The ESG Interview: Operationalising the Social Dimension

Professor Nick Robins explains the compelling need for a just transition to a low-carbon economy and the role of asset owners in realising this aim.

For many focused on ESG investing, the urgency of the climate crisis has propelled environmental issues to the fore, often to the detriment of social themes, with governance looming large, if sometimes unnoticed, in the background.

Significant resource and effort are being poured into developing policy initiatives, reporting frameworks and risk methodologies to track and limit the impact of climate change on businesses and assets. Decarbonisation commitments have become de rigeur. Net zero has entered the vernacular.

But these plans will fail, if E of ESG overshadows S and G, according to Nick Robins, Professor in Practice – Sustainable Finance at the London School of Economics’ Grantham Research Institute on Climate Change and the Environment. Rather, the trinity should be regarded as inseparable.

In particular, Robins argues that the shift to a low-carbon economy must explicitly take account of the social impacts. Stranded assets must not lead to stranded industries or communities.

“When the Paris agreement was designed, there was a recognition this was a necessary transition and that we need to be thinking about human implications,” he explains.

“We know that moving to a net zero emissions economy is hugely positive, with more jobs in renewables, leading to community revitalisation, while avoiding catastrophic air pollution [in addition to mitigating climate change]. But this is a whole economy transition, so there are going to be social implications. We need to be conscious that particular sectors and regions are going to rise and fall.”

Lessons from recent history

If investors and policymakers focus on stranded assets, but not stranded workers, communities, or even countries, transition may stall.

Highlighting the existing real-world consequences of transition, Robins cites the gilets jaunes, the protest movement that swept France in late 2018, sparked by a series of hikes to fuel taxes, part of government efforts to wean the country off fossil-fuel dependence.

The protests were directed firmly at new president Emmanuel Macron, even though the taxes were set in motion under predecessor Francoise Hollande. “Introducing a carbon tax in the transport sector was technically the right thing to do, but Macron had not thought through the implications for consumers,” says Robins, noting also that US President Donald Trump’s withdrawal from the Paris agreement was predicated on concerns for American workers, specifically in the US coal industry.

With these lessons in mind, Robins says investors increasingly understand the systemic risks of failure to address the socio-economic consequences of a green transition. “They realise that if we don’t get the social dimension right, we’re not going to win.”

This need for a transition that is equally supportive of environmental and social goals is now recognised by politicians as well as investors. EC President Ursula van der Leyen’s European Green Deal Investment Plan includes a Just Transition Mechanism, which will channel around €100 billion of investments to support workers and citizens in impacted regions across 2021-2027.

Similarly, US president Joe Biden’s agenda has a strong focus on providing “good-paying union jobs” in clean energy and other new low-carbon sectors. “Policymakers are really waking up to this, and simultaneously, investors are too,” says Robins.

Just transition in practice

Alongside systemic risks and related fiduciary responsibilities, investors’ interest in ensuring a just transition also encompasses the opportunity to channel capital to under-served and disrupted sectors and regions, says Robins, including projects which support low-income consumers through  housing and transport investment.

As such they are playing an important role in the Financing a Just Transition Alliance, an initiative coordinated by Robins and colleagues at the Grantham Research Institute, focused on mapping out the ‘how’ of transitioning to a green economy.

The alliance was active before the pandemic took hold, but the urgent subsequent need to ensure an effective and comprehensive recovery means its goals are now much more closely aligned with a government policy which explicitly recognises the opportunities of the green industrial revolution, as well as the imperative to address inequalities exposed and exacerbated by Covid-19.

Robins characterises the role of the alliance as translating just transition from concept into operational practice for financial institutions. The work has been split into three areas, covering the interaction between the finance sector and businesses, regions and policy. Progress and examples will be presented at COP26.

“Investors and banks can only do so much. You also need policymakers to put in place policy frameworks and mobilise public finance,” says Robins, noting the potential role of the UK Infrastructure Bank and British Business Bank.

Setting expectations

The 40-strong alliance includes global financial institutions and major UK banks, but also a healthy representation of large asset owners, including Brunel Pension Partnership, the Church of England Pensions Board, the Local Government Pension Fund Forum and Legal & General, as well as a number of investor representative groups, including the Principles for Responsible Investment.

A key role for asset owners is setting expectations about how assets will be managed through the transition journey. Recent discussions have focused on clarifying expectations and establishing how best to deliver them, in league with asset managers, through engagement with investee companies. As Robins notes, these expectations have to be expressed clearly, with tangible targets, so that companies can incorporate them into their KPIs and report on progress.

Rather than reinventing the wheel, and imposing a new set of requirements on investee firms, the alliance is adapting and leveraging existing tools. This means starting with international frameworks, then looking to accommodate UK-specific concepts, such as the Social Value Model, before sanity checking to ensure requirements are relevant and reasonable.

