Driving a “Just Transition”

Written By: Stephen Hearle Co-Head of Institutional & Wholesale Distribution Nordea Asset Management UK

Stephen Hearle of Nordea Asset Management UK looks at how a greater focus on the social elements of ESG can make financial sense

What is an Inclusive Green Economy?
COP26 saw experts from around the world discussing the actions needed to reduce human impact on the environment and the structural commitments required to reduce our reliance on fossil fuels. While combating climate change remained the key focus, this year making a “just transition” became a complementary topic.

The Covid-19 pandemic has thrown a spotlight on social inequalities and injustices. The challenges posed by lockdowns, loss of income and changing ways of doing business have hit certain segments of society much harder than others, showing clearly how precarious the lives of many people really are. People are recognising that the transition to a more sustainable economy must be made in a way that doesn’t disadvantage certain segments of society. We are now aware that improving human well-being and social equity while reducing environmental risks and scarcities are beneficial to one another, thereby setting the soundness of building an Inclusive Green Economy.

The European Environment Agency has defined a Green Economy as one in which environmental, economic and social policies and innovations enable society to use resource efficiency – thus enhancing human well-being in an inclusive manner – while maintaining the natural systems that sustain us. An Inclusive Green Economy protects the ecosystem and ensures resilience, while also being associated to a set of opportunities, for both:

• People: to improve their life quality, increase social equality and create opportunities to enhance human lives
• Businesses: to benefit from more efficient and responsible production and take advantage of growing markets for environmental goods and services

As such, the concept of the Inclusive Green Economy forms a pathway towards achieving the 2030 agenda. It also creates an investment opportunity, as achieving the UN’s Sustainable Development Goals (SDGs) could unlock economic opportunities worth at least 12 trillion USD/year by 2030.

Bridging the gap
In 2015, the international community, recognising the need to safeguard the future wellbeing of our societies, launched the UN sustainable development goals. For companies and investors alike, the SDGs offer a framework with which they can align long-term value creation with the most pressing needs of society.

An estimated annual investment of US$5-7 trillion is needed to meet the SDG’s goals by 2030; current investment in SDG-related themes is US$3 trillion per annum, leaving a US$2-4 trillion annual investment gap¹. While most ESG inflows are geared toward the “E” in ESG, 11 of the 17 SDG’s are oriented toward social empowerment. We believe this presents a huge opportunity for companies that can meet this need. For investors, this means bridging the financial gap by backing those companies offering social goods and services. This isn’t just about prioritising social issues, it also makes financial sense.

Environmental, social and governance (ESG) investments are more popular than ever with assets expected to reach US$140.5 trillion within the next four years, accounting for one-third of global AUM². As the trend builds, investors are expanding their horizons beyond the “E” to consider factors that fall within the “S” category – e.g. labour rights and standards, health and safety, human capital development and diversity. The corporate reputational and regulatory risks companies face can cause lasting damage and drive down stock value, while ESG leadership can provide upside. An increasing body of data suggests there is a link between ESG and financial performance.³

The ESG zeitgeist is here to stay
Certainly, if anything has taught us the importance of social stability and cohesion, it’s the outbreak of Covid-19. Every country, sector and individual has been impacted by the pandemic, which has highlighted the importance of examining the sustainability of global business models more closely. Covid has also been a good litmus test for investors to assess how resilient companies have been in the face of the crisis and how prepared they are for any future disruptions.

ESG considerations in investing have taken on particular relevance in light of the ongoing health crisis. The virus has had a profound impact on the global economy. The initial lockdowns imposed in response caused a collapse in the oil price, a broad-based sell-off in risk assets and an unprecedented suppression of economic output. In this environment, ESG investment solutions performed strongly, throwing an additional spotlight on the area.

The pandemic has not only highlighted in particular the social challenges that some business models are facing, it has also flagged the agility of companies which were able to adapt more easily to new ways of working and those whose businesses were able to thrive as they met pandemic challenges. For example, Chinese e-health provider Ping An has been particularly well-positioned for the rapid surge in demand for its services during the pandemic. The company has been helpful in reducing the strain on hospitals during these difficult times. The number of new users on its digital platform rose nearly 900% in January 2020, over the previous month.

In addition to pandemic-driven investor focus, ESG has also taken on greater significance within the regulatory landscape, with new requirements to report on certain aspects of ESG – once solely voluntary but now mandatory – in many jurisdictions, including the UK, EU and Hong Kong (and the US likely to follow suit).

