Namita Vikas is the Founder and Managing Director of auctusESG, providing specialized advisory towards designing and developing sustainable finance products, climate strategy, ESG and climate risk integration, and knowledge and innovation products. Namita is a senior business leader with 30 years of diverse global experience in climate strategy and sustainability across sectors including banking, technology and FMCG, with a particular focus on sustainable, climate and green finance, climate action, ESG & Climate Risk Management.

We discussed several topics with Namita, including climate-related opportunities for investors, the role of central banks in advancing sustainable finance and investment, and challenges facing ESG investors in emerging markets.

Hi Namita, thanks for joining us. What are the opportunities that may arise for ESG investing, given the climate risks the world faces today?

Environmental risks dominate the WEF’s Global Risks Report 2022- for the short, medium and long term. “Climate action failure”, “extreme weather events”, and “biodiversity loss” have been identified as the most severe risks over the next 10 years. Not only are all of them related to ESG, but they, standalone or combined, pose significant risks to business and financial stakeholders. With conversations around climate risks growing rapidly, investors globally are now looking for ways by which they can address these risks and its effect on their portfolios. In this context, 2020 was a perhaps clarion call that led to several investors redirecting their assets into more sustainability-oriented portfolios. For example, ESG-oriented assets in 5 major markets reached US $35.3 trillion in 2020, up 15% CAGR from 2018, and 55% from 2016.

From an opportunity perspective, investors could benefit from reduced probability of regulatory and reputational risks, by reducing their exposure to high emission, polluting sectors. In the energy sector, growing concerns over stranded assets, diminishing returns from fossil fuel plants, rising pressures from civil society and a growing unwillingness of banks to extend conventional energy loans is already compelling investors to disinvest from conventional energy sectors.

Apart from installing fresh capacity in renewable energy, transitioning existent carbon-intensive assets in oil, gas and coal sectors, or in other hard to abate sectors like cement, to cleaner fuels/technologies offers ample headroom for growth. Major investors, including Blackstone and Apollo Global Management, no longer invest as much in traditional energy as they once did, preferring to migrate towards solar, wind or other cleaner sources. Kinder Morgan, one of the largest infrastructure companies in North America, formed a new unit to explore green energy opportunities, including the storage and handling of liquid renewable transportation fuels such as ethanol, biodiesel, renewable diesel, and hydrogen.

Apart from clean energy, emerging business models around specific themes such as e-mobility, water, waste, circular economy, climate smart agriculture and green buildings also offer an investment opportunity, while accelerating the transition to a low-carbon economy.

For instance, research shows that every US $1 invested in the WASH sector is expected to give a return of US $4.3. Despite this, the capital gap to meet just two of the targets under SDG 6 (clean water) remains US $114 billion per year globally.

Essentially, those who venture to create opportunities arising out of climate risks would be better placed in terms of meeting their climate commitments while safeguarding their financial returns, in the long term.

How can central banks and public finance be used more effectively to scale up ESG-oriented investing?

With intensifying climate events, the case for scaling up ESG integration has never been stronger. Central banks are strategically placed to set the momentum with policies and regulations centred around ESG, thus accelerate its buy-in from the industry and its integration across the latter’s investment decisions.

The positive news is awareness amongst central banks is picking up. An ADB survey conducted across 18 central banks in the Asia- Pacific region found majority were already encouraging sustainable finance.

However, given the vast amount of investments required to meet sustainability and climate goals, central banks need to work in concert with finance ministries and financial market regulators to adapt and align the policies and regulations governing capital flows with climate goals. In terms of commitments, the Bank of Japan announced is disbursing loans from December under a new scheme targeting activities aimed at combating climate change.

There is a need to align their extant policy instruments to tackle climate change, including enhanced supervisory review, risk disclosure and market discipline, capital and liquidity requirements.

What are the biggest barriers in ESG investing faced by investors in emerging markets?

The OECD report 2020 on “ESG Investing: Practices, Progress and Challenges” states that ESG investing is not without its challenges. Almost 50% investment companies lacked access to quantitative data which posed as a barrier for ESG implementation. Even where data is available, there is a lack of data standardization.

Lack of transparency in terms of corporate disclosure of firms’ ESG activities is another challenge. A uniform consensus on ESG ratings and methodologies amongst rating providers and asset managers is still found wanting, which may also lead to incidences of inadvertent greenwashing.

There is a lack of standardisation, and there is no agreed-upon ESG reporting organization, with several organizations reporting ESG ratings as per their own standards. Due to the lack of consistency on what defines green, or ESG, companies are also often seen to adopt varying interpretations of ESG aspects, and methods of reporting on ESG activities also differ.

Other challenges include uncertainties around government policy and regulations, especially mandatory regulations, which affects investment decisions and makes the establishment of a long-term investment strategy quite a challenge.

Why do investors disproportionately focus on ‘E’? How can greater financing be directed towards the ‘S’ or ‘G’?

I would like to look at this from another perspective. First, while the focus of investments has been seen to be more on the E of ESG, the eventual impact has been felt across S and G, especially S. That is because, these three elements (E, S and G), are inter-connected and are not in isolation to each other. Climate change may seem more environmental at first, but digging through the layers shows its implications and impact on the social aspect as well. In short, investments in E will trickle down towards S, or social impact.  For example, investments in renewable energy, waste management, afforestation and conservation of scarce natural resources helps local communities and livelihoods as much as it helps the environment.

Having said that, it might be said that investments have generally been skewed towards the E of ESG. This is because a lot of regulatory compliances and awareness building have occurred on the environment aspect, thus bringing it more in the buzz of the broader community of stakeholders. A lot of work has occurred in terms of environment impact measurement, product development (like carbon credits, for instance), or in education and training, and these changes have created opportunities, albeit often involving higher risks and longer gestation periods, for investors.

Continuing on regulations, the EU Legislative Package, which focuses on climate change mitigation and adaptation and transition to a greener circular economy, is an example that has motivated investors to disproportionality align their investment towards ‘E’ of ESG. Closely aligned to this is the concept of stranded assets, since changes in regulations and policies around environment could put long term investments at risk of realising the expected returns. That, in itself, has been a key motivator for investors.

Additionally, a major challenge has been the lack of sophistication and precision of impact measurement and monitoring systems for S and G. Even within E, a bias has been seen towards renewable energy and energy efficiency, because the impact (emission reduction) is tangible; however the same may not hold true for ecosystem/biodiversity oriented projects.

However, the focus is shifting. For example, the COVID-19 pandemic was a revelation of the inequities that exist in healthcare access, especially in rural areas that house 66 percent of India’s 1.3 billion population. Governance issues leading to the appointment of independent directors have challenged the balance, transparency and quality in the functioning of the corporate boards, resulting in a growing buzz around the G of ESG. All these factors have resulted in investors looking at S and G issues, and not just E.

However, for investments to be directed towards S and G, public finance sources needs to be leveraged to risk-proof investments, preferably in blended finance models that catalyse private sector capital to scale up investment flows towards the SDGs. This will help elicit more interest from investors. Secondly, to direct more financing towards S and G, outcome-based mechanisms could be leveraged to deliver market returns along with measurable impact. Such pay-for-success financing models would help evince interest, especially from private sector investors. In this context, it may be worthwhile to explore how social collateral can be utilized to enhance financial access, especially of bottom of the pyramid community who lack physical assets for collateral. The microfinance institutions have leveraged this model to scale up microcredit access in rural regions, and this needs to scale up in innovative ways in order to expand credit access, which would help enhance social impact and livelihoods, translating into the S of ESG.