He noted that investment in these pioneering sectors involved working with teams that understand the technology, regulatory barriers and supply chain risk as well as an understanding of the policy needed to create these markets.

The Boston Consulting Group – the consultancy partner of COP26 – has worked across multiple industries with investors to transform high emitting businesses while creating meaningful value in the process. The consultant outlines why decarbonization and value creation can go hand-in-hand.

Companies developing a decarbonisation strategy can create value for their customers, investors and the planet, said BCG sustainable finance leads speaking at Sustainability in Practice.

Decarbonization holds two main levers that can drive value, said Thomas Baker, leader energy practice, BCG, adding that the levers are not mutually exclusive and that companies can pull both. On one hand decarbonization will reduce Scope 1,2 and possibly 3 emissions; the second lever to drive value comes with identifying new business opportunities and looking for new value pools where companies can leverage their competitive strengths.

The conversation highlighted corporate examples where decarbonisation has created value. Finish oil and gas company Neste has invested in biofuels, pushing into refining and development. Now a household name, the company operates globally and has introduced clear investor value by recognising the shift to biofuels.

Elsewhere, Nextera Energy, a US energy group, has changed strategy to derive more of its generating capacity from renewables away from fossil fuels. The company had done two things over the last decade, explained Baker. It has reduced its Scope 1 and 2 emissions, divested out of coal and invested in renewable clean fuels for its own electricity production leaving the business now split between renewables development and its core utility business.

“It has created significant value for shareholders over the last decade,” he said.

He added that Nextera is an example of how decarbonisation can create a “win for climate, customers and shareholders”.

“When utilities shift to renewables it can lead to less cost for customers,” he said.

BCG notes that some of the hardest sectors to decarbonise are in industrial goods, and carbon intensive industries that use processes that can’t be easily electrified, requiring fuel as a unique chemical property. For example, aviation could be one of the hardest industries to decarbonise because of oil’s high energy density, needed to power planes. For sure, sustainable aviation fuels are developing but they are costly, and the supply of biofuels holds challenges. Similarly heavy road transport could be hard to decarbonise.

Panellists urged investors to take on exposure to sectors where opportunity exists. Importantly, investors should consider the fact some sectors need more time to reduce emissions. Net zero is exciting but ensure you have enough flexibility in the portfolio to tolerate assets with higher emissions if those companies are on track to achieve a lower carbon footprint, they advised.

Vinay Shandal, global leader, sustainable finance, BCG noted the recent proliferation in enabler funds, whereby investors take a stake in a company on track for a broad sustainability transformation.

Shandal also touched on how sustainability can drive value in other areas. Getting a company’s sustainability story right helps companies secure the best talent, informs consumers purchasing decisions and allows companies to break into new customers and secure a pricing premium. “Operational value creation is driving a lot of excitement,” he said.

He concluded that the combined function of maturing technology and policy frameworks is seeing value pools shift and said that investors should bring capability as well as capital to companies, and that technology, data, and measurement solutions are all vital.

What does it really mean to achieve a net zero strategy? As more investors make pledges for net zero, they need to set a strategy to achieve it. Investors leading the pack – ABP, Church Commissioners for England and CalSTRS – discuss the behaviour changes that are needed and how to allocate.

The Netherland’s €493 billion civil service scheme ABP has had a sustainable policy since 2008.

Since then, it has steadily strengthened policy and set more targets, with strategy shaped around asking the pension fund’s stakeholders and beneficiaries to list their ESG priorities.

“Every year we ask them how they view our sustainability strategy and for their preferences,” said Diane Griffioen, chief investment officer of ABP, speaking at Sustainability in Practice adding that the pension fund’s board is closely involved in the process.

The bulk of ABP’s assets are managed by Dutch asset manager APG although the fund does also use some external managers. If these managers wish to invest in a company that doesn’t fit the fund’s sustainability criteria, managers must put forward an engagement plan that the sustainability team then reviews. It led her to stress the importance of working with others around engagement and standards.

“Using the same standards would help comparisons.”

One of the key reason the £9.2 billion Church Commissioners for England embarked on its own net zero strategy was to align its own goals and ambitions with investee companies.

“We didn’t feel it was credible in our engagement and stewardship policy when we asked others to align with Paris, but were not doing it ourselves,” said Tom Joy, CIO at the fund.

He said skills across both the investment function and executive level, plus clear communication is key to success noting the “challenge of getting everyone on board with what we are trying to do.” The fund has a seven-member internal responsible investment team.

