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ESG Focus: Covid, The Aftermath – Part 1

ESG Focus | Oct 01 2020

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

Covid is being touted by many as the perfect opportunity to accelerate the transition to a circular, sustainable economy. It has exposed the vulnerable underbellies of critical and not-so-critical industries; guided to a grand future for others; and triggered fundamental shifts in economic monetary policy, the repercussions of which will reverberate for decades. This is Part One in a two-part series titled Covid, The Aftermath.

-Governments punting on “green” recoveries
-Investors preferred ESG strategies during 2020 equities sell-off
-The EU and other experts see enormous potential from green investments
-Systemic transitions could potentially create 395m jobs by 2030

By Sarah Mills

The release of covid-19 upon the world proved a fright – then the lockdown of global economies proved a shock. Global financial markets plunged, businesses closed, people changed the way they worked and interacted. And that was just the beginning.

The timing could not have been worse. The world was on the brink of a recession regardless (or so it seemed). The Federal Reserve, which had been printing money for over a decade, appeared to be running out of ammunition, according to market speculation, and the covid-19 monetary injections propelled debt-to-GDP to historical highs.

Central banks around the world initiated massive fiscal injections, the US pumping US$2.1trn into its economy alone. 

The International Monetary Fund now forecasts the world will face the greatest recession since the Great Depression and will shrink by -3%, exceeding the global financial crisis (GFC). Advanced economies are expected to slump -6% before recovering in 2021.

The Organisation for Economic Co-operation and Development (OECD) has forecast that each month of lockdown equates to a -2% loss of annual productivity, with sectors such as tourism and hospitality declining up to -70%.

Everyone has a crystal ball

Every man and his dog have turned soothsayers, from the usual cadre of financial and political forecasters to a growing number of conspiracy theorists. The list is exhausting.

The answers are likely to be more complex. There is much afoot.

To start, covid-19 is coinciding with climate-change risk, which analysts say is less than 50% hedge-able, an ageing baby boomer population, and the push to a circular economy, so it will be difficult to extricate the deleterious affects of a one-off shock like covid-19 from these strong megatrends.

The economic stimulus expected from the helicoptering of money into the economy may well be outweighed by the effects of more than a decade of quantitative easing (QE); especially given the world is already carrying massive debt.

But then, there is also a lack of transparency to consider. The US Federal Reserve has not been subject to a government audit in decades, despite attempts to pass the Federal Reserve Transparency Act, so it is difficult to get a clear view of monetary reality. Who knows what the Fed has up its sleeve.

Then, there is the Fourth Industrial Revolution (4IR). Advances in technology can massively boost productivity. Electric tools, for example, improved the productivity of one person by a factor of roughly 10x. New technologies could dwarf that.

Add to that the fact that we may now stand on the cusp of a new approach to monetary and economic stimulus, not to mention universal basic income, and there are plenty of variables.

Now more than ever, the adage “only those who know, know” resounds across the globe – and all ears are to the ground.

What we do know

One thing we can be certain is that UN Sustainable Development Goals and Environmental Social Governance (ESG) investing will play a critical role in the covid-19 recovery.

Initially, many commentators were arguing the crisis and the accompanying oil-price plunge would set back the world’s environmental and social commitments, signalling a return to cheap fossil fuels and business as usual. Some argued the collapse in oil prices removed incentives to move away from dirty energy. 

But the reality suggests otherwise.

“Covid-19 has gutted global sharemarkets but it is far from indiscriminate in the extent to which it bestows destruction,” says Citi in a report. "Rather, the green theme came into focus as the sharp fall in the oil price left many investors questioning the wisdom of energy exposures."

Stocks with strong ESG profiles, or ESG themes, benefited during the covid-19 crash, as investors either sought protection behind ESG capital flows, or jumped into stocks and sectors favoured by ESG investors. Stability in ESG funds is aided by the fact that most ESG investors tend to passive investors and funds seeking long-term safe havens

Covid-19 plays to the concept of demand shock. The theory goes that companies with high ESG scores are more resilient to shocks such as those triggered by pandemics, which favour more onshoring and technology adoption.

ESG funds prove star performers in the age of covid

Morningstar’s Embedding Sustainability into Valuation Report notes that sustainable investing has emerged stronger post covid.

ESG investments as a percentage of assets under management grew, while inflows quickly recovered to pre-pandemic levels. Headline socially responsible investment indices outperformed the broader market.

