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Podcast: Global risks for 2023 - what we learned and how we’re dealing with them

We speak to sustainability specialists Andy Howard and Sarah Woodfield about the risks investors are facing and how they might approach them in their investments.

01/02/2023
girl on rocks

Authors

David Brett
Multi-media Editor

This is a transcript of a discussion from an episode of The Investor Download. It's available above or you can download it from Apple podcasts, Spotify or wherever you get your podcasts.

David Brett: Just when you thought that things couldn’t get much more fraught than the last two years, the World Economic Forum (WEF) releases their global risks for 2023. According to the WEF, the world's top current risks, perhaps unsurprisingly, remain related to the cost of living crisis. The bulk of the top 10 are risks emanating from biodiversity loss and climate catastrophe. These are risks investors need to be aware of, not just for 2023, but for years ahead. So on this show, we've got two of my colleagues who know much more about the subject than me.

Andy Howard: My name's Andy Howard. I'm the Global Head of Sustainable Investment at Schroders.

Sarah Woodfield: My name's Sarah Woodfield. I'm an Active Ownership Manager at Schroders, focusing on biodiversity and natural capital.

Part 1:

DB: We'll discuss what investors are doing to engage with companies on the potential impacts on their businesses, and ultimately their bottom line and the businesses' impact on the wider world. Also, after attending COP15, the biodiversity summit in Montreal last month, whether Andy and Sarah thought it lived up to its pre-summit billing of a potential Paris moment for nature. So in the first part of the show, we'll look at Andy Howard's sustainable outlook for 2023 and the WEF's Global Risks Report. Andy, welcome back to the show. It's been a minute, it's been a while.

AH: Yeah, thank you. Great to be here.

DB: It's good to see you. Before we start to dig into the risks, I want to ask a direct question. Why should investors care about these risks, particularly those associated with biodiversity and climate?

AH: Well, to be honest, I don't really think we've got a choice. Social-environmental pressures broadly, the challenges, the opportunities, the changes that we're seeing playing out, are going to impact investments, they're going to impact portfolios. The only real question is are we thinking about that consciously? Are we taking action to try and identify the opportunities, to identify the impacts and managing them proactively, or are we just letting them happen? So I do think that we're past the point at which this is an optional exercise.

DB: So this is something that maybe investors may have escaped up to a certain point, but there's no getting away from it from now on.

AH: It's certainly getting more challenging. I think that's certainly the case. If you look at across a whole spectrum, whether you think about this in terms of the environmental areas that you mentioned, whether you think about this in terms of social challenges, inequality, cost of living crises, the challenges are becoming more acute and their impacts are becoming more pronounced.

DB: Okay, so you published your sustainability outlook for 2023, which covers five trends to watch. What are the main events for 2023 we should be aware of from a sustainability perspective and why?

AH: Well, it's always nice to be able to put the dates in the diary for these are the big events of the year. The reality is, if the experience of the last few years have been anything to go by is actually, on the one hand, it's as much about the progression that we see through the course of the year in over several years rather than necessary specific events. But I do think that in particular, COP28 coming up in the United Arab Emirates in November/December of this year is going to be an important time. That's going to set, I think, a real indication of the degree to which we're seeing policymakers, governments around the world stepping forward, in a way that frankly, there was a bit of disappointment in terms of how much progress we saw last year, and the degree to which we see that continued momentum this year on the climate front.

But I think there's a slightly broader point here as well. I mean, we've talked about this before, that we are going into a different period, that we are going into a period where sustainability as investors, for investors, is becoming a more complex and more nuanced topic, and really understanding the degree to which we're seeing policy action, the degree to which we're seeing social change, the degree to which we're seeing continued momentum in terms of the willingness to take action to tackle climate change, take action to tackle the cost of living impacts that we're seeing around the world is going to be really critical. Do we see that action playing out evenly? Do we see it playing out in different countries in different ways? And how do we see that continued momentum and continued political willingness to intervene? We're now at a point where 90-odd % of the world's economy comes from countries where those governments have committed to transitioning to net zero. We still need to see continued policy action to deliver that transition. It is picking up, but it needs to carry on increasing.