“It is a journey we have been on for the last decade,” he said.

At Church Commissioners, ESG is embedded in manager selection where the fund has recently added additional requirements around diversity and inclusion.

“We engage as much with managers as we do companies, asking them to improve,” said Joy, adding that “telling managers what to do” doesn’t work. Instead, relationships are based on partnership and cooperation. He added that the fund tends to partner with managers who are implicit about ESG integration; his team’s role is to nudge them to being more explicit so that the pension fund can take more assurance from the manager strategy.

Elsewhere he said the fund has a particular focus on real world impacts where it “looks under the bonnet” on how well the portfolio aligns to real world impacts.

Panellists reiterated the importance of building the right skills and frameworks at an executive and non-executive level. Frameworks like the TPI help assess investments and the extent to which companies are meeting the challenge. Clear and transparent communication is key given “the finance industry is good at over complicating,” warned Joy.

Board level buy-in is crucial to CalSTRS sustainability success, said Geraldine Jimenez, director of investment strategy and risk at the fund where sustainable investment includes a green bond portfolio, investment in a low carbon index and vocal stewardship and engagement as well as thermal coal exclusion. She said that achieving a net zero portfolio required investee companies to move into this new environment. Cutting carbon in the global equity portfolio is easier than in other allocations, especially a 30 per cent allocation to private assets where data is scarce.

Strategy is also influenced by CalSTRS passionate teacher beneficiaries – who often bring pressure to divest. The pressure CalSTRS and other asset owners bought to bear on oil giant Exxon that resulted in board level director changes will act as a flag to other companies on the importance of disclosure and the power of investor engagement.

She said greenwashing will become more difficult the more investors can use the same language and structures. Investing in-house helps prevent greenwashing, but the problem calls for the wide adoption of standards and the same measurements and working with like-minded investors.

Concluding with a look ahead to COP26, panellists reflected on the importance of the conference addressing the need for a Just Transition and stressed the need for regulatory ambition.

“We would like to see the end of fuel subsidies of fossil fuels that many governments have in place,” concluded Joy.

Poor corporate sustainability disclosure and the absence of global standards is now a systemic risk for investors, said panellists at Sustainability in Practice which included chief governance and compliance officer at Norges Bank, Carine Smith Ihencho.

Investors need a global standard against which they can measure corporate sustainability based on comprehensive disclosure, said Carine Smith Ihenacho, chief governance and compliance officer, Norges Bank, manager of Norway’s giant SWF which invests in an estimated 9,000 public companies.

She told delegates that better disclosure was essential to enable investors to make better decisions.

“How companies deal with sustainability issues affects how much money they make,” she said. It affects how they address business opportunities, and disclosure is also vital in informing the engagement process. Norges Bank held over 3,000 meetings last year she said, outlining a strategy grounded in access to information, regular reviews and divestment considerations.

Ihenacho said that investor knowledge of corporate sustainability risk should includes sight of risk in corporate supply chains and customer bases, entailing “a list of suppliers and country-by-country revenue.”

Moreover, she said investors needed to know how companies are managing these risks including reassurance of board level oversight, strategic decision making and policy initiatives to deal with the risk. Performance metrics to measure how a company is responding to the challenge around, for example, reducing Scope 1 and 2 emissions, are also key.

She noted that corporate reporting is getting much better but that there is still a long way to go – particularly around corporates producing correct and comparable data.

Janine Guillot chief executive of The Value Reporting Foundation referred to the lack of corporate ESG disclosure as a market infrastructure problem. Solving it involves pulling three levers – a regulatory lever where she noted the EU’s leadership, and an investor lever.

“Investors are doing a fantastic job mobilising globally to get standardisation,” she said.

A third lever must come from companies themselves where she noted many lagging in terms of engaging with a global solution. She said investors’ ability to integrate information on sustainability into their decision making and have access to quality investment products is now a strategic issue.

In contrast, companies are not facing the same strategic issue – although companies want sustainable reporting simplified and less costly. She said the drive towards standards needs CFOs to get involved in the same way they were involved in creating global accounting standards. All the while investors need to continue to work directly with companies, helping them understand why change is so crucial.

One of the most important regulatory levers will come via the IFRS Foundation. The body that oversees the work of the International Accounting Standards Board, IASB, in setting financial reporting requirements for most companies in the world, on track to launch a Sustainability Standards Board, SSB, at the UN’s COP26 climate summit in November.

