By Nathan Fabian, PRI Chief Responsible Investment Officer and Shelagh Whitley, PRI Chief Sustainability Officer
Acute and chronic challenges are raising the bar for responsible investors
The year to April 2022 saw the sustainable transition encounter headwinds ranging from a continuing global pandemic to the fraying of the global security order. Responsible investors were reminded not only that environmental and social changes lead to market volatility, but that geopolitics can trump all else when it comes to impacting financial market function and human prosperity. Addressing chronic and worsening planetary health – which requires committed, persistent adjustment in what gets financed and where – is made even more challenging by the threat of acute injury to the liberal trade in goods and capital that is the very foundation of global markets.
COVID-19 and the resulting measures to stem the global pandemic showed how disruptive social issues can be for economies and markets. The likelihood that rapid encroachment into animal habitats was a cause of the virus migrating to humans has further highlighted the consequences of unfettered growth and the stripping of environmental resources. For investors, human health rocketed up their ESG risk priorities list.
The realisation that ESG investing and sustainable finance must ultimately lead to sustainable outcomes, and do so in a transparent way, appeared to cross a point of no return for market supervisors in multiple markets.
The moment of hope among environmental realists – that pandemic restrictions would be the beginning of the end for runaway environmental harm – evaporated through the year. The temporary massive disruption to transport, supply chains and use of built environments led to less reduction in annual emissions (down 5%) than the year-on-year savings needed to meet our global climate change mitigation goals (7%) – and emissions are now back to historic highs. Lasting emissions reductions can only come from persistent, muti-faceted adjustments in the economy.
In 2021, sustainability-related financial reform went global, with dozens of markets introducing new laws and developing sustainable taxonomies. Policy makers and regulators are becoming more aware of the scale of private financial flows required to reach global goals on climate change and the SDGs, leading financial regulation to continue to internalise sustainability – through disclosure requirements, stewardship codes and investor obligations.
Ever-more widespread claims of sustainable finance practice – including across sustainable funds, green bonds and green fiscal stimulus by governments – has led to increased scrutiny of sustainability claims and greenwashing. The realisation that ESG investing and sustainable finance must ultimately lead to sustainable outcomes, and do so in a transparent way, appeared to cross a point of no return for market supervisors in multiple markets. This has started a wave of review and renaming of investment funds, as the “ESG” moniker has become only the start of explaining an investment approach, not the end. In fact, considering ESG and progress towards sustainability goals is the very basis of fiduciary practice in a global economy that is in transition due to environmental and social trends.
Maintaining exposure to clean growth sectors will require deliberate attention from investment teams.
Respecting diversity, pursuing equitable outcomes and ensuring inclusive societies has continued to gain recognition and momentum in many countries. For some citizens and politicians, this is a lens for a culture war, but for those on the receiving end of past injustice, it is simply a path to fair access to respect, freedoms and prosperity. For investors, it is a basis for building their organisations and their investment philosophies, and seeking out the companies that can maintain their social licence to operate in the years ahead.
In markets, the end of cheap money backed by low interest rates has changed the outlook for some investment styles and asset classes, such as growth strategies, technology companies and private equity investments. A period of rapidly rising interest rates and a market rotation into government bonds now risks the progress made in growing the companies of the future. Maintaining exposure to clean growth sectors will require deliberate attention from investment teams.
On top of the long-term environmental, social and economic trends facing investors and the world, the war in Ukraine has set off a wave of human suffering, and highlighted the prospect of a less stable international order. This will have implications for investors’ outlook on environmental goals, energy policy, human rights and global governance. Quick government action on financial sanctions decided most investors’ reaction to the conflict, but many investors also used ESG frameworks and responsible investment priorities to guide their decisions. Building an ability to judge geopolitical tensions has not traditionally been the purpose of responsible investment, but with a changeable geopolitical environment, institutional investors with a stake in the future may be forced to consider how they can buttress international diplomacy and institution-building on global environmental and social challenges.
The past year was materially disruptive in economic and financial terms, but in this era of sustainable transition, the investment community – including the PRI – must be ready to deal with both chronic and acute disruptions. The bar for responsible and successful investors just got higher.