DB: Okay, great. But since you've produced your outlook, the World Economic Forum has followed, they've produced their Global Risk Report for 2023, which sets out the most severe risks for the next decade as well as for the next two years. I won't go through all of them, you can go to the World Economic Forum website to find this, but I reckon at least 5 of the top 10 are linked to climate and biodiversity. So what do you make of the list as a whole, certainly for the next two years?

AH: Yeah. Now, I think you're right a bit. When I take it a step further, we've looked at this over the last 10, 15 years and they've been producing and publishing that report every year for a long time. If you look at it and go back 10 or 15 years, actually very few of those top risks that identified by, say, business executives were social or environmental topics as we might ordinarily think of them. Now, social and environmental topics dominate that list. I mean, you mentioned climate change and biodiversity, there's also cost of living crises, there are also a whole range of social challenges on there as well. So it's not just what's happened this year, I think it's a change that's really played out over the last decade or so, but I think it really is indicative of the point.

This is not an isolated voice calling from the sidelines talking about sustainability as an aside topic. These are real issues identified by companies in thinking about how are they going to run their business, how are they going to compete, what are the challenges they need to navigate over the next few years? And I think we're going to carry on seeing that trend continue. And I think the real question that companies I know around the world are grappling with is how do we navigate this? How do we tackle this? And how do we think about this s strategically so that we are in a stronger position as those risks intensify?

DB: And we'll cover a bit of that in the second part of the show. But were there any surprises on the list?

AH: Honestly, not really. I think if you look at cost of living was featured prominently, as, as you say, did climate change and biodiversity. Again, I think, to some degree, they're reflections of the issues that the world faces. And let's be honest, these are structural challenges that will take time to tackle. These aren't issues that are going to go away in a 6-month, 12-month period, but they are very much issues that are front and centre of how businesses think about their own strategies, the sustainability and the profitability of those companies, and ultimately, therefore have to be important for us as investors. I mean, I think this is a topic that's in boardrooms around the world. Look, when I started looking at climate change just over 20 years ago, it was more mixed, let's be honest. There were certainly companies around the world who were yet to think about it, wasn't really on their agenda. Pretty surprised today if there are many companies around the world for whom this isn't part of their strategic and boardroom discussions.

Part 2

DB: Okay. That's it for part one. In part two, we're going to discuss nature as an investment issue, and what was achieved at COP15 to try to address it. Sarah, welcome to the show. It's the first time, it's good to see you.

SW: Nice to be here.

DB: Okay, so global wildlife population sizes have plummeted by 69% on average since 1970, that's according to the WWF's Living Planet Report. Clearly there are huge problems, but how do these issues relate to businesses and investors?

SW: So it's a really critical issue for businesses and investors be paying attention to, both as a risk in its own right, but also actually if you look at how biodiversity loss is relating to other really critical risks, such as climate change and such as social issues. Climate change is one of the top five drivers of biodiversity loss, and then we know that protecting, restoring nature is one of the key solutions we need to think about as we try and mitigate the physical impact of climate change as well. So these are all really high-priority issues for boards to have right at the top of their agendas. Now, from an investment perspective, one of the challenges here is actually some of the differences between biodiversity loss and climate change, but climate change typically presents at a macro, at global level, but actually biodiversity loss is location-specific. So what this means for companies is actually really understanding, in very granular detail, the length, the depth and the complexity of their supply chain, and really understanding that to the point where they can identify location-specific challenges with biodiversity that their operations may be impacting.

So they may have operations impacting critically important ecosystems where certain species might be of danger of extinction. Now, doing the work to understand that is really important to then understand, well, what does this mean for my business model going forward? Particularly if regulation comes in to manage that risk if governments around the world are deciding that businesses aren't taking this seriously enough soon enough. And I think what's really important, and actually what we've seen over the last year, that looking back to things like COP15 is setting the global policy framework to incentivize governments and companies to start looking at those regulatory challenges and implementation going forward.

