Introduction
Since its “officially” tracked inception back in the mid 1990’s, or at least when it started to be of significant interest, impact investing has seen dramatic growth. According to many, this trend will continue upwards due to increasing climate problems, government and business commitments to these, and the increasing voices of younger generation investors who are statistically more conscientious and concerned with “making a difference” and who want their investments to make more than money (these are often referred to as “personal values investors”).
In this note, we shall discuss the following aspects of the impact investing phenomenon:
Climate deterioration as a key driver behind the impact investment development.
Emission of atmospheric pollutants, including CO2
Implications for:
Investors
Asset managers
Corporations
The challenge of reporting.
At this point is should also be noted that there are several “competing labels” to impact investing, responsible or socially responsible investing (which reduces harm) or sustainability investing being perhaps the most commonly used alternative, or even regenerative investing (which evolves capacity) . In this note we shall use the impact investing label solely, however.
Global Warming – the key driver
Recently we have been seeing dramatic changes in the world’s climate, mostly for the worse. Examples: temperatures have gone up significantly, almost everywhere, and the ice formations around the North Pole, including Greenland and the Oceans of Northern Russian are melting at an alarming rate. To a lesser extent, we see this also in the far south. Hurricanes are becoming more abundant, with major damages from flooding and/or strong winds, perhaps most noticeable in Central America, the Mexico Bay area and in South East Asia. Large areas of our earth are experiencing sustained extreme draught, perhaps above all in areas of Africa, and so on. We could go on and on. Most scientists, as well as politicians, seem to agree that our earth’s climate is deteriorating.
There have been noticeable responses, but so far without much tangible result. First of all, there seems to be general political agreement that the climate challenge is a global phenomenon. A small minority of politicians seem to deny this, such as ex-President Trump in the US. However, the almost general acceptance that climate deterioration is a world-wide dilemma is noticeable.
Second, there have been at least four global conventions (such as COP25 United Nations Framework Convention on Climate Change - UNFCCC, World Climate Conference, WHO Global Conference on Health and Climate) where this phenomenon has been the topic, and where revised targets and ameliorating actions have been discussed and even agreed upon, so far without much effect. The first such conference, held in Rio, was followed by global meeting in Kyoto, Doha, Copenhagen and Paris, and another such global meeting is scheduled for Glasgow in 2022.
The meeting in Paris was indeed different from previous ones, in that the so-called Paris Agreement (UNFCCC) was agreed to by the majority of delegate nations, including all of the world’s large powers. Specific CO2 emission targets were set (see next section), and deadlines established. A differentiation between the so-called developed nations and the developing ones was introduced, whereby some lesser developed nations were granted more time and emission quotas so as to guide their economic developments. The bulk of the economic burden was to be carried by the developed countries, the US in particular.
As we know, the US withdrew from the Paris Agreement during the reign of ex-President Trump. However, it is noticeable that all the other world nation signatories remained. Further, significant “polluters” such as China, have committed themselves to specific ameliorating emission targets, such as to become carbon neutral by 2060 in the case of China. And the US has rejoined the Paris accord and even established a cabinet level position to deal with the climate issue, headed by former foreign secretary, presidential candidate and senator John Kerry.
The Key Driver: Emissions of pollutants, such as CO2
The emission of polluting gases into the world’s atmosphere seem to be at the heart of the problem. Most well-known is CO2. However, there are many other potentially dangerous pollutants, such as Sulfur oxides (SOx), Nitrogen oxides (NOx) and Carbon monoxide (CO). Noticeably, the emission ozone gas a few years ago was curtailed, through a worldwide agreement mostly among industrialized nations. Spray bottles, then-conventional refrigerators and so-called reefer ships were forbidden or significantly curtailed. Alternative technologies were developed. The result seems to have been a significant improvement of the so-called ozone hole in the atmosphere around the South Pole.
