ESG in the Macro
Today we will be switching gears from bottom-up ESG analysis to top-down, looking at ESG risks as they pertain to the global macro.
Picture Source: Hermonto
Today we will be switching gears from bottom-up ESG analysis to top-down, looking at ESG risks as they pertain to the global macro. Our environmental, social, and governance risk case studies look at climate change & monetary policy, female labor force participation, and the humanitarian crisis in Ukraine, respectively. Our ‘Hot Tea’ this week focuses on states with pro- and anti-ESG policies in place.
Environmental, social, and governance (ESG) investing, as we’ve discussed in previous posts about the “Greening” of the financial sector and values-based investing, focuses on selecting companies that have an ESG risk/return profile that fits into the portfolio’s investment mandate. Typically, ESG-oriented investors look for companies that are involved in initiatives to accelerate the transition to a more sustainable and equitable future.
However, with global events (such as the Russian invasion of Ukraine) and recent domestic regulatory developments (such as the Inflation Reduction Act), it is clear that investors will need to develop strategies to analyze ESG factors at the macro level. Integrating ESG factors into macroeconomic analysis will allow investors to understand how sustainability & social issues could influence how capital markets react to traditional policy, regulatory, and economic developments.
Environmental Factors
Environmental factors such as climate change, water scarcity, and pollution are important across the world but are particularly critical in emerging markets that may have looser regulation or more limited resources to react. Considerations regarding the impact of environmental issues on the global economy include:
1. Chronic Risks[1] that impact regions differently: For example, colder regions such as Europe and North America are likely to experience a boost in productivity, largely due to an expected rise in agricultural productivity and construction activity, while the reverse is likely to occur in warmer regions such as Latin America and Asia. On the social side, rising global temperatures are correlated to rising social tensions and political violence[2].
2. Acute Risks[3] (such as extreme weather events): It’s hard to capture extreme weather events (typhoons, earthquakes, and droughts) that can heighten market, credit, and liquidity risks and lead to potential supply chain disruptions. These acute risks are also expected to drive immigration patterns and create stranded assets.
3. Transition Risks[4] (and opportunities): For instance, a fall in clean energy prices—an outcome of technological advancements—could lead to a drop in demand for fossil fuels.
Case Study - Climate Change & Monetary Policy
Efforts to mitigate and adapt to the impacts of climate change are already having a discernable impact on how central banks assess transition risk and inform their approach to monetary policy (as a reminder, monetary policy is set by the Central Bank to control a nation’s overall money supply and economic growth. For more info on monetary policy see the footnotes[5]). A study by Manulife analyzes the ways that climate change is altering investor expectations about monetary policy.
Source: Manulife Investment Management, July 1, 2021.
Social Factors
Social factors are those that pertain to human rights, labor rights & management, diversity & inclusion, health & safety, equality, and indigenous rights. Social factors can influence a wide variety of political issues and directly impact economic growth & development. Inequality, rising cost of living, social instability, and labor rights violations can result in social unrest and potentially lead to armed conflicts. On the other side, quality education, public health, reduced inequalities, and strong protections around labor rights are often correlated to increases in labor force participation and overall economic growth.
Case Study – Labor Force Participation Increases as Employees Demand Stronger Childcare Benefits
The U.S. Bureau of Labor Statistics released a report on August 5th, entitled “The Employment Situation”, that detailed widespread job growth and an unemployment rate that has returned to its pre-pandemic level. The labor force participation rate has been increasing over the last two years, from its low in April 2020. Over this same period, we’ve been seeing an increase specifically in female labor force participation rates, perhaps as a result of companies implementing stronger paid family leave policies and a rising government focus on national childcare programs in a post-COVID-19 environment.
Source: U.S. Bureau of Labor Statistics via FRED
Paid family leave, expanded childcare benefits, and national childcare programs meaningfully support labor supply, boost growth, and reduce pressure on wages. All of these impacts support economic growth, as seen in the chart below.
Source: Organization for Economic Co-Operation and Development via EquitableGrowth.Org
Governance Factors
Finally, the governance quality of political and economic institutions plays a critical role in macroeconomic performance, particularly in emerging and frontier markets. Strong governance results in a stable policy environment, which contributes to stronger potential economic growth and resilience in the face of domestic or external shocks. It contributes in an important way to determining the risk of financial and economic crises. Governance factors like corruption and attitude toward foreign investment present significant risks of political scandals and instability.
