Inclusive recovery: Can a post-pandemic economy shift society and sectors to greener pastures?

The narrative around the green recovery continues to take shape. Calls for national economic packages to respond to the coronavirus pandemic by stimulating low-carbon markets have grown week from week.

While much of the demands have fallen at the door – and often on deaf ears – of politicians, the financial sectors are increasingly focused on reducing risk in their portfolios by screening out high-carbon companies.

For a risk-averse sector, the more proactive financial organisations are now realising – or at least exploring – the opportunities of the low-carbon transition. The rise of integrated reporting and the mainstream support for the Task Force on Climate-related Financial Disclosures (TCFD) have started the process of marrying sustainability and finance and post-pandemic recovery could be the honeymoon period.

The likes of BNP Paribas and BlackRock have recently doubled-down on commitments to phase-out high-carbon activities from their portfolio and the issuance of Environmental, Social, and Governance (ESG) bonds has increased by 272% year-on-year, as investors and insurance firms take proactive steps to respond to the coronavirus pandemic.

At edie’s Sustainable Investment virtual conference (held this week), green finance experts from Morgan Stanley, ING, Triodos Investment Management and Alquity emphasised that reshaping the economy of the future would be a transition whereby financial sectors would have to analyse their entire portfolios to examine what sectors and businesses could play a part in the low-carbon transition to a more just society.

“We see all too often that transitions go too slowly. As an investor, it means you have to make bolder choices if you want to see positive impact. We want to finance change and change finance,” Triodos Investment Management’s head of investment analysis and economics Hans Stegeman says.

“One of the worries I have is that the massive recovery of markets after the pandemic is an attempt to invest in the real economy and see real economic returns is getting more and more difficult. Somethings [that are invested in] won’t be sustainable.”

Stegeman’s concerns are apparent when looking at some national bailouts of sectors and businesses that have suffered as a result of the pandemic. Aviation is notably a sector where bailouts have been provided, though not always with green strings attached.

Transition and recover

Financial markets are clearly pivoting towards the green recovery Since Covid-19 was first declared a pandemic in March, a string of banks and investors have bolstered their sustainability targets and requirements, amid rapidly rising interest in ESG.

However, the panellists were quick to point out that sustainability and ESG are different entities and that differentiating between the two will likely decide what kind of green recovery is delivered.

Suresh Mistry, co-founder and head of ESG & impact reporting at Alquity notes that sustainability consists of some “inconvenient truths” that not all investors will look beyond through their stringent ESG parameters.

“There are a lot of sustainability-themed funds that don’t do ESG full stop,” Mistry says. “Some companies are working on sustainability, but can just fail on ESG, especially on the governance aspect. Investors need to know what it is they’re actually investing in.”

Alquity works in a lot of emerging markets where people “aspire towards better housing and sanitation”, according to Mistry. However, these critical infrastructure pieces won’t be achievable now with supporting high-carbon industries like cement. Additionally, while some investors are eager to invest in electric vehicles (EVs), they have less appetite to place copper mines into their portfolios, despite the material being a key component in EV production.

While innovation may eventually enable society to replace these resources, the pandemic sudden and severe impact means that society needs to be supported now. As such, a green recovery also entails supporting sectors to “transition” to greener ways of working.

Dutch bank ING has been one of the pioneers of the green finance movements. It issued its first green bond in 2015 and one year later, revealed that it had funded more than €27bn to clients aiming to solve environmental challenges.

In 2018, the bank began assessing its $600bn lending portfolio on climate impacts, as part of an ambition to align it with the emissions reductions required by the Paris Agreement.

It has partnered with the Two Degrees Investing Initiative to develop a methodology that it believes should be the standard for how “international banks measure the climate impact of their lending portfolios”.

Called the Terra approach, the standard uses detailed data on the assets companies use for their production today, as well as future investment plans. ING also uses global databases such as independent researcher Sustainalytics to examine current corporate efforts to transition to the low-carbon economy.

