Sunday Brunch: 18 June 2023
More on ....getting finance people to listen
Back at the end of May I wrote the first blog in a series on the topic of what gets financial peoples attention when we talk about Sustainable Finance. And yes, its mostly, but not exclusively, about money. My starting point is that we all want to deliver change and impact. Which means that we need to be able to persuade companies that sustainability can also add financial value.
In that first blog I discussed the motivations of generating profit now, the potential for future profit, and managing technological pressure. Today I want to round out the list by discussing the motivation to act in relation to regulation/social pressure, and how we get the right mix of carrot and stick. By this I don't mean ESG regulation and reporting. This is about regulation that directly impacts a companies operations, and hence their profit and loss - you must use these buildings materials, your cars must not emit more than X CO2/km, you must stop using gas boilers and you must reduce fertiliser usage by X%. The focus here is on Europe, which is the engagement region I know best.
Just to quickly recap - my professional life has largely been spent persuading financial people to listen: as a corporate finance advisor and banker, as a broker to investment funds, and as an investor: persuading companies to listen and act. I now want to bring the lessons I learnt from this into sustainability finance.
Regulation & social pressure
When most sustainability and ESG people talk about regulation, they often mean ESG reporting regulations such as the recent update to the European Union Corporate Sustainability Reporting Directive (CSRD).
While these are important, most finance people are more concerned about regulations that have a direct financial impact on their business. A good example of this second type of regulation is Regulation (EU) 2019/631 - which covers the CO2 emissions of road transport vehicles sold in Europe. Non-compliance brings real costs, this is not just about reporting.
From a finance perspective, how do these different types of regulations differ?
If there is a financial penalty, my experience has been that companies are more likely to fundamentally change their operating practices.
To be clear, this doesn't mean I don't see the advantages of the various sustainability reporting frameworks. I can see the benefits of investors and other stakeholders having more information. I am a particular fan of the EU taxonomy, which is a useful classification system for economic activities that can be considered to be environmentally sustainable. Although even here, politics plays a part, with the European Parliament backing the labelling of nuclear and gas as green.
My concern is that the various reporting requirements put the onus on investors and other stakeholders to act. Without that action, the reporting standards just end up giving us useful information. In a few years everyone should have access to much of the data to make the required investment judgements. But it's what happens next that bothers me. It's not clear that most investors have the resources, the expertise, or the time, to run the required detailed corporate engagement programmes. By comparison direct rule based regulation, with suitable fines, can drive action more directly.
Regulation as a reporting requirement
Under the CSRD from the 2024 financial year, many companies need to start publishing information related to environmental matters, social matters and the treatment of employees, respect for human rights, anti-corruption and bribery and diversity of company boards. The logic underlying the process is to ensure that ...
investors and other stakeholders have access to the information they need to assess investment risks arising from climate change and other sustainability issues. They will also create a culture of transparency about the impact of companies on people and the environment.
Putting it another way, it's underpinned by a belief that if you measure something, then it gets managed. This is often linked to the work of influential business strategist's such as Peter Drucker. Although apparently he never said "what gets measured gets managed”. In fact he argued the opposite, that many of the things that are important to a company cannot be measured - but that's a debate for another day.
From the perspective of the company, they are 'just' obligated to report the information. There is no legal obligation to act, to change their business practices. There is however an implicit assumption that stakeholders and the 'court of public opinion' will, over time, put pressure on the company to improve its practices.
Regulation with financial implications
By contrast, regulation (EU) 2019/631 sets very concrete fleet wide targets for CO2/km emissions for different types of new road transport vehicles. The level to be achieved by 2024 is a very specific number - 95g CO2/km. And any company that fails to meet the standards is required to pay an excess emission premium of EUR95 per car per g/km of target exceedance.
The incentive to meet the standards is clear - go over the target and there is a financial cost. Perhaps un-surprisingly, almost all car manufacturers — either individually, or as members of a pool — met their 2020 targets. This direct approach seems to be working.
A slightly weaker example is the recent German Supply Chain Due Diligence Act, which requires that German companies "make reasonable efforts to ensure that there are no violations of human rights in their own business operations and in their supply chains". This can be thought of as a best endeavors act - the companies covered must make reasonable efforts, at their own discretion. This gives companies the companies a bit of a let out. But, the bottom line is that there are fines and other sanctions for companies that fail to meet their obligations.
Recent blog on the German Supply Chain regulation
And something else to watch, trade unions and non-governmental organisations may be authorised by an interested party to conduct litigation. In my view this is going to be a very interesting trend over the coming decade, with many organization's gaining practical expertise in using the law to force change on reluctant companies. Certain NGO's seem to be increasingly well resourced in this area.
Blog on More Climate Change Law is coming
Round up - what does this mean for Sustainable Finance?