Case Study – The Humanitarian Crisis Resulting From the Russian Invasion of Ukraine
Russia has historically exhibited a great amount of fiscal strength, with an enormous share of the world’s natural resources. As of 2021, it was the fifth-largest economy in Europe, the world's eleventh-largest economy by nominal GDP, and the sixth-largest by PPP. Russia’s fiscal strengths included strong institutions like the Central Bank of Russia and the Finance Ministry. The country was seen as willing and able to service debt, and so was able to receive significant debt financing. However, the Putin-led government posed significant governance risks that were overlooked by creditors. Following the invasion of Ukraine, Russia defaulted on its external sovereign bonds for the first time in a century. This resulted in even stricter Western sanctions that shut down payment routes to overseas creditors. Russians are currently dealing with double-digit inflation and the worst economic contraction in years, as the country has transformed into an economic, financial, and political outcast[6]. A recent Bloomberg article showcases how Russia’s Eurobonds have traded at distressed levels since the start of March, the central bank’s foreign reserves remain frozen, and the biggest banks are severed from the global financial system.
Source: Bloomberg
Hot Tea
Our hot tea for today is going to focus on how different states are reacting to broader trends in individual preferences around environmental and social topics.
States Investing in ESG
California to End Sales of Gas-Powered Cars by 2035: California’s pollution and air quality-focused agency, the California Air Resources Board (CARB), announced on Thursday the approval of a rule requiring all new car, pickup truck, and SUV sales in the state to be zero-emissions vehicles (ZEVs) by 2035.
Illinois Approved Climate Legislation in September 2021 and the City of Chicago Set New Climate Goals in 2022 to Reduce the City's Carbon Emissions by 62% by 2040.
Additional States with Climate Goals:
Source: Center for Climate & Energy Solutions
States Limiting ESG Investment
Florida Bans ESG Investing in $228 Billion State Pension Funds: Fund managers for Florida’s $228 billion pension funds will no longer be allowed to incorporate ESG considerations in the investment process, according to a new resolution passed by the administration of Governor Ron DeSantis.
Texas Places BlackRock, Credit Suisse & UBS on Divestment List for “Boycotting” Fossil Fuel Companies in Anti-ESG Backlash: Investment and finance giants BlackRock, Credit Suisse, and UBS are among a list of ten financial companies published by Texas as subject to potential divestment for boycotting energy companies.
Additional States with Anti-ESG Bills:
Source: Reuters
Sustainability Mover & Shakers
Today’s Sustainability Mover & Shaker is Jane Burston, the founding executive director of The Clean Air Fund, a philanthropic foundation tackling global air pollution and working globally to empower funders, researchers, policymakers, and campaigners to deliver clean air for all.
Source: Forbes
Jane’s ethical and environmental principles were established at a young age - she gave up meat when she was eleven, and as a student fought to eliminate plastic in her college canteen[7]. In 2008, Burston founded Carbon Retirement, a social enterprise that reformed emissions trading and carbon offsetting[8]. In 2012, she joined the National Physical Laboratory 2012, where she led a team of 150 scientists and engineers. At NPL, she founded the Centre for Carbon Measurement, looking at carbon markets, low-carbon technologies, and climate data. She was seconded to the Department for Business, Energy and Industrial Strategy in 2017 as Deputy Director of Science for Climate and Energy and in June 2019, founded the Clean Air Fund.
Jane’s career has been marked by a variety of awards: She was named as a ‘Young Global Leader’ of the World Economic Forum, one of the ‘40 under 40 European Young Leaders by Friends of Europe, and was previously a UK Social Entrepreneur of the year.
2009 - Selected as a Climate Change Ambassador for the British Council
2011 - Named as one of Management Today's High Flying Women Under 35 and the Square Mile Social Entrepreneur of the Year
2012 - Selected as a World Economic Forum Young Global Leader and won the 2012 Management Today Future Leaders Award
2015 - Named as one of the Top 20 Young People Globally by the International Chamber of Commerce and a Friends of Europe European Young Leader: 40 under 40
2021 - Nominated by Christina Figueres as a WIRED changemaker of tomorrow.
[1] Chronic physical risks refer to longer-term shifts in climate patterns (e.g., sustained higher temperatures) that may cause sea level rise or chronic heat waves. (TCFD)
[2] The Effects of Temperature on Political Violence: Global Evidence at the Subnational Level
[3] Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, such as cyclones, hurricanes, or floods. (TCFD)
[4] Transition Risks are related to the transition to a lower-carbon economy and may entail extensive policy, legal, technology, and market changes to address mitigation and adaptation requirements related to climate change. (TCFD)
[5] In the US, the Federal Open Market Committee (FOMC) is mandated by Congress to promote maximum employment, stable prices, and moderate long-term interest rates. Employment, inflation, and long-term interest rates fluctuate over time in response to economic and financial disturbances. Monetary policy plays an important role in stabilizing the economy in response to these disturbances. The FOMC’s primary means of adjusting the stance of monetary policy is through changes in the target range for the federal funds rate. (Statement on Longer-Run Goals and Monetary Policy Strategy)
[6] Russia Slips Into Historic Default as Sanctions Muddy Next Steps