Empowering emerging markets to achieve a just transition

Supporting emerging markets in the green transition is important to the entire planet, as developing nations are home to 85 per cent of the world’s population and produce two thirds of global greenhouse carbon emissions to power their rapidly growing economies.

“There is a lot of work to do to ensure emerging markets leapfrog on this transition process, and don’t make the mistake that some developed countries may have done in the past, in terms of economic development models,” says Margarita Pirovska, director of policy at the Principles for Responsible Investment (PRI), a UN-supported network of investors.

At last year’s UN climate summit, COP27, richer nations agreed to set-up a ‘loss and damage’ fund aiming to provide financial assistance to the most vulnerable, low and middle income countries. These nations have typically contributed the least to greenhouse gas emissions but are likely to be most at risk to climate hazards.

While raising and distributing such funds will prove challenging, it will be a fraction of the total investment needed by developing nations to transition, estimated to reach $94.8tn by 2060, according to a recent Standard Chartered study.

This massive investment is needed to transform energy production, infrastructure, efficiency, transport and several of the world’s highest-emitting industries.

Private finance is key to helping emerging economies reduce their emissions and adapt to the physical effects of global warming, but international investors seem to be staying away, spooked by potential geopolitical risks and uncertainty.

Climate risk

It is the concept itself of risk that must be reviewed, believes Alix Lebec, founder and CEO of women-owned and led Lebec Consulting, working across philanthropy, impact investing, and environmental, social and governance (ESG).

“We continue to look at risk solely based on past performance, and that’s one of the big things that must change, for companies and financial institutions to start moving more capital to where it needs to go. Future risk, and climate risk especially, must be embedded in investment decision-making.”

While asset prices and capital markets still struggle to fully reflect climate risk, consulting firm Deloitte estimates that, if unchecked, climate change could cost the global economy $178tn over the next 50 years, “unless global leaders unite in a systemic net-zero transition”. If they do, the global economy could see new five-decade gains of $43tn.

In the same way risk management was integrated in the investment process two decades ago, embedding standardised impact measurement into mainstream investment practice would mean more effective capital allocation, allowing capital to flow where it is most needed, states Ms Lebec. It would also allow the ESG industry “to get out of the greenwashing bucket, because we’ll be able to see who is really having an impact and who’s not”.

It is critical to stop quarterly earnings calls. “Continuing to prioritise profitability for today, at the expense of sustainability and profitability for tomorrow, is a breach of fiduciary responsibility,” she warns. “Investors need to put value on business leaders that are prioritising the long game and these are the businesses that are going to dominate what are expected to become trillion-dollar industries.” These range from renewable energy to electric vehicles, plant-based proteins and precision agriculture.

To accelerate the transition, it is vital to diversify leadership and include women and leaders from emerging markets at decision-making tables, she adds. This would allow decision-makers to gain different insight perspectives and promote innovation. Investing more in women-owned and led businesses would also be beneficial to the green transition, as female-owned firms tend to perform better than male-founded ones, despite getting just 2 per cent of all venture capital funds globally, says Ms Lebec. She brings many examples of ground-breaking and innovative women-owned firms, especially in emerging markets. “But even after proving performance, both socially and from an impact standpoint, and their potential for long-term profitability, they still cannot get any capital,” she adds, pointing to “biases and a way in which investors are looking at risk and opportunity that is not aligned with where the world is moving”.

Energy enablers

ESG investments have grown rapidly, but developing economies are at a disadvantage from such investments, although their climate impact is unclear, because of systematically lower ESG scores and low investment allocations from ESG funds.

However, responsible investors can find interesting risk return opportunities in supporting emerging markets’ journey to a low carbon economy. Some emerging market companies will be among the most important enablers of the energy transition, not only in emerging markets themselves but the rest of the world too, according to recent analysis from asset management firm Candriam.

Solar panel producers, mostly based in Asia, are crucial to meet demand for solar photovoltaic (PV) and wind energy generation capacity, which is set to increase fourfold in the decade from 2020 to 2030. China and the rest of Asia will account for the lion’s share of the expansion of solar power generation through to 2028.

The Asian continent is also set to become the “battery workshop” of the world, helping meet the huge demand for electric vehicles.

‘Greenablers’ include producers of semiconductors, which are mostly manufactured in Asia and play a critical role in reducing electricity consumption.

“The global journey to net zero will not succeed until emerging markets feel incentivised to take equally effective measures and investors will play an important role directing capital flows towards climate action enablers,” according to the study.

“While emerging markets may be perceived as riskier investments, ESG is a useful toolbox to analyse, measure and price those risks,” says Ms Niemczyk, explaining that investors’ allocation to emerging markets depends on investor type, overall asset allocation and risk appetite, as well as market movements.

A study conducted by Candriam over more than a decade shows that “ESG eligible” companies in emerging markets outperform peers in the overall emerging market universe, across sectors, countries and sub-regions. Those same companies, after being downgraded from an ESG perspective, produced negative excess returns for periods beyond one year and up to three years.

