Themes for ESG Investing in 2022

Blaine Townsend, CIMA®, Director of Bailard’s Sustainable, Responsible, and Impact Investing Group, highlights decarbonization as a crucial ESG investing focus for the coming year.


December 31, 2021


Climate was the central ESG theme in 2021, and it’s near impossible that it won’t be again in 2022. In fact, it will remain so in the decades ahead. To riff off of Frank Sinatra: It is a Net Zero world and we are just living (and investing) in it.

The term “Net Zero”—awash in the headlines and political platforms worldwide—describes the balance between the amount of greenhouse gas emissions versus the amount removed from the atmosphere. The goal is to reach Net Zero in these emissions by 2050 to avoid the most catastrophic effects of climate change. Greenhouse gas concentrations are at their highest levels in two million years and, currently, the earth is roughly 1.1° Celsius warmer than it was in the 1800s and on track to increase by as much as 4.4 degrees by the end of the century.(1) Committing to Net Zero emissions is the path to curbing global temperature rise.

The commitment of nearly 200 countries Using this relative comparison to the pre-industrial period, scientists and governments agreed that holding the global temperature rise to 1.5 degrees Celsius would limit the worst climate impacts (as part of the 2015 UN Climate Change Conference, COP21, in Paris). (2)

Known as COP26, the five-year follow-up to the Paris Agreement was held this past fall in Glasgow. Progress was made in Scotland, particularly around the framework for pricing carbon, but the global community is moving too slowly and is not on track for Net Zero by 2050. The key to Net Zero is cutting emissions as soon as possible to reduce the absolute amount of the carbon budget being spent along the way. The Intergovernmental Panel on Climate Change [IPCC] re- ports that emissions must be halved by 2030 in order to even have the possibility of limiting warming to 1.5 degrees by 2050. (3)


Getting on the 1.5-degree path as quickly as possible matters. And this is where the potential for ESG in- vesting comes in. The race to “Net Zero” will have a transformative effect on the investment landscape and capital markets, as well as the way in which companies themselves operate.


Investment opportunities based on Net Zero While helpful as a strategic commitment, pledges from political jurisdictions are only words, and the work of reducing net emissions is done on the ground. With carbon as the primary greenhouse gas, it garners much of the focus. Decarbonization—which is the road to carbon-neutrality—will be led by rethinking the sectors that generate the bulk of the emissions, including electricity generation, transportation, buildings, and agriculture among others.

Decarbonization is expected to be a vital area for new capital investment and an important ESG theme ahead. Already, the investment opportunities for sequestering carbon (pulling already-emitted carbon out of the atmosphere), offsetting carbon elsewhere (through land restoration or planting of trees), and new technologies (to reduce emissions in the first place) are growing rapidly. It will just take a massive amount of investment of capital before it really takes off.

Pledges at the company level In addition to commitments from countries and municipalities around the world, numerous companies have made Net Zero pledges. Right now, big business is internalizing and communicating its path to Net Zero to investors based on largely voluntary disclosures and voluntary reporting. ESG investors would definitely like to understand where companies are with respect to these pledges. Once regulators agree on which disclosures should be required and standardized, companies will be better able to produce interim targets for the markets. Interim targets are extremely important because they force the decisions makers to stay accountable, particularly as CEOs typically operate with five- to seven-year time frames.

Additionally, the slow progress is vexing for ESG investors still in search of the best data possible to track portfolio alignment with Net Zero goals. ESG investors are eager for true science-based targets [SBTs] to better understand the risks in investment portfolios.

The financing gap There is a well-discussed gap between necessary infrastructure capital investment and new innovation required to decarbonize the global economy. This gap needs to close. The financial services industry has been slowly investing in decarbonization (by way of instruments like “green bonds”), but the pace needs to quicken and the commitment needs to grow or alternative funding schemes will emerge to meet demand.

Predictably, the banking sector is still adding to the short-term part of its balance sheet: traditional energy and traditional tech. There is incredible demand for capital for transformative energy projects or new technologies. For this energy transition to reach scale, the capital must come from somewhere. Filling that gap is in itself an investment theme. Does the green bond market continue to grow? Do FinTech, crowd-sourcing, or other new tools take market share from the banks in the decarbonization transition? Do regulators change anything to help make this investment more feasible? What would it take for this to become a catalyst for financial services? These are all big questions right now. Strides were made in 2021 by an alliance of the world’s 33 largest institutional investors, but time will tell whether the plans being put in place are effective. (4)

The growth of ESG investing has proven to the industry that investors want climate risk at least to be taken seriously in their portfolios. Right now, in the early days of this transformation, it is the ESG investors that are pulling the lever they have available: directing their capital. Getting on a path to limit temperature rise to 1.5 degrees Celsius by mid-century won’t happen without total engagement by all market participants, regulators, big business, consumers, big and small investors alike. If these players in the capital markets truly internalize this goal of decarbonization, it will transform the investment landscape.


 

1 https://www.un.org/sites/un2.un.org/files/fastfacts-what-is-climate-change.pdf

2 https://www.un.org/en/climatechange/paris-agreement 3 https://www.nature.com/articles/d41586-018-06876-2

4 https://www.un.org/en/climate-action/sg-institutional-investors-crucial-net-zero