Covid-19 and ESG
This report is mostly a reflection on 2019, however, it would be remiss given the timing of publication, not to consider the Covid-19 pandemic in some part. There has been a plethora of material published on the virus that brought most of the globe to a standstill. Rather than re-framing this material, below are a few key reflections we think are important. At this stage, it is impossible to know exactly how Covid-19 will change the world and ESG.
- Overall change in perceptions to ESG - there have been essentially two schools of thought. One school says that the pandemic will increase the adoption of ESG practice and drive more climate action. The other says that businesses will decrease the focus on ESG outcomes as they focus on the economic challenges caused by the pandemic and focus on the financial bottom line. Most media reports stress the former will play out.
- Realization that ESG materiality in a business may not in fact be static, but dynamic. Regular analysis of the ecosystem within which the business finds itself is important.
- The increased awareness and prioritization of ‘S’ factors such as employee health and well-being, labour practices, supply chain management and competitive behavior.
- Prioritization of the climate crisis – it appears that while short-term climate-action related initiatives may have been delayed by global governance institutions, the awareness of the climate crisis significance should increase, leading to more support and funding for climate action in the medium and long-term.
- Long-term the material ESG aspects to a business remain, and therefore even with inevitable disruptions, a continued focus on good ESG practice is critical.
- Businesses may begin to look beyond just economic efficiency, and rather to resilience.
Climate crisis currently a runaway train
2019 saw the IPCC publish the Special Report on Global Warming of 1.5°C. The report has been based on around 6,000 peer-reviewed publications, most of these published in the last few years. The report confirms that climate change is already affecting people, ecosystems and livelihoods. According to the IPCC limiting warming to 1.5°C is possible, but would require unprecedented transitions in all aspects of society. Overall the report shows there are clear benefits to keeping warming to 1.5°C, rather than the previously thought safe limit of 2°C.
The report shows that recent trends in emissions and the level of international ambition indicated by nationally determined contributions under the Paris Agreement, deviate from a trajectory that would limit warming to well below 2°C. ‘Without increased and urgent mitigation ambition in the coming years, leading to a sharp decline in greenhouse gas emissions by 2030, global warming will surpass 1.5°C in the following decades, leading to irreversible loss of the most fragile ecosystems, and crisis after crisis for the most vulnerable people and societies’. We are at a crisis point.
Limiting warming to 1.5°C compared to 2°C is projected to result in smaller net reductions in yields of maize, rice, wheat, and potentially other cereal crops, particularly in sub-Saharan Africa, in the CO2-dependent nutritional quality of rice and wheat (high confidence). Reductions in projected food availability are larger at 2°C than at 1.5°C of global warming in the Sahel, Southern Africa. Livestock is projected to be adversely affected with rising temperatures, depending on the extent of changes in feed quality, spread of diseases, and water resource availability (high confidence).
IPCC projections show the western Sahel region will experience the strongest drying, with a significant increase in the maximum length of dry spells. Central Africa is set to see a decrease in the length of wet spells, with slight increase in heavy rainfall. West Africa has been identified as a high-risk region for change, with likely decreasing crop yields and production impacting food security. The western part of Southern Africa is set to become drier, with increases in drought frequency and heat waves. From a precipitation perspective, at 1.5°C, less rain would fall over the Limpopo basin, parts of the Western Cape in South Africa and areas of the Zambezi basin in Zambia.
But at 2°C, Southern Africa is set to have a decrease in precipitation of about 20% and increases in consecutive dry days in Namibia, Botswana, northern Zimbabwe and southern Zambia, resulting in precipitation reductions in the Zambezi basin projected at 5% to 10%.
At 2°C of global warming, significant changes in the occurrence and intensity of temperature extremes in all sub-Saharan regions is set to occur. West and Central Africa are forecast to have particularly large increases in the number of hot days at both 1.5°C and 2°C. Temperatures are expected to rise faster at 2°C for Southern Africa, and areas of the southwestern region, especially in South Africa and parts of Namibia and Botswana, are expected to experience the greatest increases in temperature.
Climate risks from higher temperatures, drought, flooding, food security and extreme weather events pose a high risk for the people of Africa.
