COMMENT: The finance profession is ill-equipped to push for the transition of critical sectors, says ShareAction’s Wolfgang Kuhn
Finance sector efforts to turn the Paris Agreement into reality are like the colour TVs generation X grew up with. When you moved closer, you didn’t see more detail. You just saw unconnected colourful dots.
While the carbon transformation seems well under way, financial sector participants so far have focused on energy and transport, with relatively little attention given to equally important activities like heavy industry. This is despite the fact that cement and steel alone are estimated to account for 15% of anthropogenic CO2-emissions.
ShareAction recently conducted a scoping project on the decarbonisation of cement, steel and plastics. We looked at the way heavy industry is financed in Europe through new equity, bonds and syndicated loans, finding that the latter has been the biggest source of funding for most of the past 10 years across all three sectors.
We also conducted in-depth interviews with sustainable finance experts. We spoke about what is needed to accelerate decarbonisation and what barriers are impeding progress. And we concluded – perhaps not surprisingly – that there is simply not enough understanding of what needs to be done.
Mention biodiversity loss, and everyone throws their hands up: too complex. Thematic thinking: yes. Systemic thinking: no
Several participants noted that, while for the energy sector, investors had a rather clear understanding of the necessary steps, the same was not true for the industries in question: What needs to happen to take carbon out of the production of steel, cement, and plastics? Should we find ways of construction that save on material? Should we find new materials? Should we trust in recycling? Or technologies that promise to keep carbon out of the atmosphere?
Investors want to show that their portfolios are aligned with a decarbonisation pathway, but by and large, they are not trained to understand what needs doing and why.
That is not surprising; systems change used to be the domain of idealistic environmentalists, not hard-nosed investment professionals tasked to maximise risk-adjusted profits. We see that in other areas as well – mention biodiversity loss, and everyone throws their hands up: too complex, not enough data. Thematic thinking: yes. Systemic thinking: no.
Of course, most asset managers will take issue with this characterisation, as the pursuit of the Sustainable Development Goals has become a big area of financial product development and marketing. There has been a proliferation of funds that are either dedicated to particular SDGs, or map their activities to SDGs, claiming to support them.
But we are concerned that, while SDGs are admirable goals set by and intended for the world’s nations, they are adopted and interpreted by the financial industry as a set of colourful product stickers, not as a system that needs to be addressed in total.
Essentially, sustainability is looked at not from the perspective of solving the problems of our time, but from the perspective of what appeals to investment clients. If you want to market a green fund, you need the stuff in it to be green. Even the most sustainably produced steel can’t make that cut, so financial product developers ignore these critical but hard-to-abate sectors.
Unsurprisingly, there is much talk about transition finance. This describes finance of activities with emissions lower than the status quo, but not low enough to be part of a Paris-aligned future. Heavy industry is an obvious target for transition products and they could be part of the solution.
At this point, engagement is still a largely unstructured activity with vague objectives
The problem is that pretty much anything could be called a transition, risking a descent into incrementalism. Fitting oil tankers with solar panels is a transition of sorts, after all. We could see transition bonds come to dominate the market, yet emissions remain stubbornly high.
All of this is not surprising. Diversified portfolios are built in order to achieve financial returns, with the composition of the portfolio diversified in a way that best mitigates risk. Environmental objectives are usually mere side conditions, a restriction on the investment universe (the need to “find something green”). With the exception of dedicated impact portfolios, it is usually not an objective in its own right, and often relegated to an engagement topic for mainstream portfolios.
Engagement is supposed to be a stewardship tool, and used wisely, can materially change how companies are run. At this point, however, engagement is still a largely unstructured activity with vague objectives, which conveniently allows portfolio managers to claim climate action without having to change their portfolio holdings.
Engagement is needed to make changes in hard-to-abate sectors. But this would require planned coordination, with investors knowing what to push for. It would also involve engaging with banks whose lending portfolios need to be part of the equation. That kind of engagement, however, is only in its infancy, with asset managers still trying to decide just how much change they are allowed to push for.
This article is part of the in-depth Race to net zero briefing. See also:Paris Agreement CO2 emissions steel cement ShareAction SDGs ethical investing