Morningstar data show that sustainable funds attracted record inflows in the first quarter as investors sought protection and that many funds outperformed the broader market for the year.

Sustainability-focused funds experienced inflows of $45.7bn as the broader funds market recorded an outflow of -US$384.7bn.

Bank of America analysts found companies registering below-median ESG scores have experienced larger downwards EPS revisions.

Blackrock Data reports 88% of sustainable funds in their survey outperformed non-sustainable counterparts between January 1 and April 30, 2020. Morningstar reports that 51 of their 57 sustainable indices outperformed their broader market counterparts in the March quarter and MSCI reports 15 of 17 of their funds also outperformed.

Morgan Stanley meanwhile, found that sustainable funds’ downside risk in turbulent years such as 2008, 2009, 2015 and 2018 was much smaller than traditional funds.

RBC Capital markets notes that 64% of actively managed ESG funds beat their benchmarks, versus 29% of traditional funds in the first week.

Green stimulus to rain down

The broader narrative, however, is that covid-19 is being viewed as an opportunity to accelerate the push towards sustainability and the circular economy, proponents touting a “green” recovery.

“It is unclear whether the high fiscal and economic costs of COVID-19 will limit progress or otherwise distract from transitions to clean energy and other environmental policies,” says Morningstar.

“Nevertheless, the expected recovery will present a chance for governments to advance their ecological transition and thus reduce long-term risks associated with climate change to government balance sheets and to society at large.”

These sentiments are echoed by the OECD, which argues economic growth is decoupling from fossil fuels and that post-crisis recovery initiatives present an opportunity to more closely align public policies with climate objectives. 

The OECD also argues that the faster the transition and investment in new technologies, the faster and more powerful and sustainable the covid-19 recovery. 

Trillions of dollars are being printed to stimulate the economy and governments are weighing how much of this will be allocated to sustainable innovation in a hotly contested battle between what is being dubbed “clean aid” and “dirty aid”.

The International Energy Agency (IEA) and the International Monetary Fund (IMF) have jointly produced a Sustainable Recovery Plan. 

The plan claims that investing US$1trn annually in green energy over 2021 to 2023 could add 1.1% to global economic growth each year, with roughly 9m jobs created or saved in a variety of sectors including energy efficiency and electricity.

Under this scenario, 2019 would represent peak carbon, and emissions would fall -15% out to 2023. New infrastructure would improve overall productivity of workers and capital.

It is likely governments will be incentivised to favour the mooted green recovery as sovereign credit ratings increasingly become linked to sustainability measures. However, Morningstar says there is no evidence of this yet.

Where’s the money – stimulus and taxes

Quantitative easing remains the darling of the stimulus brigade, however, there are a few changes on the horizon with governments expected to take a stronger role in borrowing and distributing funds. This plays into a bigger story on economic theory and monetary policy post-covid, which we discuss in Part 2 of this series.

The OECD favours flexible, market-based instruments, such as taxes, to redistribute funds and achieve recovery goals, arguing these are more favourable to productivity growth than policies that create barriers to entry and competition by imposing additional administrative burdens on start-ups.

The European Union estimates the resource efficiencies gained from the shift to sustainability alone could pay for the green transition.

Taxes are mooted as a key instrument to help deal with covid debt-stimulus issues.

Citi analysts say the environment would benefit from higher carbon taxes and that global economic prospects would not suffer if the public revenue from the higher carbon taxes was allocated to support consumers via lower income taxes.

The analysts state trading consumer tax cuts for the higher energy prices arising from carbon taxes and the removal of fossil-fuel subsidies (which previous articles have noted are massive), also has a beneficial affect on public debt ratios.

They suggest major economies would experience a fall in debt-to-GDP, another nasty bogeyman lurking in the covid-19 cupboard, also discussed in Part 2. 

Clean-aid and the EU Green Deal

The European Union (EU) led the charge on the clean aid front, announcing in April its EUR1trn green recovery package, in which the government determined the transition to a green economy, would play a central role in the covid-19 recovery and stimulus. Since, that number has risen to EUR1.8trn, almost one third of which is linked to climate action.

Under the deal, half will be sourced from governments, more than one quarter from the private sector backed by loan guarantees, and EUR100bn from Brussels’ own bank to create a “just transition” to support workers. (The intimidating French gilets jaunes protests in response to rising fuel taxes suggests the working poor are unable, or will refuse, to bear the cost of the transition). 