The major challenge, however, is to limit the emission of CO2. The statistics regarding the global emissions are not encouraging. According to the EU Commission’s EDGAR (Emissions Database for Global Atmospheric Research), “the global GHG emissions trend has increased since the beginning of the 21st century in comparison to the three previous decades, mainly due to the increase in CO2 emissions from China and the other emerging economies.”. EDGAR reports that compared to 1990 numbers, in 2019 CO2 emissions from the power industry saw a 78% increase, from other industrial combustion by 67%, from buildings by 8%, from transport 78%, and from other sectors 100%.
Where are these emissions coming from now? Are there specific industries? It may be useful to distinguish between types of firms that are directly contributing to CO2 emissions, in contrast to firms that indirectly might be close to the source of this problem. The Eco-experts claim that the fuel, agriculture, fashion, food retail, transport, construction work and technology industries rank as the 7 most polluting industries. A few more comments to consider:
Direct polluters – Perhaps surprisingly a very significant source of CO2 emission comes from cattle. We are accordingly witnessing a gradual change in eating habits, away from meat, in part to decrease health risks but also to help reduce CO2 emission (plant-based hamburgers, …). The shipping industry is also a major source of CO2 emissions. Stringent new rules for emissions in this industry are coming into effect in 2022. In the airline industry, new engine technology is leading to important reductions of CO2. In general, technological advances are critical. Coal-fired electric power plants are still a problem. However, new natural gas-powered power plants are not less expensive! Thus, we see positive effects from alternative used of fuel to burn.
Indirect polluters – CO2 emission results, in most cases, from the burning of materials that are carbon-rich, such as oil, coal and/or wood. Thus, major indirect polluters are oil producing companies, as well as coal mining firms.
So, what are some of the key implications of these pollution-related issues? We shall now discuss these for three stakeholder groups:
1) For investors
The key for most investors shall be to restructure their investment portfolios, with less focus on direct and/or indirect polluting entities. Many investors are utilizing so-called index funds for shaping their portfolios. For them, it shall be critical to be able to identify good alternative index funds, which avoid the direct/indirect polluters while nevertheless providing satisfactory promised investments returns. In general, it appears that there are indeed such funds available, i.e. which do not “impose” a “penalty” on investors for “going green”!
2) For asset managers
Examples of major asset management firms that have pioneered the development of impact investing (avoiding heavy polluters) are Blackstone, BlackRock, UBS, Credit Suisse and others. These firms tend to pursue two avenues:
They tend to offer specific “clean firm” investment opportunities.
They tend to offer funds that are “light” or totally defunct from polluting firms, based on indexes that are similar.
Many asset managers are also following through in the way in which they rate their specific holdings when it comes to companies that might be dealing with pollution challenges. Are such firms specifically making progress in implementing strategies that would result in them becoming “cleaner”? And/or are top management, as well as boards of directors, also showing clear commitments to the avoidance of pollution? While such rating behaviors on behalf of asset managers do not typically lead to specific changes in strategies, board compositions and/or top management positions, such ratings can often send important signals to the investment community, to politicians and to the employees alike. So-called activist investors are increasingly following suit when it comes to these rating actions.
3) For companies
As already alluded to, corporations shall now typically want to develop strategies that specifically take into account how to reduce environmentally dysfunctional effects, such as pollution. And, this shall also be reflected in these companies’ reporting, in most cases (to be discussed in the next section). Examples of how (formerly) heavy polluters have changed/are changing their strategies are:
DONG, the Danish publicly traded company, formerly controlled by the Danish government, which used to be the major Danish company active in the country’s offshore oil sector and now is the world’s largest owner of offshore-installed windmills for electricity generation.
BP, the major UK-based oil and gas producer, which has declared that no dividends are to be paid in the foreseeable future, so as to make use of this liquidity stream to diversify instead.
Food companies, such as Nestlé, Tyson and Hormel which are becoming active in plant-based “meats” (hamburgers, sausages, chicken…).
Yara, the world’s largest producer of fertilizers, based in Norway, which is reactivating its 100-year old technology of developing fertilizers through electricity (non-CO2 polluting), away from the oil-based conversion (CO2 emitting).
