Green Finance Blossoms

The perfect storm is right now

The world is facing the perfect storm for environmental change. We are at the most exciting time to fight climate disaster in the last four years. The US is set to rejoin the Paris Agreement, China announced it will be carbon neutral in 40 years, and the mid-November Green Horizon Summit hosted by the City of London saw a handful of key regulatory and financial advances.

Despite weather-related catastrophes like wildfires in California and massive flooding in parts of Asia during his term, outgoing President Trump stuck to his early decision to withdraw from the Paris climate accord. Incoming President Biden, instead, affirms his intention to lead a diplomatic initiative to go beyond its current goals of keeping the temperature rise well below 2 degrees Celsius this century. Sustainability is central to the President-elect’s agenda. 

Biden has not simply jumped on the latest bandwagon: he was responsible for one of the first climate change bills ever introduced to the Senate. His goal is for the US to be net zero emissions by 2050, and he has promised to create an enforcement mechanism by the end of his first term. That is a crucial element in a democracy where those who deny climate change represent a substantial force and could back in power in four years.

Meanwhile, China may be the world’s largest emitter of greenhouse gases, but its leadership has now taken a stand on the issue.  A couple of months ago, President Xi Jinping announced at the UN General Assembly that his country will achieve carbon neutrality by 2060, only ten years after the US, not a simple achievement for a fast-growing economy that relies on coal.

In part, this plays into China’s narrative of being a responsible member of the international community, ably contrasting with US withdrawal under President Trump.  However, with a Democratic Party administration in place from 2021, one that will continue to stand up to China’s military and economic might, cooperation on climate change looks likely to be the one area where the two superpowers can work together and achieve major progress on tackling the environmental disaster.

The third part of the equation is not as headline-grabbing as the first two but is arguably as important for its private sector consequences. Last week the Financial Conduct Authority (FCA) announced that from January 1st all London-listed companies will have to disclose how climate change affects their business under Taskforce on Climate-related Financial Disclosures (TCFD) standards; the Bank of England announced the launch of its climate stress test for financial institutions in June 2021; Chancellor Rishi Sunak announced the launch of the first green gilts (UK green treasury bonds), in essence government borrowing for low-carbon projects.

London hosts the world’s most global stock exchange, while the City of London is, still, the centre of international finance. Thus although these UK rules may have arrived after those of the European Union, a leader in this sector, they will have global consequences.

In fact, it is indicative of the City’s aim to lead on green finance that China Yangtze Power plans to list on the London Stock Exchange (LSE). It will be the first Chinese company to receive the LSE’s ‘Green Economy Mark’ for companies that derive at least half their revenues from the green economy. Yangtze Power is the world’s biggest hydropower plant operator in terms of capacity.

Meanwhile, the carbon credit market – where regulatory allowances for emissions can be bought and sold – looks like becoming mainstream. This summer, the KFA Global Carbon ETF listed in New York. The exchange-traded fund tracks the performance of the world’s three most liquid markets for carbon credits.

Critics argue there is a plethora of standards on the environment, making it almost impossible to compare like with like and allowing ‘greenwashing’ of projects and companies. These are but growing pains that will sort themselves out. And the reality is that helping companies transition from high carbon-producing energy via ‘brown bonds’ is just as important for the world economy and jobs as the ‘green bonds’ that finance more fashionable endeavours.

A more meaningful criticism is of the asset managers who are slow to take action while their CEOs publicly take companies to task.

BlackRock, the world’s largest investor, is a case in point. A report released last year by Friends of the Earth and other activist groups concluded that the company’s investment in sectors like palm oil and rubber which generally encourage deforestation had increased by over half a billion dollars in the past five years, while its CEO Larry Fink sends out self-reverential missives.

Admittedly it is far from easy to steer a different course quickly when captain of a behemoth with over $6.5 trillion in assets. What will help move the dial is the FCA’s aim to introduce TCFD obligations for the largest asset managers, life insurers and pension providers by 2022. In the US, even with a divided Congress, the new President could use government procurement as a lever, while the Securities and Exchange Commission (SEC) can write mandatory rules for listed companies.

ESG funds already have $40 trillion under management, and growing apace.

A few other factors are critical. Generation Z and millennials form an ever-larger part of the workforce and are pressuring companies to make stronger commitments to change; living legend David Attenborough and environmental campaigner Extinction Rebellion and others are stepping up their activities; and the 2021 COP26 global climate talks in Glasgow will lead to more advances.

Last, zero interest rates allow governments to invest in a sustainable economy at a time when the pandemic-induced crisis demands job creation in new sectors. At the time of writing, UK Prime Minister Boris Johnson was due to announce a ten point plan to combat climate change, including new national parks, energy efficiency for homes and businesses and innovation funding to achieve net-zero.

Dealing with major global problems relies on collaboration between countries and between the private and the public sector, underpinned by dynamic and innovative financial systems. In a potentially more civil era ushered in by Joe Biden’s arrival in the White House, the next few years look like being ground-breaking in transforming how we produce energy – with outer space a distinct possibility for solar farms over the next decade.

In the words of Antonio Guterres, Secretary General of the United Nations,”Decarbonisation is the greatest commercial opportunity of all time.”