For ING’s global head of sustainable finance Leonie Schreve, banks can support businesses in high-carbon sectors transition to a lower-carbon way of operating. This, in turn, enables society to benefit from the products and services it provides in the short-term while exploring alternatives.

“If you look at transitions, you have some companies that aren’t in a sustainable sector. But rather than issuing an exclusion policy for that sector, the client may want to move towards a transition model,” Schreve says. “We guide them on how to establish the governance about the transition and how you deal with making sure you have responsibility across all the chains in the value chain. We can help connect finance towards strategic and ambitious goals.”

Social trickle down

Aligning with the Paris Agreement is a common target amongst leading businesses and investors, but the ESG movement now has a renewed focus on society.

The global issuance of sustainable and green bonds totalled a record $99.9bn (£75.5bn) in the second quarter of 2020, with investors increasingly focusing on ESG risks and seeking to play their part in the green recovery movement, according to the latest in-depth sector analysis from Moody’s. The analysis revealed that sustainable bond issuance was 65% higher between April and June than between January and March, with social bonds and sustainability bonds leading the trend. While green bonds are used to finance projects on the basis of their positive environmental impacts, social bonds finance activities intrinsically linked to social sustainability and sustainability bonds cover a mix.

Due to these trends, Moody’s believes that combined social and sustainability bond issuance may near that of green bonds this year for the first time ever. Green loan levels are now broadly similar to those recorded in 2019, despite a drop in the first quarter of 2020, it said, while social and sustainability bond offerings are expanding rapidly.

Morgan Stanley’s head of sustainable investing and global fixed income Navindu Katugampola notes that social inclusion is just as important sectoral inclusion in spurring the green recovery.

“Having an inclusive approach to the companies we look at to transition the entirety of sectors to a more sustainable business model is critically important,” Katugampola says.

“However, the pandemic has made us acutely aware of is how negative sustainability issues are exacerbated by inequalities. It is critically important to realise that when focusing on the climate transition, it has to be inclusive from a societal position. A proper move towards a more sustainable society has to be inclusive for all.”

Morgan Stanley recently became the first US-based global bank to commit to measuring and disclosing the environmental impact of its investment portfolio and loan offerings and became the first US bank to join the Partnership for Carbon Accounting Financials (PCAF) and its Steering Committee. The company currently holds more than $2trn in client assets, growing exponentially from $546bn in 2008 during the financial crash.

Focusing on the climate crises through the lens of societal prosperity is often referred to as a just transition.

The European Commission’s Green Deal chief, Frans Timmermans, assured EU lawmakers that “every euro” spent on economic recovery measures after the Covid-19 crisis would be linked to the green and digital transitions. The deal features a €100bn fund for ‘just’ low-carbon transition.

At a business level, the coronavirus pandemic has also reframed the low-carbon transition based on its impact on society. The chief executives of Danone, L’Oreal and Philips were among the signatories of a new open letter calling for the creation of an economic system that “puts purpose first, so our planet and society can thrive”, through Covid-19 recovery efforts.

Recognising the key role which finance will play in the delivery of key frameworks like the Sustainable Development Goals and Paris Agreement, the letter recommends that new incentives are developed to help the financial sector innovate its products, valuation models and risk assessment and ratings processes. New standards for measuring and disclosing value should, therefore, result. This would be a radical step change from today’s current economic model, the panellists stated.

“Trickle-down economics doesn’t work,” Mistry adds. “Its always the top end of the economy that has benefitted. The way you deploy capital shapes market…if you keep pointing it at the top you’ll create a society that values that.

“Social cohesion means investing money at the bottom and to work with the companies and the work they do in communities. The Covid-19 pandemic has brought out in big capital letters the S in ESG. It has historically been the forgotten pillar. Your license to operate is driven by your relationship to your community.”

While social and green bonds are rising in prominence, the keys to unlocking a green recovery is how nations, business and investors view these two issues in synergy, realising the impact that one will have on the other.

Matt Mace