Not unlike the guidelines of the Task Force on Climate-related Financial Disclosures (TCFD), there is a primary focus on questions around strategy, i.e. how the company perceives and manages the social risks and opportunities in the transition. But the alliance’s due diligence will extend to how firms’ plans affect various stakeholder groups such as consumers and employees, both those ‘transitioning’ in and out of a particular sector or company, with implications for skills and training requirements.

Robins says alliance members recognise the difficulties of reporting on social performance in the context of a dynamic, disruptive and multi-dimensional transition exercise.

A “common sense” set of expectations is emerging from discussions involving asset owners, some leveraging existing initiatives, such as an ongoing engagement programme with UK energy utilities, conducted by the Friends Provident Foundation and Royal London Asset Management.

“We’re in the first phase of asset owners setting expectations, in terms of getting to net zero in a socially aligned way. But we expect to see greater clarity over the next year,” says Robins. Data on transition plans is becoming more available to asset owners through the efforts of other collaborative initiatives, such as Climate Action 100+, which is asking global corporates to report on their net-zero programmes, and the World Benchmarking Alliance, which has started to track the social dimension of transition.

“These initiatives will be really useful in operationalising how asset owners assess and engage with companies, and how they allocate capital,” says Robins.

Doubling down on materiality

Despite investors, policy makers and other stakeholders putting the measures in place to ensure a comprehensive and just transition, we still cannot be certain the current pace is sufficient to avoid catastrophe. Eric Usher, Head of the UN Environment Programme Finance Initiative, recently dispelled any complacency when he emphasised the importance of double materiality.

In effect, double materiality means our actions cannot be informed solely by the desire to minimise the impact of physical and transition risks on ourselves; we must also fully consider the impact of our actions, as individuals, companies and providers of capital.

Robins draws some level of reassurance from the journey made in recent years by the central banking community, who are now alert to risks on both sides of the equation, and increasing mandated to act accordingly.

“Central banks have a real role in understanding both sides of double materiality,” he says, “not only the impact of physical and transition risks on financial institutions, but also how, at an aggregate level, those risks could rebound and threaten financial stability as a whole.”

As highlighted in a co-authored report published this week, Robins characterises the evolving role of central banks in tackling climate change in terms of two distinct stages, the first dating from then-Bank of England Governor Mark Carney’s 2015 speech to Lloyd’s of London, ‘Breaking the tragedy in the horizon’. Since then, climate change has risen firmly to the top of the agenda for those overseeing the global finance, with the Financial Stability Board initiating the TCFD and more than 80 central banks and supervisors joining the Network for Greening the Financial System, including, since last December, the US Federal Reserve.

It has become accepted practice for central banks to factor climate change into mainstream operational issues, for example incorporating climate change scenarios into regulated entities’ stress-testing requirement. But now, says Robins, we’re entering a second phase in which addressing climate change becomes core to their mandate, a shift dictated by the commitment of an increasing number of countries to net-zero carbon deadlines and targets.

“There is a recognition that achieving net zero is fully consistent with the mandates of central banks,” observes Robins.

Sending a signal to the market

Typically charged primarily with delivering price stability, central banks are often also expected to act more broadly in support of government strategy, notes Robins.

In the recent UK budget, a good deal of attention was paid to details provided about the first UK sovereign green bonds, which included a commitment to report on the contribution of its proceeds to delivering social benefits, but other announcements were also significant. In particular, the Bank of England’s remit on financial and monetary policy was updated to explicitly refer to the role of the government’s net zero commitments within its broader economic strategy.

This means, for example, that the Bank of England will need to factor climate considerations in its asset purchasing activities, perhaps favouring bonds of firms with stronger credentials in reducing carbon emissions. This is significant in its own right, but more so, suggests Robins, in terms of the example it sets.

“This has material implications for how the central bank operates and also wider market impacts. When the central bank, as a major player in the market, sets out its processes, it will send a signal,” he says.

Robins believes there is every reason to expect the European Central Bank to follow suit, given the economic strategy implicit in the EU Green Deal. There is also scope for the Federal Reserve to play a role in effecting a just transition in the US, in part due to its dual mandate on price stability and employment.

As noted in his newly released report, mechanisms already exist, such as the US Community Reinvestment Act, which the Federal Reserve oversees at a state level and thus can use to steer the finance sector toward initiatives and activities that support or facilitate President Biden’s clean energy jobs agenda. To the casual observer, the Federal Reserve may be focused on price stability, inflation and employment. But, says Robins, there are many ways it can use its influence in support of a just transition.

“Central banks have a clear mandate, but they also have an important role as an independent advisor of government. They have a limited role but they can signal issues that governments or indeed need to be responding to.”

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