Announcing the stimulus, European Commission president Ursula von der Leyen vowed to leave no-one behind, a reminder that the social and green themes go hand-in-hand.

“The Green transition will play a central and priority role in relaunching and modernising our economy,” she has been quoted, perhaps a veiled reference to the sustainable 4IR.

The European Green Deal plans to transform the bloc of 27 countries from a high to a low-carbon economy, while maintaining prosperity and improving quality of life through cleaner air and water, better health and a healthier natural world.

Nearly every major aspect of the European economy will be overhauled, offering a plethora of opportunities for investors.

The plan aims to create jobs in new high-tech industries from renewable energy to electric vehicle manufacturing and sustainable building. It predicts that resource efficiency will repay the cost of the changes.

To secure this funding, member states must demonstrate that 25% of spending is in line with climate goals.

Key takeouts include:

-the concept of a climate-neutral Europe using smart-sector integration;
-a renewable energy directive, energy efficiency directive, emissions trading direction and effort sharing directive;
-a circular economy action plan;
-a bid to double the sustainable renovation rate of buildings;
-a chemical strategy for a toxic-free environment;
-biodiversity strategy to end soil and water pollution and reduce deforestation;
-a farm to fork strategy to create a healthier agri-industry;
-and transport strategy targeting charging points,
-and sustainable alternatives to fossil fuels for aviation, shipping and heavy-duty road transport such as biofuels and hydrogen;
-a just transition mechanism to help regions dependent on fossil fuels (EUR100bn from the EU’s own bank);
-green research and technology; and funds to policy support for external relations such as a carbon border tax; and
-public transport.

It is likely other governments will mimic all or part of this plan, each of the above bullet points offering investment opportunities.

The International Monetary Fund backs the European Union’s approach of making direct support contingent on environmentally friendly policy and actions that support behavioural changes that support a low-carbon transition as a model for other countries.

The IMF is calling for public investment in climate-smart infrastructure and technologies, and proposes debt guarantees and other support be extended to green industries and activities.

Dirty aid

The EU package contrasts sharply with recovery packages in the rest of the world, where, according to Bloomberg, only US$54bn of the trillions of dollars of recovery funds will be channelled into green policies, compared with “dirty aid” to support carbon intensive sectors such as air travel and fossil fuel production.

According to Eurasia Review, US$11trn in global fiscal support has been approved, about US$5trn of which is in the pipeline. Less than 1% was green.

Transport and Infrastructure has been the biggest recipient attracting US$308.53bn, followed by energy transition at US183.2bn. Energy efficiency and the circular economy have garnered only US$44.7bn and US$12.01bn

There also remains scepticism as to whether green funds will really find their way into the right pockets, and that carbon financiers might game the system.

Many EU member countries have publicly announced they want to increase their emissions out to 2030, posing another obstacle. The management of covid has also aggravated tensions between northern and southern Europe, further undermining efforts to achieve a united front.

But wait, there’s more – much more!!

But perhaps all is not as it seems. And there is the US election to consider.

Credit Suisse’s Global ESG Strategy: Beyond the Pandemic: The Green-shaped Recovery suggests that global funding far exceeds the EU’s Green Deal.

The analysts note only a modest increase of 0.3% of GDP within the G20 (assuming there is any GDP left after covid-19’s demands on the dwindling GDP pie) could allow non-EU funding to increase to US$3.2trn. 

This is before accounting for a Biden victory, under which scenario stimulus could exceed US$5trn, says Credit Suisse.

This investment could be accelerated by structural tailwinds such a 4IR, renewable technology, Internet of things, 5G and quantum technology.

The World Economic Forum, meanwhile, argues half of global GDP is threatened by nature loss and proposes 15 systemic transitions worth US$10trn of annual business opportunities that could create 395m jobs by 2030 – this is in addition to covid-19 stimulus. 

WEF identifies food, land and ocean use, infrastructure and the built environment, energy and extractive technologies as target sectors and estimates US$2.7trn of annual capital investment will be required to capture the US$10trn of annual business opportunities – not a bad return on investment. The funds will flow.

The E, the S and the G and the big D – debt

In the second part of this two-part series, FNArena examines the effects of covid-19 on the individual environmental, social and governance themes, quickly summarises the winners and losers, and examines the future of debt and monetary policy and theory post covid-19.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future:

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