7 January 2020
On the last day of the last decade, the outgoing Governor of the Bank of England issued a stark warning to the world. He noted that the financial sector had begun to curb investments in fossil fuels, but far too slowly. He said leading pension fund analysis "is that if you add up the policies of all of the companies out there, they are consistent with warming of 3.7-3.8C”. He made it clear that business as usual is no good, and finance has to up its game. How will it rise to the challenge?
One of WRAP’s ways of effecting change has always been to provide finance, in the shape of grants, loans and leases, to businesses that help establish the circular economy. This has included paper and plastics reprocessors, and the early providers of anaerobic digestion, amongst others. So, I was recently invited to represent WRAP at Environmental Finance Magazine’s conference on Green Equities, on a panel that sought to highlight opportunities outside of the renewable energy businesses that often dominate discussions of green finance.
‘Green’ is such a flexible concept, not least in finance circles where it can mean different judgements in different contexts (e.g. carbon emissions, deforestation, unsustainable palm oil, …), but however characterised, these concerns are rising rapidly up investors’ agendas.
This has been driven by well-publicised ‘divestment’ campaigns – the push to move pension funds away from fossil fuels, for instance. It is being driven by policy, including the 2018 European Commission Action Plan on Financing Sustainable Growth.
But there is also increasing awareness among investors, of all kinds, of the financial risks posed by climate change, pollution and resource depletion, an awareness that puts acting on these concerns squarely within shareholders’ fiduciary duty to address.
The establishment of the Task Force on Climate-Related Financial Disclosures (TCFD) is clear evidence of this. At the same time, there is increasing evidence that selecting holdings that are aligned to climate and other long-term goals need not mean lower financial performance in the near term, unless investments are being made to kickstart a sector on an almost philanthropic model.
Aligned with Reality?
But what does ‘aligned’ really mean? There is huge potential for ‘impact wash’ where investors can sound as if their choices are making a difference, but actually there is limited action leading to change. Where is leverage being effectively exerted?
There is a spectrum of strategies for ‘Green’ or ‘Ethical’ Finance. At one end is screening out – eschewing investment in companies that are doing damage, not least to the investors’ reputation. The United Nations pensions fund coming out of coal, the Church of England ending its indirect investment in a payday lender, WWF campaigning against investments in companies linked to deforestation are all good examples. Arms, gambling and tobacco are classic no-nos for many charities and are increasingly being joined by fossil fuels.
Next comes engagement, through what is a commonly termed an ESG agenda – collecting information on companies’ Environmental, Social and Governance performance. This is a more holistic approach, but there is recognition that ESG is first of all a process of analysis – what counts is what is done with the information to influence company strategy. At the conference we heard that 86% of shareholders in one survey have plans to ‘engage’ on the Paris Agreement targets - but half of those have no plans to follow up on the information gathered.
At the other end of the scale, there is ‘impact’ investing. Sounds good, but impact is notoriously hard to measure. There are ‘pure play’ companies – a wonderful term for the incontrovertibly green, such as renewable energy companies. But beyond that, in more traditional sectors, how to tell who is really serious, who are the game changers?
The good news is that a lot of effort is going into ‘transition indexes’ – scoring companies on how well they are aligned to, and making the transition towards, the Paris climate goals. For instance, the Church of England and the Environment Agency are collaborating on the Transition Pathway Initiative (TPI), a tool to enable the assessment of companies’ carbon performance, within a selected sector. On the basis of available data, companies are graded into five levels from 0 (unaware) to 4 (strategic assessment), with the aim of investor pressure pushing them up the scale.
This increasingly sophisticated approach makes it clear that the divest/ invest positioning is a false dichotomy. Divestment is a good campaigning tool, and undoubtedly sends strong messages, but little will change if those company stocks are simply passed on to less concerned buyers, with no resulting change of strategy. Engagement and transition have to be the name of the game.
Investing in the Circular Economy
At WRAP, we are looking to influence investors, companies and entire supply chains to embrace the Circular Economy – abandoning the ‘take, make dispose’ model and aiming to keep resources in the economy for as long as possible. This is about both opportunity and risk. The opportunities lie in new business models that do more with less – everything from leasing clothes and appliances to ensure that they are kept in circulation rather than rapidly discarded, through repair and remanufacturing, to re-use models that replace throwaway items such as water bottles, coffee cups and much more.
At the recycling end, there will be huge opportunities to invest in new infrastructure to reprocess plastic, paper and metals, rather than letting it end up in landfill. For consumers, apps and data platforms that tell us where our stuff has come from, and what it is made of, will make green purchasing and recycling decisions easier. As for risk, avoiding risk in the circular economy is about lower carbon and water footprints, as well as retaining scarce materials and reducing damaging extraction.
Our challenge is that many of these investment opportunities are still small scale – certainly compared to off-shore wind farms, electric vehicles and smart grids. If consumption emissions of greenhouse gases were more routinely calculated by companies (so Scope 3, as well as 1 and 2), it would bring circular economy approaches to the fore, but they still might need to be pooled in some way to attract investors.
A broader challenge is that financial communities want to be more sure of the policy landscape – a key theme at the conference was the discontinuity between the pressing need for recycling infrastructure, the speed of policy development, and the needs of financial communities to have clear direction of travel and an understanding of how any given investment can work at scale. This is reasonable enough, but then perhaps finance also needs to change? Should investors be more daring, even those not officially in the venture capital space? Should they accept a different timing or level of returns, or could they pool resources more? What is the bare minimum of policy certainty that is needed? Helping finance and policy to understand each others’ goals is something that WRAP is well placed to do, given our very successful joint convening of businesses and government.
So a question for 2020, the COP 26 year - where are the sweet spots of policy, business success and long-term financial return that everyone can buy into?