According to recent research, investors should anticipate that green assets will under perform brown assets. Investors tend to invest in green assets and divest their stakes in brown holdings. The demand for green assets increases their market price while diminishing the value of future returns. Green assets are a 'climate hedge' as they will perform better than brown assets in the face of adverse climate change impacts, and investors tend to attribute more value to this hedging ability. When evaluating potential green investments versus brown investments, companies anticipate higher returns from green investments by measuring the greenness of an investment using the Morgan Stanley Capital International indices on environmental ratings. Eventually, when the returns fall below the cost of capital, brown investments tend to outperform green holdings. Further, research findings imply that greener assets have a lower cost of capital with all other parameters remaining equal, and therefore companies should use a lower cost of capital when evaluating potential green investments when comparing them with brown holdings, creating an incentive for investors to hold a portfolio with increased investments in green holdings.
Long-term climate strategies include shifting from fossil fuel consumption to clean electricity, clean fuels and electrification of end-uses is viewed as the most efficient and economical way to reduce emissions in power, transportation and construction sectors. In sectors that are deemed as hard-to-abate sectors such as industries and heavy-duty transportation that include aviation and shipping. It would be pertinent to quote an example of green investments in producing sustainable aviation fuel (SAF). Technological advancement in production of SAF, a low-carbon alternative to traditional jet fuel made from crude oil has accelerated investments in the technology aided by incentives from state and federal governments of the US and EU. A consortium including the United Airlines has started a $100 million venture capital fund on Tuesday to invest in the technology. Aircraft manufacturer, Boeing has announced that it as doubling its use of sustainable fuel this year. Yet, as on date, no flights are powered by sustainable fuel because of the cost factor which makes it three times as expensive as conventional fuel and it seems difficult to overcome the considerable cost differential that exist between conventional fuel and SAF owing to the production pathways for SAF.
Investment levels in the production of electro-fuels or power-to-liquids have been insufficient due to high production costs thereby creating a negative feedback loop among investors. The demand for SAF needs to be consistent with the certainty for future supply of the product and eliminating the risk factor surrounding its production pathways. Presently, the lack of real large-scale demand for SAF has stymied the deployment of the product at a global level.
Policy development by the International Civil Aviation Organization (ICAO) has brought in a three-phase program known as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) that aims to stabilize international aviation emissions at 2020 levels by 2035. It is stated that a mandatory participation by all countries starting 2027 could create new demands for SAF globally. It is estimated that low-cost pathway for production of SAF could reach price parity with conventional jet fuels in 2027. Additional incentives and/or tax credits can render costlier production pathways to become cost-competitive as has been brought in under The Inflation Reduction Act of the USA. Investments in producing sustainable CO2 via point-source capture or direct air-capture (DAC) and green hydrogen (H2) can help in producing clean fuels. Scientists believe that only SAF technology has the potential for unbounded production.
A European Corporate Governance Institute working paper on finance focused on a "natural experiment in responsible investment" conducted by the world's largest public pension fund, Japan's Government Pension Investment Fund (GPIF). In 2018, the GPIF gave its largest portfolio manager a compensation-based mandate to enhance the ESG performance of portfolio companies. The authors concluded that "engagement by the asset manager has led to improvements in certain ESG scores for mid- and large cap companies." The mandate was distinct from the asset management contract already in place to invest in and manage equity securities. The incentive of remuneration for stewardship services above and beyond a standard asset management fee motivates passive managers of assets to increase the value of active stocks, creating financial incentives to improve a company’s ESG scores and consequently increasing equity investments in such companies.
To understand if ESG criteria have been met by companies, it is essential to be aware of the calls for stringent norms for scrutiny, regulation, and reform of practices followed by ESG rating agencies that wield a substantial influence over market fluctuations and retail investors. It is recommended that regulatory agencies prohibit rating agencies' direct outreach to businesses in order to reduce their influence and prevent an imbalance in favour of those who pay them for consulting and insurance services. These agencies require universal norms for ESG compliance by companies based on standards such as resource efficiency, waste management, ecological harm, and disclosure of the amount of 'natural capital' inputs to their businesses. Profits from the practise of sustainable business processes should not be the only metric used to declare ESG compliance. For an accurate assessment of ESG compliance, the negative environmental impacts of business processes that tend to affect the environment should be used to offset profits. The objectives of rating agencies should not be based on a company's market capitalization or financial significance. It should aid in enhancing corporate performance, thereby contributing to sustainability and the circular economy. The methodology employed by rating agencies to collect and aggregate relevant data has been criticised by financial analysts as lacking transparency. It is simple to attract investments using ESG ratings on sustainability, but the absence of uniformity and harmonised benchmarks for compliance assessments can divert funds to projects and companies that engage in greenwashing.
In 2021, the International Organisation of Securities Commissions urged global regulators to investigate the veracity of claims made by various ESG data providers regarding environmental and social governance. In response, the Securities and Exchange Board of India (SEBI) mandated that all ESG rating agencies register with the regulator in order to prevent conflicts of interest and increase transparency in rating ESG compliances by corporations. It is important for large-scale investors and institutional investors to compare the outcomes of ESG compliance by companies that impact several industries and sectors to get an overall view to guide their future investments. Several ESG data providers sell volumes of data online, which means that the data available on their website has been verified both quantitatively and qualitatively. One such website, for example, is Statista, which provides information from individual nations pertaining to various sectors for a price.
References:
1. Pástor, R. F. Stambaugh, and L. A. Taylor (2022). Examining green yields. 146(2) Journal of Financial Economics: 403-424.
2. Pástor, R. F. Stambaugh, and L. A. Taylor (2021). Balanced investments in sustainability. 142(2) Journal of Financial Economics: 550-571.
3. Berg, F., Koelbel, J. F., & Rigobon, R. (2022). The divergence of ESG ratings has led to widespread confusion. Finance Review, 26(6), 1315-1344.
4. Berg, F., Koelbel, J. F., Pavlova, A., & Rigobon, R. (2022). ESG ambiguity and stock returns: Addressing the issue of noise (No. w30562). Bureau of Economic Research, National.
5. Go to https://www.esgthereport.com
6. Go to https://www.statista.com
7. Go to https://www.sasb.com.
8. Go to https://www.globalreporting.org.
9. Inputs from Financial Times and The New York Times
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