For institutional investors keen to maintain environmental, social and governance commitments made in recent years, there’s a steep climb ahead.
The Paris Agreement — and its call to keep climate change to a 2°C warming scenario — is shrinking the investable universe for those still seeking to align with its confines, according to a report from MSCI Inc. on the environmental, social and governance trends likely to dominate 2021.
“Barring dramatic policy and technological breakthroughs and corporate action, the availability of Paris-aligned investment opportunities will become increasingly limited with each passing year as the required reductions to reach net-zero emissions grow ever deeper,” the report said. “In response, investors may demand radical transformation of business models or look more creatively beyond the existing investment opportunities to align their portfolios with Paris.”
Indeed, for a world that warms by just 1.5°C by the end of the century, global emissions will need to fall by between nine per cent and 15 per cent every year from 2019 levels, eventually becoming net-zero by 2050.
MSCI estimated a meagre 16 per cent of the more than 8,900 constituents comprising its MSCI ACWI investable markets index were aligned with a 2°C scenario as of Nov. 30, 2020. Just five per cent of them were aligned with a 1.5°C scenario.
Institutional investors that are serious about maintaining climate change mandates have a massive amount of engagement ahead of them, the report said. Indeed, for a 1.5°C to 2°C warming scenario to be possible, MSCI ACWI constituents — representing a large swathe but certainly not all carbon-emitting enterprises globally — would need to begin reducing carbon emissions by between eight per cent and 15 per cent every year henceforth.
Were a significant number of global investors to stick rigidly to such guidelines, equity portfolios would become dramatically concentrated, the report noted. The threat of being left off the table could conceivably prompt the drastic decarbonization required among some companies. But a more and more limited investment universe could also simply make maintaining those guidelines impracticable for investors.
“As we hurtle through 2021, climate investors will see the Paris accord transform from a guiding beacon to a mile-marker in a race where we are not keeping pace.”
In another environmental trend set to dominate the year ahead, policy makers will focus on the devastating economic implications of biodiversity loss, the report suggested.
“In 2021, the fifteenth Conference of the Parties to the Convention on Biological Diversity is slated to take place in Kunming, China, with a goal to adopt a post-2020 global biodiversity framework, featuring global and national measurable targets,” the report noted. “While few would mistake the city of Kunming for Paris, this conference has the potential to mark a tipping point for biodiversity as the Paris Agreement did for the climate in 2015.”
Biodiversity, and the loss thereof, has major implications for investors. While it is difficult to apply these implications to portfolios, investors should begin examining biodiversity’s “impact and dependency” with regard to investments, said the report. Some sectors, such as energy and mining and materials, have an outsized impact on biodiversity. Others, like travel and consumer staples, depend on biodiversity for their survival. And some sectors have both relationships.
Food is the most evident investment arena where this issue applies, the report said: “Food producers are highly dependent on healthy soil, crop diversity, pollinators, fresh water and climate stability.”
At the same time, agriculture drives about 80 per cent of global deforestation, with soy, cattle and timbre the biggest culprits.
Deforestation is becoming a distinct reason why enterprises may choose not to do business with one another, but challenges remain. The report said of soy, for example, “We analyzed the world’s largest soy processors, traders and purchasers and found that a gulf remains between aspiration and practice. The largest soy processors and traders have all adopted zero-deforestation targets, but the vast majority of their soy exports remained uncertified to third-party sustainability standards as of Nov. 2020.
“A few of their big buyers have likewise adopted targets to source ‘deforestation-free’ soy. But among the largest soy users in the food industry, so far only Danone and Mowi have achieved significant levels of sustainable soy certification.”