For 2017 and 2018, the global insurance industry paid out a staggering USD 219 billion in claims from weather-related events, this being the highest recorded payout over a two-year period. However, USD 280 billion of weather-related natural catastrophe losses were not insured and were required to be covered by governments, business and households. The protection gap for insurance in Africa is significant. For Cyclone Idai in 2019, Swiss Re Institute reported that the overall economic loss for Mozambique, Malawi and Zimbabwe was about USD 2 billion, of which only 7% was subject to insurance, highlighting a 93% protection gap. Only six African countries have insurance penetration premiums higher than 1% of GDP.
From a business perspective climate risks can be broadly considered as transition or physical risks. Transition risk results from a move to a lower-carbon economy entailing extensive policy, legal, technology, and market changes to address mitigation and adaptation requirements. Businesses may face varying levels of financial and/or reputational risk through this transition. Physical climate risks can be from event driven (acute) or longer-term shifts (chronic) in climate patterns.
Financial implications from physical risks may include direct damage to assets and indirect impacts from supply chain disruption. Financial performance may also be affected by changes in water availability, sourcing, and quality; food security; and extreme temperature changes affecting premises, operations, supply chain, transport needs, and employee safety.
OMAI has climate action as one of its four key themes. The others are decent job creation, gender equality and reducing inequalities through transformation. OMAI wants to be part of the solution for a 1.5°C world. The Task Force on Climate-related Financial Disclosures (TCFD) framework for disclosing climate change risks and liabilities has continued to gain traction globally. In February 2019, the UNPRI announced that as a signatory, TCFD-based climate indicators will become mandatory for at least private reporting to the UNPRI. Late in 2019, OMAI initiated a review of the TCFD framework and how this can be implemented. This included a review of climate risk considerations in the investment lifecycle, as asset managers of existing portfolios and from a governance perspective within OMAI, which will be implemented in 2020.
We look to measure the carbon footprint of our portfolios, and the carbon offset generated by our renewable energy investments, and drive a transition to a sustainable, 1.5°C world energy mix. This means aligning our investments with a practical energy mix across Africa that promotes development but remains within the carbon budget of a 1.5°C world. Within this energy mix the two MVPs (most valuable players) are renewables and gas. We support and promote as far as possible, a just transition of employees currently located in unsustainable industries into the sustainable industries of the future.
Standardization of ESG metrics
A continual challenge in ESG is the use of varied metrics, often essentially measuring the same aspect. Globally it is recognized that we should have a standardized set of ESG metrics that if material to their operations businesses track and report on. The pressure on this point continued to increase in 2019, with many views being published on the subject. What is needed is an International Financial Reporting Standard (IFRS) for ESG. The potential standard setters include the UNPRI, Sustainable Development Goals, Global Reporting Initiative, Sustainability Accounting Standards Board (SASB), CDP (formerly known as the Carbon Disclosure Project), CFA Institute, Global Impact Investing Network (GIIN), leading Development Finance Institutions and the Impact Management Project. SASB may become the overall standard setter in time, with support from other global organizations. What should we do right now though? Our suggestion is to keep it simple, only capture data that is material, leads to a possible management decision and use generic globalized metrics. Good places to look for these include SASB, the DFIs harmonized indicators (HIPSO) and for impact metrics IRIS+ run by GIIN.
Requirement for quality ESG data
Linked to the standardization of ESG metrics, is the growing need to report on accurate, timely ESG data to shareholders and stakeholders. This is not a growing expectation but an existing one. Businesses are expected to know what is material to them, accurately track that data and report in a timely manner. Not doing so in 2020 puts you squarely in the laggard bucket.
Much was published in 2019 about impact measurement as businesses and investors continue to grapple with demonstrating positive impact. Like the standardization of ESG metrics, there is likely to be a consolidation of methodologies on this, allowing investors to apply a degree of comparability between portfolios and individual investments. OMAI has adopted an approach for impact measurement which is explained in Our Strategy. 2019 saw the launch of the IFC Operating Principles for Impact Management and a useful document titled Creating Impact—The Promise of Impact Investing, which provides a useful taxonomy of the three main types of impact measurement being employed. The Impact Management Project also gained further traction and adoption as a rating system.
Rise of impact investing continues
The impact investing market has continued to grow through 2019. The Global Impact Investing Network’s (GIIN) in 2019 published market information stated that an estimated 1,340 organizations currently manage USD 502 billion in impact investing assets worldwide as at the end of 2018. The impact investing market also continues to be diverse, with a median investor AUM of USD 29 million and an average USD 452 million, indicating that while most organizations are relatively small, several investors manage large impact investing portfolios.