ESG data in emerging countries, like in many developed markets, may not be easy to obtain and requires time consuming analysis for quality and materiality, but there are plenty of interesting investment opportunities for asset managers to support firms in the transition, explains Ms Niemczyk. “Larger companies that are already transitioning also need to be supported, because they will create the demand and a marketplace for players to enter and launch sustainability-related solutions,” she adds.

Blended finance vehicles, combining capital with different levels of risk, could prove efficient instruments to de-risk impactful investments in emerging markets, and meet investors’ risk adjusted return expectations.

In addition to client education on the benefits of geographic diversification in portfolios, innovation in fund vehicles and strategies can help address investor concerns and needs, driving more capital into emerging markets, says UBS Global Wealth Management’s global head of sustainable and impact investing Andrew Lee. “Public-private partnerships and the availability of philanthropic or investment capital that is willing to be catalytic would also be essential in helping to mitigate actual or perceived risks and bring in market-rate capital at greater scale to emerging and frontier markets.”

Product innovation

The emerging markets transition to net zero offers investors the opportunity to gain access to new asset classes and products targeting green infrastructure and technology, says HSBC Private Banking’s global head of investments and wealth solutions Lavanya Chari, based in Singapore.

In Asia, governments’ net zero commitments and new regulatory developments are expected to accelerate the adoption of ESG principles by Asian asset managers, adding “momentum to product innovation” to meet increasing investor demand, she adds.

But the transition is still “at a relatively early stage”, infrastructure needs to be updated to accommodate renewable energy format, and the growing trend for residential renewable energy generation also needs funding.

Every company in every sector will be affected by the energy transition in some way, through regulation or rising emission costs or increased risk of stranded assets, states Ms Chari.

“An ‘enhanced thematic’ or impact approach to sustainable investing becomes even more important for clients and for core portfolios,” she says, reporting the region “has come far” in terms of client engagement, client interest and penetration.

What she would like to see, though, is “greater engagement from asset managers with Asian companies”, and more support to firms in their journey to a low carbon economy.

Clean energy and solar, wind, hydrogen power, electric vehicles and green infrastructure are all areas where she would like to see a wider range of viable investment solutions.

“We don’t have as many products as we need yet. If we’re able to offer solutions in each of these specific themes, be it clean energy, water or solar, we will accelerate investment into impact and overall sustainable strategies in Asia.”

Just transition

The notion of a ‘just transition’ to net zero applies not only in emerging markets, which are going to suffer the most from the effects of global challenges such as the climate crisis, but everywhere in the world.

It is vital, therefore, to make sure that the move away from fossil fuel industries is “socially acceptable”, says PRI’s Ms Pirovska. This means supporting workers and communities currently making a living from these activities, which may involve developing new renewable net zero business models.

“Unless the transition is just, it will not happen,” warns Ms Pirovska. “Either investors understand, support and invest in this just transition, or we fail.”

Active engagement

Investors can avoid financing an unjust transition by actively engaging with companies in low-carbon portfolios, says LGT Private Banking’s head of sustainable investing Chris Greenwald. “It is important to engage with transitioning companies and their leaders to ensure they take social factors into account, as they transform their business models to adapt to a low-carbon future.”

A disorderly transition could have inflationary effects and result in energy insecurity or issues of affordability, impacting low-income populations most adversely, explains UBS’s Mr Lee.

As investors and companies pursue opportunities related to the green transition, it is vital to work collectively to minimise potential negative impacts for workers and communities, and support retraining and re-skilling as part of the investment process, adds Mr Lee.

Investors, he suggests, should prioritise underinvested communities, deploying a variety of instruments, including fixed income, with the proceeds helping bridge gaps in core areas like education, housing and healthcare. Private market strategies focused on community development and resilience also have potential, as do strategies operating through an explicit lens of diversity, equality and inclusion, for example investing in companies with better employee recruitment and engagement policies.

Those investors directly focused on the energy transition should consider how companies and projects they are invested in are managing and treating their employees and the communities they impact, attaching appropriate safeguards and conditions to ensure their protection, explains Mr Lee.

They also need to actively engage with traditional energy companies to accelerate strategy changes and investment in new forms of energy: “Balancing the three goals of energy reliability, affordability and decarbonisation is important.”

Fair and inclusive

The thinking within the investment community is that a “fair and inclusive transition” is crucial to meet global sustainability challenges, with impact investors able to play a key role, particularly in the ‘global south’, disproportionately affected by global warming.

The cost of living crisis, fuelled by energy and food inflation, is bringing the concept of a ‘just’ transition even further to the fore, as food and energy represent a significant and increasing percentage of the consumer basket of low income countries and families.

“For the climate transition to be effective, investors, companies and governments cannot just focus on carbon emissions and other environmental metrics, but need to consider socio-economic factors too,” warns PRI’s Ms Pirovska.

None of this can be considered in isolation, she believes. For any meaningful solution to be reached, the investment community must understand key links between social and environmental issues and appreciate the interconnectedness between the UN’s sustainable development goals.