14 September 2022

Advertising Material

Exclusions will not solve climate crisis

By Paul Malpas, ESG Distribution Lead at Nordea Asset Management

We are currently embarking on a great migration to a greener world – with public and private organisations both working hard to transition from fossil-based energy production and consumption to renewable sources. As this evolution gains momentum, new ecosystems are forming, and innovative technologies are emerging.

However, many companies are still lagging in the green transition, particularly those heavy emitters responsible for a considerable part of the world’s pollution problem. These groups continue to face meaningful fundamental and environmental risks.

With climate awareness intensifying in recent years, we have witnessed a significant flight of capital from heavy emitting companies. The rapid growth of ESG has been a key factor in this investor exodus, as asset managers seek to demonstrate strong sustainability credentials.

However, simply steering clear of high-emitting stocks and sectors is not the right approach for investors to take, in our view. While there will always be companies to avoid – namely those requiring a complete business model reinvention – there are vast swathes of businesses that just need a nudge in the right direction.

It is important for investors to engage with these largely forgotten companies, as like it or not, today’s heavy emitters will play a crucial role in our transition to a more sustainable future. The expertise capital allocators can impart on corporates be invaluable in efforts to curb real-world emissions. In addition to this, many environmental laggards are currently trading at historically cheap valuations, so the value that can be unlocked by helping high emitters decarbonise over the coming years is immense.

Decarbonisation requires collaboration and action

In order to enact meaningful change through corporate engagement, we believe investors are best served by focusing on five primary sustainability factors. Unsurprisingly, the first key consideration is greenhouse gas emissions, which is the leading driver of global warming. If a large carbon emitter does not align its emissions trajectory to a sub-2°C scenario, it will continue to be highly exposed to escalating regulatory, environmental compliance, and reputational risks – which will likely increase its costs and risk profile.

Next, as economic production requires substantial energy inputs, energy management is paramount for successful climate action. With the rise in non-renewable energy prices and the implementation of carbon pricing, climate has become financially material – specifically in energy-intensive sectors like manufacturing. Through engagement, it is possible to help companies improve energy efficiency and energy resource diversification. This can mitigate exposure to volatile energy costs, reduce greenhouse gas emissions, and help improve costs and the reliability of the overall energy supply.

Water and waste management is another vital issue. The world’s limited resources cannot meet growing demand, which creates long-term uncertainty for companies highly dependent on natural assets. Water-related capital investments and water-efficiency improvements can reduce the risk of experiencing higher operational costs or shortages. By driving the adoption of circular models, we can help face the growing scarcity of natural resources and the increasingly visible environmental costs of resource production and waste generation.

Similarly, companies need guidance on natural resource management. This includes using recycled and renewable materials, reducing the use of key supplies, and maximising resource efficiency in manufacturing. Research and development investment in substitute materials is essential if we are going to stop harming the health of ecosystems through overexploitation.

Finally, corporate management teams must be willing to reposition businesses to be resilient to the transition and physical risks of climate change. In our view, sustainable long-term value creation will be almost impossible if corporates are not responsive to the permanent migration to a low-carbon and climate-constrained economy.

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