Sustainable investing: 2022 scorecard

It has been a mixed year for progress on ESG issues with considerable disruption from the Ukraine crisis
High fossil fuel prices and insecurity of supply has galvanised policymakers to support renewables development
Companies are making tangible progress on disclosure and transparency

2022 brought both progress and failure for sustainable investors. On the one hand, the Ukraine crisis saw countries fall back on fossil fuels as they scrambled to prevent energy shortages. COP27 was disappointing, with no new carbon targets set and little apparent progress on existing targets. However, the Russian invasion also galvanised some of the world’s major economies into tangible commitments on climate initiatives – from Repower EU, to the Inflation Reduction Act. Investors can hope for better in the year ahead.

The Ukrainian crisis disrupted energy markets across the globe. It shone an uncomfortable light on the world’s dependence on Russian fossil fuels. While there were short-term measures to replace Russian gas – the use of Liquefied natural gas in Europe, for example – it focused the minds of policymakers on the risks in outsourcing their energy needs to unstable nations. In the long-term, this is likely to be good for renewables.

Andrew Risk, ESG analyst on the abrdn UK equities team, says: “Renewables are trying to be cost competitive with fossil fuels. That’s largely a function of the price of fossil fuels, so if the gas price goes up, there is much more incentive to shift to renewables. Governments have shown real commitment to moving away from gas this year and that is unlikely to be reversed. In Europe, they were saying they couldn’t transition fast, but the situation has brought huge investment into renewables.”

There has been considerable short-term gain for fossil fuel providers, but in the longer-term, the outcome for these companies may not be as encouraging. Ben Ritchie, manager of the Dunedin Income Growth investment trust, says: “Regulation in the corporate sector to achieve climate goals will accelerate. There are going to be some sectors and some companies whose business models are challenged, and challenged more quickly than they currently think.”

“Oil and gas companies have done well during the Ukraine crisis, but this has been a terminal blow for the duration of those cash flows: it will significantly increase the focus on renewables and energy independence. In the long-term, it makes us more concerned about the investment case.”

COP 27

Against this backdrop, the outcomes from this year’s flagship environmental conference, COP27, were disappointing. Alok Sharma, former cabinet minister and president of the COP26 conference concluded: “I said in Glasgow that the pulse of 1.5 degrees was weak. Unfortunately, it remains on life support.” Countries had made little progress on the commitments made in Glasgow and proved disinclined to make new commitments.

However, the conference did produce an important breakthrough on ‘loss and damage’ – compensation for poorer countries for environmental damage inflicted by major industrialised nations. Andrew says this was an important step, even if the lack of progress elsewhere was frustrating.

These conferences remain important, says Tzoulianna Leventi, investment and ESG analyst on the abrdn UK Smaller Companies Growth team, says: “Regulatory initiatives need to be agreed at national and international level. Regulators need to create new regimes, creating better harmonisation and better targets for companies to operate based on those targets. Net zero is not a sprint, it’s a marathon. Everyone has to work together to make the right agreements and develop the right action points.” COP 28 is scheduled for early December 2023 in the United Arab Emirates and sustainable investors will be hoping for improvement.

Improving disclosure

Regulatory progress, including the EU environmental and social taxonomies and other initiatives to improve standardisation for sustainable investment definitions, is helping ensure broader disclosure from companies, including among previous laggards such as smaller companies. Tzoulianna says: “There had been less disclosure among smaller companies, but that doesn’t mean they are not doing the right thing. I’ve seen significant improvement this year.” She says companies are increasingly setting targets for decarbonisation, but also improvising disclosure on social metrics: diversity & inclusion and employee incentives, for example.

For larger companies, the focus has been on getting more relevant disclosure. Andrew says: “There is often enormous levels of disclosure from the largest companies, but the companies complain that it’s too much and there are too many frameworks out there - and we still find gaps on what we want to know. In our engagement with companies, we aim to link to the reality of what a company does.”

The lack of clarity on ESG definitions has long been a frustration for investors. There remain significant differences in the interpretation of ESG by different fund groups and this can make selection difficult. Against this backdrop, new proposals to introduce UK fund categories are welcome. Andrew says: “Assuming it is introduced as proposed, it will add credibility to the communication and marketing about how ESG is considered in a portfolio. There are three labels, sustainable focus, sustainable improver and sustainable impact.”

Tangible progress

Across its engagements with companies on sustainability issues, abrdn analysts see real progress. Tzoulianna gives the example of an Italian company that didn’t have any ESG disclosure at all. After Abrdn initiated a dialogue with the company, it made significant improvements and has just released a long-term strategy for change.

Andrew points to chemicals group Croda, which is now regarded as one of the sustainability leaders globally. He also highlights Standard Chartered, which has set out ambitious targets for its financed emissions. “It is one of the few banks that puts out disclosures on the income that it is making from its sustainable finance transactions.” There has even been progress for oil and gas companies. They may still be significant polluters but have moved a long way in the right direction. However, there are still laggards. Andrew suggests the agricultural and foods sectors still have a long way to go.

The Ukraine crisis provided a tough backdrop from which to make progress on ESG issues. Nevertheless, 2022 has had its victories. Perhaps more importantly, it has created new momentum for action from companies and governments alike. There are better signs for 2023.

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Issued by abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Authorised and regulated by the Financial Conduct Authority in the UK.

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