DB: In the end, if these issues aren't addressed, we all lose in the end. But do you think, at the moment, investors care or even understand?

SW: Absolutely. Investors are working hard to discuss with the companies that they're invested in, how some of these issues might impact their business model going forward. Now, that may impact them in different ways, it may be to do with deforestation, it may be to do with water, it may be more to do with issues to do with the circular economy. But actually, that starting conversation investors are having with those companies is understanding is this on the board's agenda? Are they taking that work to understand the risks along their supply change, and are they thinking about what the forward-looking implications are for their business models?

DB: Okay. It's increasingly said that the world's waking up to the importance of nature. The conversation seems to have progressed from trying to get to net zero to being nature-positive. Andy, can you just explain what we mean by nature-positive?

AH: Probably not. I mean, and I say that slightly facetious, but nature-positive sounds similar to net zero when you say it quickly. Net zero, on the other hand, is pretty well defined. It's about net zero emissions as measured in tons of carbon. Nature-positive is really about a similar concept, but probably without quite the same level of specificity. It's about essentially eliminating the negative impacts that companies, that investments, that economies are having on nature over time. One of the challenges in this area, as Sarah alluded to there, is that how do we measure that? Companies have become relatively good at reporting carbon emissions. Again, there's more that needs to be done, but we've got information there to work with that's reasonably comprehensive for the most part, certainly in most areas. Nature is a whole different kettle of fish.

And I think when you start trying to say, "Well, how do we really bring an objectivity and a quantification so that we can understand not only conceptually and in principle where are we going, but also how do we measure tangible progress towards that goal, either at a global level, at an investment level, or at a company level," there is still more to be done. And that's part of what I think the changes that could play out pretty quickly in fact, as we get more momentum and more consensus around this over the next few years.

DB: There will be the age-old expression from investors about trade-offs being made between doing good and making money off your investments. But how do we balance doing the right thing with investment performance?

AH: Well, I think, so I would start by the idea that if you think about it as a trade-off, one's possibly looking at it through the wrong lens. I think the reality is that there's figures that are quoted, the World Economic Forum throws around the figure of $44 trillion of economic value-add being highly dependent on nature, which is about half the world's GDP, very nearly. There's an unavoidable link between economic output, corporate output and nature at its core. The idea that there is a trade-off between managing the exposures and the risks that are associated with the dependency on nature and unsustainable use of nature's resources with generating returns and finding those companies with more sustainable businesses that will thrive and succeed in the future seems to be misplaced. I think actually the two things are complimentary, and actually for us to understand where the future winners will come from, where those companies that can succeed in the long run will come from, really requires us to think about nature and think about companies' dependency on nature as we go through that.

This is an area where we are still dealing with incomplete data, where we're still dealing with companies that in many cases are grappling with challenges and questions that, frankly, are far from straightforward questions. Anyone who says that they've worked this out and has got the answers as misunderstood the scale of the problem.

DB: And just be clear, this isn't just necessarily about investing in companies that are doing good, but it's not necessarily about not investing in companies that are doing bad. It's about a dialogue between companies. Would that be more appropriate?

SW: Absolutely. And giving the scale of the challenge that Andy just alluded to, you won't necessarily just be able to differentiate between good companies and bad companies. Actually, every company is going to have an interaction with nature at some point along their supply chain. So actually our role as investors is to encourage those companies to assess what those interactions are and to ensure that they are looking forward and looking at how do they transition their business model. And that might be off their own back, but it also might be to anticipate impending regulation which forces their hands.

DB: Okay.

SW: So for example, if you look at some of the recent regulation around the EU Farm to Fork Strategy, that included quite onerous expectations on pesticide manufacturers, which will have quite a significant impact on the equity valuation for pesticide.