Asset managers in this space, accounting for about 50% of the estimated impact investing AUM, include those investing in venture capital, private equity, fixed income, real assets and public equities. Development Finance Institutions account for just over a quarter of total AUM, with banks, pension funds, insurance companies, foundations and family offices making up the balance. We see the impact investing market continuing to grow not just in market share but also in diversity of investment product offering. To date much of impact investing has been focused on climate action and social impact. Over the next few years the relatively untapped aspect of biodiversity impact investing will be interesting to watch, with some global biodiversity organizations already making moves into this space.
2019 saw a continued drive for gender equality globally, in large corporates and through the financial services industry. Perhaps a good departure point is for us to recognize that gender equality is not just board representation and percentage of a workforce. It is not simply a numbers game. It is far broader, with nuanced, complex facets, and ultimately relates to real people. It includes aspects of human rights, female abuse, female violence, female genital mutilation, female discrimination, and political and economic participation.
What can we directly influence as investment professionals? While some of the aspects of gender equality are more challenging for us as individuals to directly address in our professional capacity, we can as professionals drive the empowerment of women in our own business and in our portfolio companies. We need to have the gender discussions at board and subcommittees and push our portfolio companies to do better. At less than 25% representation, any minority including women are effectively not represented.
Four key outcomes that OMAI drives include:
1. Gender equality at the board
2. Gender equality in overall employee representation
3. Equal pay
4. Implementation of gender related polices such as anti-sexual harassment
While the world has achieved progress towards gender equality and women’s empowerment, women and girls continue to suffer discrimination and violence in every part of the world. ‘While some indicators of gender equality are progressing, such as a significant decline in the prevalence of female genital mutilation and early marriage, the overall numbers continue to be high. Moreover, insufficient progress on structural issues at the root of gender inequality, such as legal discrimination, unfair social norms and attitudes, decision-making on sexual and reproductive issues and low levels of political participation, are undermining the ability to achieve Sustainable Development Goal 5.’ – United Nations, Progress on SDG 5 2019.
UN Secretary-General, Mr. António Guterres, states that gender equality and empowering women and girls is ‘the unfinished business of our time’.
Gender equality is a fundamental human right. Gender equality is a necessary foundation for a peaceful, prosperous and sustainable world. While there is much talk of gender equality, we all need to start delivering on the rhetoric.
‘Providing women and girls with equal access to education, health care, decent work, and representation in political and economic decision-making processes will fuel sustainable economies and benefit societies and humanity at large. Implementing new legal frameworks regarding female equality in the workplace and the eradication of harmful practices targeted at women is crucial to ending the gender-based discrimination prevalent in many countries around the world.’ – United Nations, 2019
Some statistics to ponder on:
- Globally, 750 million women and girls were married before the age of 18 and at least 200 million women and girls in 30 countries have undergone FGM (female genital mutilation).
- The rate of girls between 15-19 years who are subjected to FGM in the 30 countries where the practice is concentrated was 1 in 3 girls in 2017.
- In 18 countries, husbands can legally prevent their wives from working; in 39 countries, daughters and sons do not have equal inheritance rights; and 49 countries lack laws protecting women from domestic violence.
- One in five women and girls, including 19% of women and girls aged 15 to 49, have experienced physical and/or sexual violence by an intimate partner with the last 12 months. Yet, 49 countries have no laws that specifically protect women from such violence.
- Only 52% of women married or in a union freely make their own decisions about sexual relations, contraceptive use and health care.
- Globally, women are just 13% of agricultural land holders.
- Women in Northern Africa hold less than one in five paid jobs in the non-agricultural sector. The proportion of women in paid employment outside the agriculture sector has increased from 35% in 1990 to 41 percent in 2015. (United Nations, 2019)
- A girl in South Sudan is more likely to die in childbirth than to finish primary school.
- Fewer than 2% of girls in Somalia attend secondary school.
- By grade 5 only half as many girls as boys attend school in Uganda and Kenya.
- Only one disabled woman is educated for every five disabled men in East Africa.
- Fewer than 12% of teachers in Uganda are female, and only 3% in Somalia.