A Transition for All

A just transition is not only fair to all stakeholders, it is also the most efficient route to net zero, according to panellists at ESG Investor’s latest Countdown to COP26 webinar.

Transitioning to a low-carbon economy will be more costly, lengthy and painful if imposed top-down, without due consideration for the impacts on employees, suppliers, customers and voters. But a fully planned and integrated approach by policymakers, companies and investors can balance environmental with social and governance objectives to build truly sustainable, equitable and resilient business models.

In the week before COP26, ESG Investor assembled a panel of experts to discuss how asset owners can support a just transition that offers opportunities to all stakeholders and minimises the risk of stranded assets and stranding communities (click here to watch the discussion in full).

Balancing priorities

A transition on the scale and pace demanded by the climate crisis has never been attempted. In developing recommendations on how to approach the challenges facing workers and communities on the road to net-zero, the panel began with definitions.

For Hugh Gimber, Global Market Strategist, JP Morgan Asset Management, a just transition involves ensuring benefits accrued from the transition to a green economy are shared widely and that those likely to suffer most are suitably supported.

“A just transition is about balancing priorities between the environmental and social aspects of ESG,” said Gimber. “We need to ensure corporates do not focus solely on the environmental aspects of the transition at the expense of social considerations.”

The size of the challenge is evident from the numbers.

“Estimates suggest there are about 30 million people working in traditional fossil fuel industries,” said Gimber. “That’s more people than are employed in France altogether.”

The desire of governments to achieve a just transition is not in doubt, but it remains open to question whether political leaders can implement strategies accommodating both environmental and social ambitions.

A number of administrations around the world have focused on positive job creation opportunities resulting from decarbonisation. US President Joe Biden’s election campaign spoke of creating 10 million green jobs, while the UK government’s 10-Point Plan for a Green Industrial Revolution, published last November, targets 250,000, implicitly linking its net zero strategy to its ‘levelling-up’ agenda.

Nevertheless, there remains a lack of clarity as to how governments intend to realise their ambitions and at what pace, especially since the path to net zero by 2050 has not yet been precisely defined by many. It makes balancing the environmental and social aspects of transition problematic.

“There will be political opposition,” said Gimber. “Whether regionally or in a particular sector, there will be push back against change because of the adverse effects it will have on specific parts of the economy.”

Just efficient

Brendan Curran, Policy Fellow for Sustainable Finance at the London School of Economics’ Grantham Research Institute on Climate Change and the Environment (GRI), characterised just transition as an enabler of achieving net zero in a low cost and efficient manner. In other words: “If you don’t take into consideration communities and social factors, you will not get a fair and inclusive transition to a low-carbon economy,” he said.

While 90% of the world economy has some form of net zero commitment, following the announcement of India’s new policy in Glasgow, governments may not specifically use ‘just transition’ terminology in their policy frameworks. That does not mean the concept is neglected.

“The UK Net Zero Strategy didn’t use the just transition terminology, but there was a lot of discussion around how you deliver it to vulnerable customers, consumers and constituents while delivering climate action,” said Curran, until recently a senior policy advisor to the UK’s Department for Business, Energy and Industrial Strategy. “Governments are thinking about how to make it inclusive and fair, ensuring voices of communities and workers are included.”

Whether or not governments use the terminology, they are aware of the implications of ignoring the social implications of the transition away from fossil fuels. Likewise, financial institutions recognise the importance of the S in ESG. The GRI has worked closely with financial institutions, in particular those involved with the Financing a Just Transition Alliance, a coalition which sees embedding social factors as a pre-requisite.

“While we understand governments have a primary responsibility in providing a policy framework, we see financial institutions taking responsibility,” said Curran. “It is not just a question of it being the right thing to do, but a recognition of the systemic risk to an efficient transition that comes from ignoring heavily exposed and impacted communities and workers.”

Private dilemma

The panel moved on to consider a fundamental issue for investors: the extent to which corporates are currently responding to the challenge of building just transition principles into net-zero strategies.

Noting that the ability to compare companies’ progress on just transition is essential to the efficient allocation of capital, Charlotte Hugman, Research Lead, Climate and Energy Benchmark, explained the approach taken by the World Benchmarking Alliance (WBA) to measuring firms’ efforts to date.