From Competitor to Collaborator

Dealing with the S in ESG 

Rare it is to hear business call for more government regulation. Yet this is the plea heard in private conversations with some of the largest financial companies in the UK, as they face undeliverable expectations to be at the forefront of solving rising inequality, racism and environmental disaster.

“The To-do list for corporates will continue to grow. We are having to deal with issues like racial injustice [because] governments aren’t,” says the CEO of a FTSE-100.

The financial crisis led to an upsurge in regulation, ranging from capital adequacy to conduct rules. Regulators like the Financial Conduct Authority in the UK and the Securities and Exchange Commission in the US became ever more powerful. An unwelcome outcome for financial institutions, but one they fully understood and accepted, even as their compliance departments doubled and tripled in size.

Meanwhile, the E in Environmental Social Governance (ESG) became a major risk and reward factor for companies – consider the plummeting market capitalisation of coal companies and the general proliferation of environmental ratings. In this area, the change makers are the institutional shareholders rather than the regulators or government.

Covid-19 allied to Black Lives Matter has swung the spotlight onto the ‘Social’ aspect, ranging from the safety of employees in the pandemic, to key workers without proper contracts, to the minimal numbers of BAME executives in the City and Wall Street.

The backdrop to this is changes to the decades-old emphasis on an ‘efficient’ international economy.  Its weaknesses – gig economy workers who live pay check to pay check and an international supply chain too dependent on political goodwill – are now fully exposed. The shareholder-first approach is being subsumed into a multi-stakeholder approach.

The increased complexity of the new corporate model means that firms look more like universities, balancing the interests of a wide range of interest groups with the constant threat of a hostile social media campaign.

What happened at the London School of Economics a few years ago is a salutary warning. The union highlighted the appalling employment conditions of the prestigious university’s outsourced cleaners. The support of students and academics gathered pace. A couple of years later, in 2018, the cleaners won the battle to be taken on as employees of the LSE.

Interestingly, hedge fund Chanos is shorting gig economy comp­anies such as ride-hailing app Uber and online food-delivery platform Grubhub. It is betting that there is going to be a greater political focus on low-wage, precarious workers.

Boards of directors would prefer to have clearer regulation on ‘Social’ issues, such as outsourced workers. For instance, gender pay gap reporting, while not exactly welcomed with open arms by business in 2017, is now a regular part of the corporate landscape for all medium and large firms, helping highlight the continual need for action on diversity and inclusion. 

FTSE100 financial companies continually review and upgrade how they treat their permanent employees. In fact, boards at several banks have appointed designated Non-Executive Directors responsible for workforce relations in line with the revised UK Governance Code. More mental health support and flexibility on working from home are other measures implemented on the back of Covid-19 – with a decent salary as a starting point. Yet these benefits do not touch the outsourced workers like cleaners and security guards.

And yet one prescient FTSE-100 board director believes the rules are already clear: “The Board is accountable for the supply chain.” Speaking at a recent Oliver Wyman Forum event, where top executives and senior policy makers share experiences, she noted that issues related to multi-stakeholder capitalism had moved from sub-committees to main board level.

That includes tax avoidance schemes, with the most newsworthy instituted by Big Tech, yet just as prevalent at other large, global companies. Minimising tax through the use of complex schemes leads to jaw-dropping anomalies. Over 50% of the subsidiaries of foreign multinational companies report no taxable profits in the UK, for instance.

Paul Polman, the former head of Unilever, is not alone in believing that companies should embrace having to pay their fair share of tax on the back of a crisis which has seen massive spending by governments to avoid a 1929-style depression. This must include unlisted capital, such as private equity and hedge funds.

Building a level playing field and a sustainable economy means governments imposing tax reform and coordinating with other jurisdictions. The verdict so far: nul points.

Yet there are a few possible indicators of change: an OECD global tax rules blueprint might prosper if Joe Biden wins the US presidential election; the morally dubious sight of private equity firms accessing government cash could explode in a social media campaign; visionary CEOs are beginning to consider that a company’s approach to tax should be part of the ESG metrics by which investors judge them. 

Ensuring the heightened role of technology makes for an inclusive economic recovery is one of the biggest challenges facing financial services. Deepening social inequality, with Covid-19 disproportionately affecting women, BAME and those from poorer socio-economic backgrounds, sits uncomfortably alongside the accelerating digital take-up benefitting a small pool of winners. Many financial services companies are looking to cut their real estate footprint due to the permanent shift to increased home working, presaging waves of redundancies for their outsourced frontline workers.

Economist Noreena Hertz, in her recently published book The Lonely Century, writes about the neoliberal  mindset which dominated for four decades, leading to societies of unparalleled loneliness and the rise of right wing populism: “40 years of seeing ourselves as competitors not collaborators, takers not givers, hustlers not helpers.”

The effects of the pandemic have made even the most fervent small government activists mutate into advocates of big spending to stave off mass unemployment and depression. If that reversal is possible, so is the probability of legislation for the hidden workforce and international tax coordination. 

The future will involve collaboration, consensus and communication between government and the corporate sector to an unparalleled degree.  Not an easy way forward, but the only one to solve our societal problems.