Politics and the environmental, social and governance (ESG) agenda are inextricably intertwined. While COVID-19 may have pushed ESG temporarily to the back-burner, once the situation abates, financial services executives will need to understand the new political environment around ESG if they hope to develop a robust approach.
To find out how COVID-19 is shifting the political environment related to the ESG agenda (and the impacts on the financial sector) we sat down with two global thought leaders on the topic.
Kay Swinburne, currently KPMG in the UK’s Vice Chair of Financial Services, represented Wales in the European Parliament from 2009 to 2019, during which time she served as Vice Chair of the Economics and Monetary Affairs Committee (ECON).
Rohitesh Dhawan is the Managing Director of Energy, Climate and Resources at Eurasia Group, a global political risk consultancy, having previously worked with Yvo de Boer, former executive secretary of the UN Framework Convention on Climate Change.
Do politicians have the will and appetite to drive the ESG agenda forward?
Rohitesh Dhawan (RD) — 2020 was expected to be the high point of climate action. In the preceding months, the economics of new energies had been rapidly improving, investors had been piling in with ESG mandates, there were almost daily announcements by global corporates for net zero emission goals, societal concern was on the up driven by civil society actors like Greta Thunberg, and governments were getting ready for the biggest climate policy conference since Paris; COP26 in Glasgow in November.
The disruption from COVID-19 — a sharp global economic slowdown, an oil price war and a general battening down of the hatches — will affect each of these trends. Climate change will be put on the back-burner in 2020. As a result, the trajectory of climate change action needs to be recalibrated.
Kay Swinburne (KS) – I would have to agree with Rohitesh. I think governments and citizens are currently very focused on dealing with the health, economic and social implications of COVID-19. I suspect — in many ways — this tragic experience will accentuate the need for greater focus on ESG investing. Governments are already starting to think about how they can rebuild their economies and many are hoping to achieve that in a more equitable, sustainable and environmental way.
I would argue that the EU continues to take a leadership role on ESG. And I believe we have seen some significant action come from them, particularly in terms of greening the financial services sector. The EU Green Financing Deal, for example, was a policy response aimed at creating a taxonomy, setting green benchmarks and enhancing financial disclosures for funds.
What is the risk if politicians do not take the lead?
KS — I think politicians are increasingly worried that their financial systems and their businesses will get cut off from global capital flows if they do not rebuild their economies in a more sustainable fashion. BlackRock’s announcement late 2019 already made it clear that some assets will start to become increasingly costly to finance and — eventually — economies reliant on fossil fuel will find themselves at an incredible disadvantage.
RD — Even with reduced political activity on climate change as a result of COVID-19 crisis, we expect to see increasing climate action this year and beyond. Indeed, as growth returns, what concerns me is that investor appetite for ESG-related investments will outstrip the availability of ESG-positive assets available in the market. And politics and policy have a direct role to play in this.
Without clear government signals and policy, companies and businesses lack the strong incentive to transform towards alternative business models which, in turn, slows the development of new ESG-related assets. If that continues, we’ll be on a collision course where a groundswell of capital collides with a lack of top-down policy leading to a disorderly transition.
How is the financial sector being used to drive accelerated change?
KS — Before COVID-19 unfolded, financial services firms in the EU had been thrust into the very centre of the ESG action as intermediaries of capital flows. The EU doesn’t regulate corporate disclosures itself — that is the job of the individual Member States. But it does regulate the financial services space across the EU. And that has made the financial sector a valuable tool in the EU’s response. Essentially, the EU had asked the financial sector to disclose the ESG footprint of the constituent parts of their portfolios. And that was forcing them to have tough conversations with their corporate clients about what they need to disclose.
RD – That was certainly the intention and, once COVID-19 abates, I suspect those disclosure requirements will catalyse some players to take action. But without meaningful policy around targets and expectations, I worry this will simply become an accounting endeavor. Depending on how you measure it, some estimates suggest that the major oil companies spent about one percent of their CapEx on renewable energy investments between 2012 and 2018. That was at a time where oil prices were fairly high and it was already very clear that public opinion and investment capital was moving away from fossil fuels. So while the narrative around ESG will certainly get some momentum from forced disclosures and the like, I think the pace of the transition is still going to be slow.
Are you concerned about what the Principles for Responsible Investing (PRI) is calling the ‘inevitable policy response’?
RD — I am very worried about that eventuality. Essentially, the PRI had already raised concerns before COVID-19 that governments would suddenly find themselves forced to act ‘en masse’ and that would leave investor portfolios open to significant risk. That, of course, concerns me. Not because I think it’s the most likely outcome. But rather because I’m worried that it would be extremely disruptive to the financial community. And I don’t think we’ve seen enough stress testing and planning for that eventuality.
KS — Again, this is where we are hopefully seeing the EU take the lead. The European Banking Authority, the European Insurance and Occupational Pensions Authority and the Prudential Regulation Authority in the UK had been rolling out a series of stress tests to help authorities get a clear understanding of what their constituents’ ESG exposures are. Over the medium-term, I suspect that will force many banks — particularly the big multinationals — to take a much closer look at their risk across the globe.
Given the current political climate, what is your advice to financial services executives?
KS — While I certainly have faith that the political and policy environment will pick up pace towards meaningful action on the ESG agenda in the coming months, I think financial services executives must recognise that — like it or not — this shift is happening. The last thing you will want is to be left holding a portfolio of stranded assets. So this is the time to start planning and rethinking your portfolios for the short, medium and long-term.
RD — I agree. There are a number of reasons why financial services firms need to continue the march towards ESG investing and risk planning. But I think there are going to be some very serious challenges that will start to restrict firms’ ability to execute on their ESG mandates. This is where politics and the ESG agenda need to come into alignment. And this is why financial services executives need to remain very mindful of the political environment as they plan their ESG strategies.
Vice Chair, Financial Services, KPMG in the UK
Kay is Vice Chair of Financial Services with KPMG in the UK, and previously served as Vice Chair of the European Parliament’s influential Economics and Monetary Affairs Committee, playing a pivotal role in shaping EU and global financial services legislation, including setting up the EU supervisory bodies (ESAs, SSM, SRM), capital markets union (EMIR, MiFID II, Prospectus, CCP Recovery & Resolution), and the broader banking union files. Prior to Kay’s career as an MEP, Kay worked in investment banking. Kay brings a unique insight to policy ‘behind the scenes’ and the reality of Brexit in the aftermath of 31 January 2020.
Director, Energy, Climate and Resources, Eurasia Group
Rohitesh is the Director of Eurasia Groups’ Energy, Climate and Resources practice where he covers the (geo)politics of the energy transition, climate change and the transformation of the materials economy. He is a trained economist and geographer from the University of Oxford and has been named one of South Africa’s climate change leaders for his work with the country’s mining industry.