The hope is the new standards will give investors and other stakeholders as clear a view of corporate sustainability as they currently do financial performance in one integrated report.

Guillot noted that the initiative is a “building bloc” and will not meet the needs for every jurisdiction around the world. However, it will offer different regulatory organisations a global baseline.

The conversation detailed how investors are also closely watching progress in the US where SEC chair Gary Gensler has said he is in favour of the regulator stepping in to bring greater clarity and consistency to corporate climate disclosure. Panellists agreed that investors are united in their demand for standardised data and mandatory disclosure, unlike corporates where there is less call for regulatory action.

“Regulators are hearing mixed messages,” said Guillot. Given regulators will react differently in each market, she said a global solution will likely have to come from market forces, putting pressure on investors. “Investors need to be mobilised around engaging with companies and clear on their information needs.”

Reflecting on the SEC consultation process ahead of possible changes to corporate disclosure, Norges Bank’s Ihenacho noted that investors need better reporting beyond just climate change. The SEC should ask companies to use current frameworks like the TCFD, she added.

Delegates heard how Europe is leading the way when it comes to introducing regulation governing sustainable investment. Sven Gentner, head of asset management unit, European Commission’s Directorate-General for financial stability, financial services and capital markets union explained how high-level targets have been broken down to apply to individual parts of the EU economy and the financial sector.

He said the EU’s taxonomy, a common classification system for sustainable economic activities, will now be the common language. Elsewhere, he noted how the EU is proposing a European green bond standard and changes to reporting corporate reporting.

Mass PRIM is involved in an MIT initiative to improve ESG with better data, ratings and ultimately products. Executive director and CIO explains how the ambiguity around ESG ratings creates acute challenges for investors trying to achieve both financial and social return.

Rating agencies often capture the wrong or bad data and products in the market are not robust from an impact or investment perspective, according to Michael Trotsky, CIO of Mass PRIM.

This ambiguity around ESG ratings creates acute challenges for investors trying to achieve both financial and social return. He said Mass PRIM has analysed countless products from vendors and “they all come up short,” sounding concerns at pervasive greenwashing and commercialisation.

“We are committed and want to do better,” he said.

MIT’s involvement in trying to find a solution to the “bad data problem” involves Roberto Rigobon, Professor of Applied Economics at the MIT Sloan School of Management, renown for developing maths techniques to make noisy data actionable.

“He is not an ESG sceptic, he is a staunch ally and wants to make an impact,” said Trotsky, reiterating that ESG ratings are the Achilles heel of the sector which requires more robust techniques to “do ESG better.”

Boston-based Mass PRIM is partnering with the MIT Sloan Sustainability Initiative to improve the quality of ESG measurement and decision making in the financial sector, charting a course toward more rigorous, coherent methods for ESG integration.

Speaking at Sustainability in Practice Trotsky, who oversees around $100 billion in pension assets, outlined how the project includes development of an app that will allow beneficiaries to prioritise their different ESG preferences, listing which issues they care most about.

The hope is it will allow the investor to find common ESG themes that unite its diverse beneficiaries to then weave into strategy. The Aggregate Confusion Project aims to reliably assess investor preferences to enable ESG indices to be more customised and attuned to investors’ values, said Trotsky. He said the initiative is a consequence of current ESG indexes being crafted without consideration of investor preferences, and a growing belief that ESG investment urgently needs to better capture values.

 

Mass PRIM’s involvement in the initiative is linked to the investor struggling to find which ESG issues its 300,000 diverse beneficiaries in the pension funds it manages (ranging from teachers to firefighters and policemen) collectively care most about.

In what Trotsky described as Mass PRIM’s stakeholder problem, the broad range of views of its beneficiaries make it difficult to find commonality. Moreover, since the fund’s board also mirrors these broad views, it is similarly split.

“We hope to solve this problem by finding agreement on ESG values and attribute preferences,” he said.

Fellow panellist Bill Lee, chief investment officer of New York Presbyterian Hospital, overseeing its $9.5 billion investment program noted although the asset owner has started a bit later than others in ESG investment it is benefiting from learning from the more advanced efforts of other portfolios.

“We will catch up as we have great examples ahead of us,” he said.

He also noted that better technology and data will lead to more optimal positions, adding that data reveals which managers and companies are truly committed to improving sustainability, making it possible to better discern ESG laggards.