Commentary

A Fair Cop

Carmen Altenkirch, Emerging Markets Sovereign Analyst, Aviva Investors, explains why social justice is vital to climate action, in both developing and developed economies.

Until now, finance has been slow to recognise the importance of social issues and reluctant to connect the ‘E’ and the ‘S’ in ESG. But this is changing as the just transition provides a strategic lens through which to assess and manage risk. A disorderly transition will increase the vulnerability of certain economies, bringing hazards for those seeking to allocate capital.

The role of finance

The fiscal impact of funding the climate transition on developing economies, given already high debt levels, is a key risk – particularly if the bulk of the costs are borne by the state.

For sub-Saharan Africa, a rough estimate suggests meeting climate targets under the International Energy Agency’s Sustainable Development Scenarios would cost around 5% of GDP on an annual basis. Average debt across the region is already sitting at 56%, so these added costs risk making debt unsustainable very quickly. To make the climate transition affordable for poor nations, it needs to be funded by both the private and public sector – and ultimately it needs to be growth-enhancing.

One way to attract private financing is through new instruments. In June 2021, Benin raised €500 million through the issuance of bonds directly linked to the UN’s Sustainable Development Goals, pledging to devote the proceeds to relevant environmental and social objectives, including access to water and clean energy, education, health, decent housing, connectivity, and biodiversity conservation.

Such deals remain rare. Public-private partnerships or guarantees from governments and multilateral organisations, such as the World Bank, could help though, by unlocking more capital for socially valuable projects in developing economies that have modest or fair credit ratings, and making the costs more affordable.

To be sustainable, the cost of green or social bonds needs to be materially lower than conventional Eurobonds, but recent deals suggest that this has not been the case so far. Multilateral guarantees to raise the issuer rating and reduce the cost of issuance would be supportive. Ultimately, the pool of capital to support these projects needs to be expanded, as well as the capacity of countries to implement projects. More local currency issuance to fund green projects, equity investments in companies supporting the green transition, grants and foreign direct investment will all be part of the solution.

Policy and shareholder engagement

Investors can also play a role in engaging with policymakers and multilateral institutions to ensure capital is directed to where it is needed for the just transition.

One example of the just transition moving into financial reality is the UK’s recent green sovereign bond programme. In 2021, following an earlier proposal from the London School of Economics’ Grantham Research Institute, the Green Finance Institute and the Impact Investing Institute, the UK government committed to raise £15 billion with green sovereign bonds this fiscal year, and recognised the just transition as part of its Green Finance Framework, pledging to report on the social co-benefits of its spending (for example, in terms of job creation).

Engagement can also lead to results at a corporate level. By encouraging companies to take the social and political implications of the transition into account, investors can help drive positive change through the private sector.

A just transition will help mitigate risk, at a specific company level as well as the broader systemic level. Companies that fail to take into account the rights of employees or other stakeholders may face reputational hazards.

Nevertheless, recognition of the just transition is still at an early stage among companies. A 2018 study from ESG consultancy Vigeo Eiris found very few energy firms were incorporating social impact into their transition and restructuring plans. The Financing the Just Transition Alliance (FJTA), which represents nearly 40 banks, asset managers (including Aviva Investors) and other financial organisations, along with trade unions and universities, recommends investors take a more active role in order to address this lack of urgency.

It has published a framework for shareholder engagement that calls on companies to incorporate the just transition into remuneration, planning, risk management and scenario exercises; to safeguard the rights of workers and communities; and to apply labour, human rights, and environmental due diligence across their supply chains.

There are signs nascent investor engagement on the just transition can bear fruit: following shareholder dialogue at its annual general meeting in August 2020, UK power utility SSE became the first company to publish a just transition plan, setting out 20 principles for its operations, including robust stakeholder consultation and retraining initiatives.

Nevertheless, there is a long way to go before such commitments become mainstream. One issue for investors is the difficulty in obtaining data on social metrics as a basis for asset allocation and engagement. Tracking human rights standards across convoluted international supply chains is a particular challenge, which is why tougher legislation is needed to ensure businesses are complying with the UN Guiding Principles on Business and Human Rights.

This includes companies in ostensibly ‘green’ industries – human rights abuses have been highlighted in supply chains for renewable energy solutions, for instance. For example, a recent study found up to 40% of the UK’s solar farms were built using panels supplied by Chinese firms implicated in the forced labour of Uyghur and other mostly Muslim ethnic groups in the province of Xinjiang.

A holistic approach

Initiatives in the pipeline could bring about greater transparency. The World Benchmarking Alliance is developing a dedicated Just Transition Benchmark, which will provide a ranking of companies on social metrics (it delivered an initial report on 180 companies at COP26, with the full benchmark due in 2023). Companies are also being encouraged to use the Task Force for Climate-related Financial Disclosures (TCFD) to provide comprehensive reports on the social impact of their operations; this would represent a natural evolution for the platform.

Better data on the social and environmental dimensions of companies’ operations might highlight opportunities, such as companies helping nations adapt to rising water scarcity. Examples include a company that uses GPS and sensoring technologies to help farmers maximise crop yields while ensuring more accurate deployment of resources and minimising water waste, or one which provides water control and rainwater-harvesting systems to help conserve water resources and enables the filtering of safe drinking water in isolated disaster zones.

On occasion, it might make sense for investors to contribute to projects that would not pass muster when viewed through a purely environmental lens, but could be justifiable on socio-economic grounds. Real assets projects, for example, often bring a mixture of positive and negative outcomes, necessitating a case-by-case approach in which investors must liaise with a range of stakeholders to assess any trade-offs between ‘E’, ‘S’ and ‘G’. It was as a result of such a due diligence process that Aviva Investors made a loan to a major state-owned company in Ivory Coast in 2018, the proceeds from which went towards funding improvements to an existing oil refinery.

The transaction lessened the country’s reliance on energy imports, improved efficiency at the existing facility, and brought benefits to the local economy. Though it was a carbon-intensive project, it still aligned well with the UN’s Sustainable Development Goals.

As momentum builds behind the just transition, the current social and environmental trade-offs could disappear. But this will only be possible if policymakers, workers and businesses across the world collaborate on a more equitable, inclusive path to a net-zero future.

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