Facilitating an orderly transition

investment viewpoints

Facilitating an orderly transition

Emma Cusworth - Head of Marketing Strategy

Emma Cusworth

Head of Marketing Strategy

This year’s EU High-Level Conference on Sustainable Finance focused on scaling up investment, particularly, how to better engage the private sector to invest the additional €180bn yearly funding required to reach the EU’s energy and climate goals by 2030.

During the day, experts representing governments, central banks, investors, asset managers, international institutions and charitable organisations, discussed how to better mobilise the public sector to facilitate private sector investment, and the need for greater recognition of the interconnectivity between social, economic and environmental issues.

According to Pierre Heilbronn, Vice-President of the European Bank for Reconstruction and Development: “Climate action is essential. It has to be immediate and it has to be decisive. The public sector cannot finance the volumes of investment needed for the transition alone. The private sector has a vital role to play if we are going to achieve the goals outlined in the Paris Agreement.

“This will have very significant implications for capital flows,” he continued. “We need that flow of capital to drive the most fundamental shift in our history.”

As we are already seeing, a shift on this scale has the potential to create significant risks and opportunities for investors, which urgently needs to be accounted for in the investment process.

 

The EU’s three climate and energy targets for 2030:

PNG-for-article-3.png

 

Facilitating private sector sustainable investment

The key question in this debate is how the public sector, including its financial weight, can be leveraged to support greater investment from the private sector in the transition to a low-carbon economy. Panellists suggested a series of measures were necessary to align the interests of the public and private sector to help create this flow of capital towards companies and projects whose business models support the transition. 
 
Among the measures discussed were the provision of guarantees for long-term yields to shield investors from political instability. Another was the reinvigoration of carbon taxes to create the right kind of price signal to polluting companies. “If there is no incentive for private investors in the price signal,” argued Pervenche Berès, Member of the European Parliament, “then we will continue to see this focus on the short-term.”
 
Regulation of the investment market is a key lynchpin of the transition. The EU, through its Action Plan for Financing Sustainable Growth, laid out three important pieces of legislation in May 2018 to incentivise and channel private sector investment towards greater sustainability. These measures have since been agreed or adopted by the European Parliament this year.

Increasingly, there is no where left to hide from the risks and opportunities this global regulatory pathway is creating.

EU Action Plan – three key pillars of legislation:

 

EU Action Plan Taxonomy Heading.png
EU Action Plan Inv Duties Heading.png
EU Action Plan Carbon Heading.png
EU Action Plan v2 - taxonomy-01.png
EU Action Plan v2 - Inv Duties-01.png
EU Action Plan v2 - Carbon Bench.png

 

Speaking after the conference, Carolina Minio-Paluello, Global Head of Solutions for Lombard Odier Investment Managers said: “Regulators have a key role to play in creating the required shift in capital towards companies with sustainable business practices and models. Increasingly, there is no where left to hide from the risks and opportunities this global regulatory pathway is creating. This is particularly the case on climate change today, but we expect it will quickly accelerate to address other areas of the Sustainable Development Goals, particularly around issues like inequality.”

Speaking at the conference, Petteri Orpo, Minister of Finance for Finland, called on finance ministers to support the transition. He pointed, for example, to the withdrawal of subsidies that support the fossil fuel sector. “This has to stop,” he said. Finland has around €4bn in such subsidies. As data has improved, Orpo said, “we now know how our policies affect climate change and we have powerful tools as finance ministers through the budgets and taxes we control”.

The withdrawal of such subsidies could have significant implications for the returns investors can expect from fossil fuel companies. “We are already seeing that companies in this sector are finding it more difficult to secure financing for new projects,” Minio-Paluello said. “The clear path of regulation is affecting the financial viability of these developments in the long-term and we believe companies in this sector need to adapt to the transition in order to continue to thrive. Those that don’t will face existential threat.”

 

Ensuring a value-generative transition

However, Minio-Paluello also pointed to the important role investors can play in facilitating the transition. “The answer is not necessarily to simply exclude these companies from a portfolio,” she said. “In our view, there is a greater likelihood of creating an orderly transition if we adapt our investment process to favour companies who are transitioning to more sustainable business models and practices, and penalize those who are not transitioning. And the orderliness of the transition is vital if we are going to ensure it is value-generative, not value destructive.

“This approach also allows us to integrate sustainability into passive approaches, which is a vital next step towards creating greater economic sustainability and reducing systemic financial risk,” Minio-Paluello said. “This is the next frontier, especially for institutional investors, and we see increasing demand from asset owners to move in this direction.”

 

A complex socio-economic interconnection

Speakers at the conference also stressed the importance of understanding and accounting for the highly complex interconnection between the different objectives laid out in the UN’s 17 Sustainable Development Goals. 

Berès pointed out: “If we want to be successful in this transition, we need to account for the social element. If we just focus on achieving the 2°C goal, we are likely to create a social crisis, which will mean we are unable to deliver on 2°C.”

Central banks and other authorities are increasingly recognising that climate risk presents a material financial risk, but this has yet to spread to social issues. Frank Elderson, Executive Director of De Nederlandsche Bank, said: “The Dutch central bank has also looked at issues like bio-diversity and human rights, and we recognise that these factors also create financial risk. We believe it is therefore in the scope of financial market supervisory authorities to ensure financial markets are managing these risks appropriately.”

Transparency is a key point in understanding the complex interplay between externalities. Data on social factors is still relatively limited and often requires an alternative approach to gathering, verifying and standardising raw data. 

“Sustainable investments are only as robust as the data and analysis they are built on,” Minio-Paluello says. “We, as a firm and as an investment industry, need to continue to look for new ways to understand how sustainable companies are across the whole complex web of issues encompassed by the Sustainable Development goals.”

important information.

For professional investor use only. 

This document has been prepared by Lombard Odier Funds (Europe) S.A. and is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393
Lombard Odier Investment Managers (“LOIM”) is a trade name.
This document is provided for informational purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This document does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipients exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. The contents of this document are intended for persons who are sophisticated investment professionals and who are either authorised or regulated to operate in the financial markets or persons who have been vetted by LOIM as having the expertise, experience and knowledge of the investment matters set out in this document and in respect of whom LOIM has received an assurance that they are capable of making their own investment decisions and understanding the risks involved in making investments of the type included in this document or other persons that LOIM has expressly confirmed as being appropriate recipients of this document. If you are not a person falling within the above categories you are kindly asked to either return this document to LOIM or to destroy it and are expressly warned that you must not rely upon its contents or have regard to any of the matters set out in this document in relation to investment matters and must not transmit this document to any other person. This document contains the opinions of LOIM, as at the date of issue. The information and analysis contained herein are based on sources believed to be reliable. However, LOIM does not guarantee the timeliness, accuracy, or completeness of the information contained in this document, nor does it accept any liability for any loss or damage resulting from its use. All information and opinions as well as the prices indicated may change without notice. Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a financial promotion and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorised and regulated by the Financial Conduct Authority.
© 2019 Lombard Odier IM. All rights reserved.