Despite a difficult start to the year for sustainable investing, the future does not appear to be so negative.
Sustainable investing had a particularly tough start to the year. Whether it is the Russian-Ukrainian conflict, the energy super cycle or the green taxonomy, these factors have all exerted considerable pressure on the sector. However, not everything is negative. Multiple taxonomies establish new frameworks for defining and regulating sustainable activities; the number of actors who are committed to “Net Zero” continues to grow; and a set of commitments and divestments could effectively guide larger emitters towards greener practices. The question is what the rest of the year has in store for us.
Over the past two years, sustainability regulations have undergone a real revolution. Europe, in particular, has taken the lead with the “EU Green Deal” and introduced a series of proposals for a sustainable transition. While this increased legal pressure can seem complex, even downright confusing at times, it is nonetheless one of the most effective tools for redirecting capital flows towards sustainable and inclusive growth.
Existing and future taxonomies will soon cover nearly half the globe; a veritable “taxonomania”.
At the heart of this set of regulations, the “European taxonomy” specifies which investments are environmentally sustainable. Although it is among the best-known examples today, this “enduring taxonomy” is only one of many. In fact, existing and future taxonomies will soon cover nearly half the globe; a veritable “taxonomania”.
However, effective regulation must go hand in hand with ‘clear, high quality and comparable data’. Sustainable goals are often qualitative in nature and difficult to measure. Today, the great diversity of standards, objectives and definitions only adds confusion to an already complex subject, constituting a major hindrance. It is clear that the growing lack of compliance and complexity in data is something to watch, as it could easily be exploited to promote greenwashing. Nevertheless, the Corporate Sustainability Reporting Directive – an amendment to the already existing Non-Financial Reporting Directive – will help address these data challenges. Additionally, the International Sustainability Standards Council will provide a global base of sustainability-related reporting standards and offer objective information on corporate sustainability risks.
The end of the energy super cycle
According to the latest IPCC report, greenhouse gas emissions have not yet decreased, quite the contrary. And while renewables have grown tremendously in recent years, global energy demand still exceeds total renewable energy supply today.
Fortunately, the recent rise in energy prices has been an excellent incentive to further accelerate the transition to renewable energy sources. Additionally, increasing pressure from regulations and reporting requirements will also continue to drive this green transformation. In addition, over the long term, as more and more of the world commits to “Net Zero”, the fossil fuel industry will have to adapt or die out altogether.
Divestment versus commitment: the false dilemma
But then how best to reduce dependence on carbon-intensive energy? Many favor the outright removal of corporate financial support through divestment. Others prefer a more committed method, in order to guide these energy suppliers towards more sustainable production and limit the risk of non-performing assets. While the two sides seem to have fundamentally opposing views, finding common ground isn’t that hard. With a happy medium between the two, and relying on a combination of divestment and engagement, we can potentially have the best of both worlds.
ESG data tends to focus on past developments without sufficiently considering future potential and dynamics.
Moreover, fossil fuel companies have not been idle. They have been planning their own transition for some time now. Thus TotalEnergies, previously known as an oil and gas titan, has decided to completely review its economic model. It has reorganized its strategy, projects and future activities to ensure that sustainable development is at the heart of its business. So the company has already become one of the major players in the world in the field of solar energy.
However, according to the international organization “Transition Path Initiative”, only three major energy suppliers (TotalEnergies, ENI and Occidental) are currently aligned with a 1.5°C scenario as defined by the Paris Agreements. Even though TotalEnergies seems to be moving in the right direction, its current strategy does not take into account so-called “Scope 3” emissions – that is, the consequences of the company’s activities that come from sources that it does not own. or do not control. This shortcoming prompted a strong reaction from institutional investors at the company’s last general meeting. It is clear that we must continue to remain selective and critical when it comes to big promises from oil companies.
Beyond data, active engagement
The so-called “green premium” refers to the additional cost to be paid for a clean technology compared to a technology that emits a greater amount of greenhouse gases. It can also be the result of regulation that seeks to direct investment towards companies in traditionally green sectors. However, as the European taxonomy broadens its scope and includes other objectives, the universe of investment opportunities will also increase, thereby decreasing sector biases and green premiums.
To limit the impact of the green premium and go beyond the usual sectors, it is essential to look “beyond the data”. ESG data, in particular, tends to focus on past developments without sufficiently considering future potential and dynamics. This can be partially offset by taking into account measures such as capital investment expenditures, which are more forward-looking.
In short, the combination of active engagement with companies or governments and qualitative and fundamental research is essential for any investor who wishes to go beyond the most traditional green sectors.
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