Markets are not just an occupation. Markets for me are a passion! It is something I took to intuitively as a child and young adult. It is something that I have built a career around. Markets are to me the way water is to a fish. It is not something foreign that you think about in abstract terms but rather something that is around you in every aspect of life. It is the money we use daily; it is the stock of the stores we visit, the fuel we burn as we get around and more importantly, it is the air we breathe! Yes, the air we breathe!
The title may have been clickbait for those only looking at the market without necessarily contemplating the bigger picture. This beautiful blue dot in the cosmos is the only home we have and even if Elon and Jeff are successful in getting us to colonize Mars in our lifetime, Earth is home and for the foreseeable future, it is ALL we have. It is also increasingly evident that the effects of climate change because of environmental mismanagement over the centuries are now imminent and upon us.
Climate change is real
Just over the last month, During November, Ontario was experiencing above seasonal weather with little to no snow yet. Then, in the span of a few short weeks, we had a storm with winds over 100 km/h and over the last week, record snow and rainfall. Climate change is real.
Global temperatures are roughly 1.5 degrees warmer now than a century ago and the magic number touted by environmentalists is 2 degrees at which the process of warming becomes irreversible. This level also serves as the guidance for the Paris Accord, a UN driven agreement dealing with greenhouse gas emissions, mitigation and finance. We are dangerously close to this level and a sense of urgency is required.
Melting glaciers are no cause for celebration but thankfully, Canada is one of the countries in the world with a positive water balance (more precipitation than evaporation) and with one of the highest endowments of fresh water per capita. This is key as in future, fresh water will become a resource we can scarcely ignore.
My native homeland of South Africa is on the opposite end of the water spectrum being categorized as ‘water distressed’, with few viable watersheds, mostly shared with its neighbors. Potable water will become a key commodity in the future and governments the world over would be better off planning their infrastructure accordingly.
Air quality, something I referred to in my podcast on China here, is also a key consideration. The chart below, (courtesy of @MattDzugan) illustrates air pollution (fine particulate matter) around the world. A staggering 98% of China live outside the suitable range. India has 30% of its people breathing air 5 times worse than the WHO threshold. These two countries make up roughly a third of the world’s population.
Similarly, forests, the lungs of our beautiful planet are under threat. The National institute of space research in Brazil (INPE) recently released a report which claims that for the 12 months to July 2020, the estimated area of the Amazon which has be deforested amounted to 11 088 km2 ! This number is an estimate with final numbers due in early 2021. The area deforested alone is roughly the size of the country of Lebanon or 1% of the total land area of South Africa, IN ONE YEAR and in one country!
Global deforestation trends have been continuing for some time, eroding the ‘lung capacity’ of the planet at a time when it is sorely needed. Yes, some countries, like Canada have begun ambitious afforestation programs. However, we are merely trying to arrest a deforestation process, which in a global context, appears to be continuing.
The data doesn’t lie. Without forests, we don’t stand a chance at ‘cleaning’ the air pollution mess illustrated above. Without addressing emissions, we don’t stand a chance at correcting global warming and without addressing global warming, precipitation trends and general weather patterns will become more erratic, and severe. Not only is this bad for economies and market. This is an existential threat!
It is encouraging that the US under the Biden administration is set to rejoin the Paris Accord. This should bring a renewed focus on environmental matters within the US and while it may mean continued pressure for traditional fossil fuel businesses, it is imperative to building the economies of tomorrow.
The US has been a laggard of late, with most major economies aiming for carbon neutrality within the next decade or two. China, the world’s largest polluter has also committed to this by 2060 (Japan, 2050, Europe 2030). Whether this is by complete reduction of utilizing offsets (such as developing carbon sinks, afforestation, etc) remains to be seen but it is a megatrend which is still in its infancy and how we price carbon (credit), carbon taxation and the knock on impacts for project financing and investment will become key.
How can finance help FIX this?
In this context of environmental degradation and existential threat to an entire planet, it is not unreasonable to ask the most powerful industries on the planet to fundamentally change HOW we do business. As an industry which serves as the ‘water’ to all the other industrial fish in the global economy, Finance is primed to be the game changer in all this.
Already, initiatives from several quarters illustrate that large banks are scaling back or suspending their financing of ‘dirty energy’ or ‘irresponsible mining’. ESG (Environmental, Social and Governance) focussed investing, still in its infancy, is gathering momentum as more millennials realize that investing and doing good need not be mutually exclusive enterprises.
The cover of the Economist this week is titled ‘Making Coal History’. Economies, like South Africa, remain heavily reliant on fossil fuels. While significant progress has been made in clean energy initiatives, we are a very long way away from energy sustainability and a cleaner greener world. As people transition to electric cars, sure we will consume a lot less oil, but if we are plugging those cars into energy grids which are still predominantly fossil fuel dominated, who are we really fooling?
So, how can we invest in making the world a better place?
The rise of SRI and ESG orientated funds are still in their infancy. As the name suggests, the criteria of these funds and indices are not just environmental but also incorporate elements of social and governance screens. Some funds use a negative screen which seeks to exclude stocks which do not meet specified criteria.
While negative screening was the initial approach, it wasn’t necessarily seen as a proactive way to channel investment capital. Positive screens are starting to emerge as a more effective tool to ensuring that companies start to do the right thing if they aim to attract investment capital on a longer-term sustainable basis.
Regardless of the approach, what is becoming apparent is that the cost of capital, either through equity or debt markets will slowly start to penalize businesses that are not aligning to the longer term strategic objectives of social responsibility and the environment.
These changes will also not come without some pain. Carbon reliant countries like India, China (and South Africa) as well as economies in the Middle East will need to come to the painful realization that change is upon us. Furthermore, if that change is to be effected in a short term period, it is going to mean massive financial disbursements or incentives rather than allowing a gradual transition.
Green bonds will have a large role to play in building a better future. Bonds linked specifically to clean energy projects, infrastructure, water and sustainable industries, while initially du jour will become a staple for large pension funds and institutional investors and may eventually become the standard.
Investors are increasingly aligning to the UNPRI as a framework for designing their own investment processes and screens. This is a good place to start for any further reading on how a cohesive and generally accepted framework may frame investment decisions going forward.
It is a large an interesting space and undoubtedly one which I will write a lot more of in future. A blog post is merely meant to provide a teaser. For those interested in more detail on how this affects your strategy and your business, please reach out to me.
For now, lets stop worrying about the short-term gyrations of the market and keep our eye on the real goal. While global liquidity is plentiful, water scarcity is a concern. While SNOW(flake) is soaring post IPO, can we handle the blizzards, hurricanes and natural disasters heading our way? While AMZN is soaring, the Amazon is under fire.
Sustainable investing is not just a concept. It is a reality which only becomes more relevant with each passing day. Embrace it!
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