First, we suggest that a greater focus is placed on lobbying for rule based regulation, such as regulation (EU) 2019/631 on vehicle emissions. In the right situation, this type of regulation can be very powerful as a mechanism for change. There are many other similar avenues, such as building codes (which can require the use of certain materials, limitations of demolition, and stronger insulation targets).
Second, if we are going to make the reporting requirement type of regulation the bedrock of our approach to sustainability, then investors need to put a lot more resource and expertise into informed engagement. This covers everything from understanding what changes we want the companies to make, what implications this has for their financial value creation, and how this will work in terms of company culture. Change is hard, and companies are going to need a lot of support if they are going to make it happen.
Thirdly, and more positively. We need to broaden the discussion about how companies acting with purpose also create financial value. It's something that Alex Edmans (of Grow the Pie fame) and Rebecca Henderson (author of Reimaging Capitalism in a World on Fire) have been researching and speaking on for a while now. More of us need to listen.
What caught our eye
Here are three stories that we found particularly interesting this week and why. We also give our lateral thought on each one.
The expansion of Indian Steel: Companies are risking more than reputation.
Microalgae cultivation and overcoming biofilm formation in photobioreactors.
An mRNA vaccine to treat pancreatic cancer.
The Expansion of Indian Steel: Companies are risking more than reputation.
In an article in Carbon Transition Analytics, Dr Paul Griffin argues that as India seeks to double its annual steel production capacity to 300 Mt by 2031, steel companies deploying new blast furnaces are not only lock themselves into a path of carbon dioxide and methane emissions, but also in to a risky and inflexible business model.
Why do we find this interesting? Steel is a fundamental building block of our modern economy. As a large source of GHG emissions, its production is an important decarbonisation problem. But we have solutions.
We have written about possible pathways to green steel previously. As with any transition an important consideration is material security and jobs.
Link to blog 👇🏾
Blog on the Pathway to Green Steel
(Greener energy applications, Professional)
Microalgae cultivation and overcoming biofilm formation in photobioreactors.
Jana Skokan co-founder of frogeex is hosting a masterclass on the application of algae in business. Algae as an alternative to traditional resources is gaining momentum. Algae are diverse and versatile organisms. They are a superfood and supermaterial that can be used in various fields, from food and pharmaceuticals to fuel and bio-remediation. As a result, the algae industry has been growing.
Photobioreactors (PBRs) are the key devices used for cultivating microalgae, providing optimal conditions for microalgae growth and productivity while facilitating efficient harvesting and downstream processing. However, one of the main challenges in microalgae cultivation using PBRs is the formation of biofilms on reactor surfaces. Biofilms can hinder light transmission and nutrient uptake, impacting the overall efficiency of the system.To overcome this challenge, there are a number of approaches being taken including the use of antifouling coatings, periodic cleaning routines, and optimised flow rates.
We found this interesting because it reminded us of the battle against antimicrobial resistance (AMR). Stopping biofilm formation can stop bacteria from becoming pathogenic or harmful to us.
A question we had on the 'antifouling coatings' is whether they were chemical based or a physical structure effect. The latter has an inspiration from nature, dragonflies specifically, whose wings have extremely small structures called nanopillars that stop biofilm formation. We wrote about this in an article focusing on physical solutions for preventing AMR.
Link to blog 👇🏾
Blog on Spoiling the party with physics and material science
(Health and Wellness, Professional)
An mRNA vaccine to treat pancreatic cancer
A small clinical trial of a personalised mRNA-based vaccine against pancreatic cancer has demonstrated a strong tumour-specific T-cell response in half of the trial participants, according to results published in Nature. The research, led by Dr Vinod Balachandran from Memorial Sloan Kettering Cancer Center, will now progress to a larger clinical trial. The team used BioNTech, which produced one of the COVID-19 mRNA vaccines, to identify proteins that could trigger an immune response and created a customised mRNA vaccine for each patient, which targeted up to 20 neoantigens.
Pancreatic cancer is one of the most deadly cancers with a survival rate of just 12% that has remained largely unchanged for more than 50 years. It is the 7th leading cause of cancer death globally. Even after surgery, nearly 90 % of patients have a recurrence of the disease within 7-9 months. The discovery of this vaccine provides hope.
The vaccine is an example of personalised medicine as the vaccine is designed to work optimally on the specific patient's own tumour. Personalised medicine is one example of a number of broad areas that are being investigated to slow down or even stop biological ageing. This is an important sustainability theme and one which is receiving growing amounts of investment. The payback in terms of saved long term care costs and potentially early diagnosis and treatment could be big, particularly when extrapolated to productivity and quality of life gains.
We have written a number of blogs on the topic. We shall also be writing on personalised medicine in more depth in a future blog.
Link to blogs 👇🏾
Blog on the landscape of biological ageing
Blog on biological ageing - this is the way
(Health and Wellness, Premium and Professional)