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Sustainable investing has been put to the test over the past year. The war in Ukraine and the cost-of-living crisis have highlighted the ethical and social risks of complex supply chains, beyond those revealed by the pandemic, and the risks to the net-zero transition.
Unfortunately, future climate costs could dwarf today’s pressures if the world fails to decarbonise at pace. While COP26 did not deliver all that had been hoped for, agreements on coal, methane, and deforestation, the establishment of international green reporting standards and the adoption of net-zero pledges are driving an evolution in sustainable investing. Unlike ESG 1.0, ESG 2.0 is not just a risk management tool but a way of achieving impact.
An ESG evolution
At Fidelity, we see this evolution as the first of many for the industry. ESG is now considered across all asset classes, including private markets, and proactive engagement has become essential to gathering information and instigating positive change. Disclosure too has evolved in anticipation of more climate information being required by the SEC and a new set of reporting norms from the International Sustainability Standards Board. Many more companies are completing Task Force on Climate-related Financial Disclosures (TCFD) reports and providing better quality data - though still not enough.
But the biggest difference between ESG 1.0 and 2.0 is the shift towards incorporating not just those ESG factors that affect a company’s ability to operate, but also the potential impact of a firm’s activities on the wider community - so-called “double materiality”.
Chart 1: The ESG evolution from 1.0 to 2.0
Increased sophistication and focus on influence across the sustainability complex
Upgrading our ratings
We have changed Fidelity’s proprietary ratings system to explicitly include the concept of double materiality. Our ratings are constructed by our investment analysts based on the same fundamental bottom-up research process that drives our investment recommendations. As a result, our ratings take a forward-looking view of a company’s sustainability characteristics and its ability to manage negative externalities. We have already completed our assessment of over 3,700 corporate issuers across equities, fixed income, and private credit, and our sovereign and structured credit assessments are on track for full coverage this summer.
We have also begun the roll-out of our climate rating, introduced in 2021 as part of Fidelity’s Climate Investing Policy, which identifies the companies we should engage with first and foremost as part of our aim to halve portfolio emissions by 2030 and reach net zero by 2050.
Our proprietary tools are vital if we are to deliver outcomes, such as reducing carbon emissions and helping our clients and society achieve net zero in time.
At Fidelity, we believe there are multiple ways in which we can act to bring about positive change, including a greater focus on Sustainable Finance Disclosure Regulation (SFDR) Article 9 funds which require specific sustainability objectives, developing more strategies aligned to the UN’s Sustainable Development Goals (SDGs) and ramping up engagement in three key sustainable investing areas: ending deforestation, ensuring a just transition and, crucially, the principle of double materiality.
Halting forest loss
Deforestation sits at the intersection between climate change and biodiversity, destroying natural carbon sinks and ecosystems that contribute to clean air, water, soil quality and crop pollination. At COP26, over 100 countries, accounting for 90% of the world’s forests, pledged to halt forest loss and land degradation by 2030. Meanwhile, 30 financial institutions, including Fidelity, agreed to eliminate agricultural commodity-driven deforestation risk from their portfolios by 2025. To achieve this, we have assessed group exposure to companies contributing to deforestation along the entire value chain from producers and food retailers to enablers such as banks. We are pushing hard for integrated risk assessments and enhanced traceability of supply chains, while also addressing related issues such as decent working conditions for vulnerable groups of workers.
No one left behind
Equally important is ensuring that the energy transition is a just and secure one, with social and financial burdens shared fairly, and with no one left behind. That includes the workers and communities dependent on the fossil fuel industry and developing countries still reliant on carbon-intensive sources of energy. Unless their needs are accounted for and the transition properly reflects historic and current responsibility for climate change, it won’t happen fast enough.
Directors held to account
One of the most powerful ways we can bring about change is through our votes, especially where we act alongside other shareholders. Last year we set minimum standards on climate and gender diversity, and subsequently engaged with issuers to provide guidance on how we expect these to be met, allowing time for companies to incorporate our expectations in their FY21 disclosures.
We have now started to vote against the boards and directors of companies where they are not meeting our minimum standards, and already a significant number have made material improvements to their climate change strategies, governance, and disclosures.
Sustainability risks, and opportunities, are often thought of as uncertain and long-term in nature. And in benign times, the apparent importance of transparency and good governance can fade. However, it is at times of crisis that the need for robust risk management and governance comes to the fore. These are often good indicators of which companies will remain resilient and continue to serve a societal purpose beyond solely profit, to meet the multi-faceted needs of their stakeholders and to deliver the long-term value creation that investors expect.