Shifting toward the “S”
To date, the “E” has dominated focus within the “ESG” landscape, with environmental concerns like climate change high on the list of investor priorities, while the “S” has lagged. Regulation on ESG issues has overwhelmingly focused on the “E” and the “G” – something we also see in terms of the availability of corporate data. This is partly because social issues are slightly more difficult to define and are more qualitative in nature. This has been apparent even in terms of the disparity in the standards and ratings available to investors between the “E”, the “S” and the “G”. The financial and investment world has identified a number of tools to measure and report on environmental impacts, ranging from standardised methodology to measure carbon footprints, all the way through to consistent reporting standards within corporate accounts (such as those being proposed by the TCFD, the Task Force on Climate-related Financial Disclosures). Social reporting is lagging far behind this, with little consensus yet reached on how or what companies should report.

However, this is changing. Regulation is becoming more defined in terms of social issues and – as was the case with environmental reporting – social reporting is moving from the voluntary to the mandatory. In Europe, for example, the European Commission is expected to issue a directive that requires human rights due diligence for companies based (or with operations) in the EU. The EU Sustainable Finance Disclosure Regulation (SFDR), which came into force in March 2021, will require financial market participants to disclose on the sustainability of their funds – including adverse impacts – with the first mandatory reporting required in July 2022. While the EU Taxonomy regulation, which is building a framework by which economic activities can be assessed as sustainable or not, is currently focused on identifying detailed criteria for environmental sustainability, its next steps will be to address social criteria.

Because investors must disclose the sustainability of their funds, the companies they invest in will be required to report the relevant information. This year, the European Commission adopted the proposed Corporate Sustainability Reporting Directive (CSRD), which will replace the current EU Non-Financial Reporting Directive (NFRD) in 2023, to require companies to provide sustainability information to investors, including social and employee impacts, respect for human rights, and anti-corruption and anti-bribery matters. With the Biden administration advocating for greater corporate disclosure on issues like human rights abuses, the US may not be far behind Europe.

Ratings agencies are also recognising the importance of “S” considerations in issuer credit quality. Fitch specifically considers social “risk elements” such as human rights, community relations, labour practices, exposure to social impacts and data security. S&P, against the backdrop of the pandemic, has committed to monitoring the effects of safety management and community engagement on credit quality over longer time horizons.

Recent social justice movements and call-out culture emphasise how people are demanding more of the companies they invest in. Indeed, a report from the Organisation for Economic Cooperation and Development underlines the fact that investors are increasingly seeking both enhanced financial returns over time, and the societal alignment of their investments, to maximise financial and social returns. This is particularly true among younger investors, who were more attentive to the actions of companies in response to the Covid-19 pandemic. With millennials set to inherit $30 trillion over the next 40 years⁴, this is a clear opportunity companies and investors can leverage to meet demand.

What has become clear is that investors need to shift their thinking away from the environment as a single issue, and instead consider it as something to be addressed in conjunction with social challenges. However, these issues together must indeed be addressed. Failing to act on goals like social equity and resource parity may have an impact across geographies and sectors, which in turn could have detrimental effects on the global economic system, resulting in damage not only to investors’ assets but also their lives.

Nordea Asset Management is the functional name of the asset management business conducted by the legal entities Nordea Investment Funds S.A. and Nordea Investment Management AB (“the Legal Entities”) and their branches and subsidiaries. This document is advertising material is intended to provide the reader with information on Nordea’s specific capabilities. This document (or any views or opinions expressed in this document) does not amount to an investment advice nor does it constitute a recommendation to invest in any financial product, investment structure or instrument, to enter into or unwind any transaction or to participate in any particular trading strategy. This document is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instruments or to participate to any such trading strategy. Any such offering may be made only by an Offering Memorandum, or any similar contractual arrangement. This document contains information only intended for professional investors and eligible investors and is not intended for general publication. © The Legal Entities adherent to Nordea Asset Management and any of the Legal Entities’ branches and/or subsidiaries.

1. Source: United Nations

2. Bloomberg Intelligence, ESG assets may hit $53 trn by 2025, a third of global AUM, 23 Feb 2021

3. N. C. Ashwin Kumar (2016), ESG factors and risk-adjusted performance: a new quantitative model. Journal of Sustainable Finance & Investment, 2016, Vol. 6, no. 4, 292–300; Kaiser, L. (2020). ESG Integration: Value, Growth and Momentum. Journal of Asset Management, 21, 32-51. https://doi.org/10.1057/s41260-019-00148-y

4. N 9 (NYU Stern)