How sustainable finance is shaping the future
Sustainability is becoming a key driver of risk and return in a CLICTM economy
Arnaud Leclercq is Group Managing Director and Partner of Lombard Odier Group. Since 2006, he has been responsible for the new markets, including the Middle East, Turkey and Eastern Countries. GN Focus talks to Leclercq about the future of sustainable finance.
Sustainable finance is gaining prominence now. Why is this a key issue today?
There’s a rapidly growing recognition that our wasteful, idle, lopsided and dirty (Wild) economic model is pushing nature beyond its safe operating limits. Our planet has already warmed by 1 degree Celsius since the industrial revolution, threatening droughts, increasingly violent storms and rising sea levels. Wildlife populations have fallen by 70 per cent since 1970, while agrochemical pollution has led to aquatic dead zones. As a result, we’ve risked undermining the stable ecological foundations that enabled human civilisation to flourish.
Finance not only has an important role to play in helping to reverse this course. It has real incentives to do so as the risk and return profiles of financial market investments shift with the environmental transition. Indeed, the transition to a new circular, lean, inclusive and clean (CLICTM) economic model has already begun. Policy is making CO2 emissions more costly, consumers are demanding more sustainable practices, while technological innovation is driving down the costs of solutions and driving market adoption. Finance must now accelerate this transition by deploying capital at scale.
At Lombard Odier we believe that sustainability is becoming a key driver of risk and return, as the transition to a CLICTM economy gains speed. Companies that seize the enormous opportunities the transition brings will probably deliver superior returns, while those that refuse to adapt will find themselves with stranded assets.
How can investors support the transition to a carbon-neutral economy?
Investors can support the transition by looking at players that are well positioned on a forward-looking basis, not just companies that are already low carbon.
It is often ambitious firms in hard-to-abate sectors, like steel and cement, that offer the greatest potential for reducing emissions in the real economy. Allocating capital to high-carbon firms that have detailed and credible decarbonisation plans will help to accelerate the transition far more than merely divesting from these sectors entirely. After all, we will still need steel in 2050, even in a successful decarbonisation scenario.
Green bonds are currently booming. What are the other sustainable financial products that we can expect to see?
We expect to see growing numbers of leading investment managers incorporating a climate exposure lens into their strategies. We at Lombard Odier use our proprietary Implied Temperature Rise and Climate Value Impact metrics to evaluate investment opportunities, projecting how we believe companies’ emissions and earnings under a climate transition scenario will develop over time. This analysis enables us to design investment solutions for clients that maintain returns and diversification, while offering positive exposure to the transition to a CLICTM economy.
We also expect to see a scaling up of the market for carbon credits. Carbon credits are no substitute for decarbonisation at source. However, they provide a valuable way to channel funds to high-impact projects that safeguard nature and protect the climate. In the future, we believe investment managers will start to offer carbon credit funds as a supplementary product to their clients.
Switzerland is one of world's leading financial centres. How are you looking to embed sustainability deeply into the DNA of the swiss financial centre?
Switzerland manages more than 1.5 trillion Swiss francs in sustainable financial assets; nearly 14 per cent of the European market. This is already a considerable market share but there is still room to grow. One key enabler is for Switzerland to seize the opportunity to develop market leading solutions and standards to help investors allocate capital in the transition to a sustainable economic system. In Europe, much of the regulation on this topic has been designed to distinguish between what is green and what is not. The recent inclusion of natural gas and nuclear in the European taxonomy has mired these efforts in controversy. The strong opinions in this debate highlight that the distinction between green and non-green is not always clear. This has led some observers to describe it as a "giant greenwashing operation" (Taxonomygate).
Controversy aside, while it is essential to distinguish between what is green and what is not, there is an even greater need for transition actors, investors and savers to know what is going green - and what is not. Many companies in the industrial and materials sectors, for example, will be characterised by high emissions, heavy reliance on fossil fuels and large waste footprints. These impacts can only be reduced by channelling capital to companies with credible and ambitious transition plans.
UAE regulators and exchanges have pledged sustainable finance to advance net-zero goals. What lessons can the Swiss financial community offer in this regard?
At the end of 2021, the Swiss Federal Council announced its intention to be an international leader in sustainable finance with climate transparency. To this end, the State Secretariat for International Finance (SIF) has spearheaded the development of a minimum quality criterion for a voluntary, industry-led climate score. In practice, this climate score aims to provide market participants with guidance on how their investments are aligned with the key objectives of the Paris Agreement, namely to limit warming to well below 2°C and, if possible, 1.5°C. As such, the climate score seeks to provide a scientific perspective on the adequacy of the decarbonisation trajectory of financial market investments.
Such a score that informs investors and savers of the level of global warming their investments are aligned with could be remarkably intuitive and effective, as it would bridge the gap between the investment world and climate science. At Lombard Odier, we have been at the forefront of the development of such forward-looking methodologies and we welcome the Swiss Federal Council’s initiative. This is a world-leading initiative and one we think other jurisdictions, including the UAE, could really benefit from following closely and emulating.