Having already assessed companies’ low-carbon transition strategies, the WBA developed a just transition overlay, focusing on social aspects of the journey – represented by six key categories or indicators – in a pilot study encompassing 100 oil and gas, 50 electricity generation and 30 automotive manufacturing companies.

The indicators were developed with multiple stakeholders so as not to duplicate the work of others. Bringing stakeholders together helps “accelerate and enable corporate contributions to sustainable development”, said Hugman.

The results of the pilot assessment, published last week, highlighted three broad themes. Firstly, most high-emitting, globally influential companies are not yet making enough effort towards a just transition. According to Hugman, “Only about 6% of companies are able to demonstrate they’re engaging in meaningful social dialogue with affected stakeholders on all aspects.”

Secondly, the utility sector, particularly in Europe, is making the strongest inroads, although there are sharp differences between laggards and those demonstrating emerging best practice. And thirdly, too many companies operate in silos. “Different teams address the E while others the S of their strategies,” said Hugman. “It’s really important that companies think and work in a holistic way.”

The WBA’s findings have implications on strategy, capex, and R&D spend across sectors, and highlight characteristics for investors to look for as they monitor how companies tackle the transition. The challenge remains, however, that metrics used to define how companies tackle these issues are not broadly agreed or broadly understood.

The lack of clarity on the social front contrasts with progress made in understanding and evaluating environmental performance. The green bond market is an example of where the engagement of corporates in the energy transition is reflected in market prices, as Gimber observed.

“Over the last couple of years, you’ve seen a ‘greenium’ open up in green bond markets of about five basis points to equivalent corporate debt,” he said. “On the social side, differences in market pricing are currently a lot harder to see.”

Social assets

The difficulty of factoring social issues into assessments of the transition strategies of investee companies is something experienced every day by asset owners. They have a fiduciary duty to their end-beneficiaries above everything else, but if climate change is accepted and managed as systemic risk then it should be the same for just transition.

“We think of climate change as transition risk and physical risk,” said Katharina Lindmeier, Senior Responsible Investment Manager, Nest, the UK-based auto-enrolment pension scheme with more than eight million members. “Transition risk does not just mean decarbonising, but also the preparedness of companies to take advantage of green technology and green revenues. A big part of that is jobs and communities and the impact on regional economies, the national economy and the global economy.”

Metrics exist to assess impact on and of climate change, but it is more challenging for asset owners to get accurate and comparable measures on the social aspects to an investment. Assessing the social performance of a company remains a bottom-up process based on fundamental research and company engagement, either directly, through investor coalitions, or via asset managers.

“The first challenge is understanding whether a company has a transition policy at all, and then assessing how good that policy is in terms of preparing their workforce,” said Lindmeier.

As asset owners integrate social objectives into net zero investment decisions then the nascent market for social metrics will develop, the flow of funds will increase towards more socially oriented assets, and companies with a credible ‘just transition’ strategy will be rewarded with better pricing. Corporates will see the value in taking the lead in delivering a just transition for their stakeholders, independent of regulators, suggested panellists.

There is still a place for regulation, however, particularly in areas of the market where institutional investment opportunities are not immediately present.

“There is a role for governments to pump prime key markets,” said Curran. “That will help commercialise sectors that are key to the net zero transition and come with huge just transition elements as well.”

Positively just

Data on social metrics may lag for now, but this is likely to change quickly, suggested panellists, due to a growing appreciation of their importance to investors’ ability to understand transition risks.

“We’re getting to the point where, just as environmental issues are seen as key risks to a portfolio, social issues are becoming better reflected as a key risk as well,” said Gimber. “It’s not only a question of doing the right thing, but also risk mitigation from an asset allocation perspective.”

A just transition will become better reflected in the flow of assets across financial markets, which will result in it becoming more visible in corporate cost of capital.

“Yes, this is hard. This is difficult. What’s most important is that investors remain dedicated to engaging with individual companies and focused on bottom-up, fundamental research,” said Gimber. “We are optimistic that change will come. We’ve seen major progress on the environmental side, and the market will get there on the social side as well.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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