There is, of course, a potentially major challenge for many firms to implement a viable strategy away from being fundamentally “dirty” to becoming “clean”. While technological solutions often exist, these might be expensive, at times excessive. To support the transitions of such firms, a special financing investment has been developed; “pollution-reducing restructuring bonds”. This has been offered in particular by Credit Suisse, as well as by Goldman Sachs. Also, blue bonds are a recent type of sustainability bond financing projects related to preserving ocean biodiversity and general ocean conservation. Another example is the earlier introduced green bonds, a type of fixed-income instrument specifically earmarked to raise money for climate and environmental projects.
A related issue is the fact that so-called “dirty” firms shall be faced with rather more expensive costs of capital for their financing of new investments. We see this already now, and this evolution is likely to continue. Thus, it shall become less and less viable to remain “dirty” for many firms. This is quite significant for the bulk of such firms which commonly tend to be faced with large new capital investments (oil exploration, coal mine development, etc.).
Reporting
There is a clear trend towards more explicit reporting of environment-enhancing corporate efforts. The world’s former largest accounting firms, for instance, have, together with the World Economic Forum, developed a set of standards for this. Some countries, such as New Zealand being the first, have mandated such reporting, including now also the early adoption from Switzerland.
A key “problem” with this is the fact that it may be difficult to come up with stable criteria for what consists of severe pollution:
Take the electric car industry, for instance. Most observers might classify this type of industry as non-polluting, in that it significantly reduced the burning of fossil fuels in conventional engines, i.e. contributing to significantly less CO2 reduction. But the manufacturing of batteries for electric cars typically involves significant open pit mining malpractice. To find the required rare earth metals thus involves significant damage to Mother Nature. Perhaps even worse, many such open mining ventures employ child labor.
Consider the manufacturing of TEFLON coatings for kitchen accessories, pioneered by DuPont. At the time of its development, DuPont research paid little to no attention to potential health risks. For them, at the time, the key was to come up with a successful type of fiber for this purpose. And they did! It became clear only much later, however, that there were serious dysfunctional health effects. So, what we see is that the discovery process in many corporations only gradually might become sufficiently cognizant of such dysfunctional secondary effects.
The evolution of so-called steel-studded tires for cars provide a similar picture. Initially heralded for dramatically easing the difficulties of driving during icy conditions in such countries as Scandinavia, Canada, etc., it became clear that effects regarding wear and tear of asphalt roads were severe. Therefore, most countries forbade these types of tires. Only much later was it understood that the emission of relatively small particles of dust from the studded tires grinding effect on asphalt would be highly dangerous for people’s health, i.e. from the cancerous effects of breathing in this dust. While this has been the reality all the time, it was not fully understood until much later! And it is not just the particles from steel-studded tires that are toxic, rather from all tires (this is called tire and road wear particles (TRWP), and are tiny debris produced by the friction between tires and the road surface.
Clearly these types of challenges make it difficult to come up with broadly accepted measures for what constitutes pollution enhancement. What are the good measures for investors as well as asset managers to follow regarding the picking of non-polluting assets and/or which indexes to base their judgements on when it comes to index-based investment vehicles?
Conclusions
Impact investing is clearly on the rise. This is driven by a much more universally accepted realization that pollution and CO2 emissions are a reality! While, for many years, there seems to have a wide-spread recognition regarding this general challenge, in a more abstract sense, there now seems to be more urgency and specific actions regarding these issues. The United Nations says the need to reduce carbon emissions by 7 per cent a year is urgent, and many climate scientists advise that we have to limit temperature rises to 1.5 degrees C for a livable and safe climate. We see this therefore, not only at the governmental level, but also when it comes to corporations.
Perhaps most important of all, a broad based of investors seem to be following suit! According to the Global Impact Investing Network’s 2019 research, “there are over 1,340 active impact investing organizations across the world who collectively manage USD 502 billion in investments intended to bring about positive change.” Since then, the numbers have risen further. As sustainable businesses will lead the way into a better and safer future, both nextGen leaders and investors can integrate sustainability into their strategies and projects.
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