A tough backdrop allows ESG to show its worth

Runaway inflation, geopolitics and market volatility conspired to ensure 2022 was a year of significant challenges. In response, corporates could have simply shelved environmental, social and governance (ESG) initiatives while they sought to tackle their most pressing problems. Fortunately, most did not allow themselves to become distracted.

In fact, in many ways, 2022 accelerated the transition to net zero, with the need for energy stability boosting investments in renewables while introducing new regulations and ambitious global initiatives such as the Global Biodiversity Framework agreed at the COP15 conference in December.

The pressure on corporates shows no sign of abating. In Europe especially, companies understand that regulation will start to impact the real economy as it moves beyond the financial industry. Their clients and other stakeholders are already beginning to scrutinise their carbon emissions – and track record in areas such as gender and ethnic diversity. Their need for guidance makes them willing to engage with responsible investors and, consequently, we are increasingly seeing real progress made by corporates on a host of key ESG issues. Engagement is working, and we have set out our experience of this in AXA IM’s latest Stewardship Report.

Maintaining momentum

While great strides are being made, it is vital that companies are kept on the right path. Here, there are good reasons for optimism. Initiatives such as the REPowerEU Plan, designed to reduce Europe’s dependence on Russian fossil fuels and accelerate the green transition, and the newly reformed EU Emissions Trading System, the world’s largest carbon market, are ratcheting up the pressure on companies to focus on net zero.

In the US, the passing of the Inflation Reduction Act (IRA) – the largest piece of federal legislation ever to address climate change – has transformed a laggard into a leader. A huge $370bn package, the IRA will, among other things, accelerate America’s development of low-carbon solutions, particularly in the transportation industry, and turbocharge investment in renewables. The competitive tensions introduced by the IRA have riled many in Europe, but this landmark legislation demonstrates that, when it comes to tackling the climate crisis, the US means business. This is likely to have implications for investors that far outweigh the effects of the so-called ‘ESG backlash’ among certain players in the country.

Last year also saw a welcome rise in the prominence of the ‘S’ in ESG. For instance, it became clear that the huge transformation of labour catalysed by COVID-19 is now permanent, raising questions for social policies. How is working from home going to change assessments of working conditions? For years, statistics such as the number of industrial accidents in firms have been a key performance indicator (KPI) for investors seeking to score companies on social issues. The rise of home working may have altered the dynamics of how we work, but it will not stop people having accidents.

A changed landscape

Our perspectives as investors must change to ensure policies adapt to the new reality. Similarly, corporates find themselves competing for talent in unfamiliar ways. The pandemic is the first crisis we have experienced where unemployment has fallen. Labour markets remain tight everywhere. This makes the ‘S’ pillar even more important from an investment perspective because companies that are able to develop progressive social policies may stand to retain their workforces and potentially enjoy a competitive advantage that could filter through to portfolios performance. With wages rising across the board, workers, particularly in the younger generation, are becoming increasingly swayed by an employer’s purpose and values.

Investors that take ESG factors seriously can use a variety of tools, from engagement and voting to exclusions and divestment. We think it is best to use all the tools, tailored to the idiosyncrasies of the companies or industries in question, and this includes encouraging fossil fuel companies towards ambitious but achievable emissions reduction targets and investment in renewables.

We believe in the power of active and focused stewardship to generate change and we can see it in the oil and gas sector and among other companies where we engage. They understand their reputation is at stake and increasingly responsive to meaningful dialogue. With regulation driving better nonfinancial disclosures and investors able to wield significant influence, we are confident and hopeful the collective momentum towards a more sustainable world is here to stay.