DB: Okay. Well, you mentioned COP15 there, both you and Andy were very lucky to be out in Montreal to attend some meetings out there. It took place just before Christmas, it was a huge gathering of policymakers, business leaders, scientists and investors like ourselves. The aim, we were told, was to get a deal done for nature similar to that of the Paris Climate Agreement in 2015. In your opinion, what was achieved?

SW: So there's actually a huge amount of substance to the agreement. So everything from requiring companies to report on their risks, impacts and dependencies on nature, removing harmful financial subsidies, protecting genetic resources, supporting the role of Indigenous knowledge in protecting those genetic resources as well. So a huge package. And actually, if you think about it in comparison to the Climate Agreement where the headline figure is 1.5 degrees, you are looking at a bit more of a complex ecosystem, which is maybe a bit harder to communicate in terms of the substance and the meaning going forward. I think for us, as financial institution, one of the key pieces of progress there is actually the requirement to ensure that companies are reporting on their impacts and dependencies on nature, because that will support us to really get the words from the companies' mouths on their impacts and dependencies on natures, which will enable us to better integrate that into financial decision-making.

DB: Andy, is not having a headline figure like the Paris Climate Agreement going to be an issue for the deal that was struck last year?

AH: There's a lot more elements to biodiversity. By definition, there are dozens and dozens of ecosystem services, which are the benefits that nature provides for society, the benefits of nature provides for economies. Sequestering or capturing carbon is one of them, but there are many, many others. And trying to encompass all of that into one phrase, one terminology, one headline is probably superficial if you can even do it. And it goes back to the point about nature-positive versus net zero. It's not quite so straightforward.

DB: So what it sounds like it's a bit more sprawling and less targeted, certainly with the headline figure, than Paris. There must be plenty of opportunities in there.

AH: Well, there are, and in any situation where you're dealing with imperfect data, where you're having to make judgment calls around what individual companies are doing, where the benefits might accrue, is an area where judgment, insight, industry knowledge, are all really critical to making thoughtful, informed decisions. Well, there are. And in any situation where you're dealing with imperfect data, where you're having to make judgment calls around what individual companies are doing, where the benefits might accrue, is an area where judgment, insight, industry knowledge are all really critical to making thoughtful, informed decisions. And I think that really does play into our organization's strengths in terms of the breadth of global knowledge that we have across the organization, and that real focus on how do we understand complex questions of the future, that we can't simply model by looking at what's happened in the past, in order to make better investment decisions. So there are real opportunities in there, I think, yes.

Part 3

DB: Okay. That's it for part two. In the final part of the show, with all these risks we're facing and all the discussions taking place to try to mitigate them, we're going to discuss what the future looks like and what that entails for investors.

So it feels like the risks are building and there's going to be more pressure on companies in the future outside your standard economic concerns. So Sarah, what's your perspective on how investors can influence the companies they've got shares in or companies they've got holdings in?

SW: So there are a huge number of actions that investors can take to engage with a company on biodiversity. And we've discussed earlier how biodiversity loss is actually quite a wide-ranging topic. When you look at the five key drivers of biodiversity loss, you've got climate change, you've got pollution, invasive species, overexploitation of land. So these are all topics that investors can be talking to the boards and management of the companies that they're invested in, to understand have you thought about these risks? Have you identified which of these drivers are actually interacting with your business model, your operations and your supply chain? And do you have a plan in place? Now, the likelihood is, at this moment in time, some of the most leading companies have only really just started on that journey of mapping those out. So not many of these companies have a very clearly-defined plan in place.

And I think we see as our responsibility as investors to be working with those companies as they go on that journey. We can also use that information then to support us to make better informed investment decisions. So the starting point really is to engage with the board and management of the companies to have that conversation to understand how they're looking at these risks and opportunities, and what they're doing with them going forward. The other role that we can play is working with other investors. If we've got a particular concern, we can participate in collaborative initiatives.

DB: The investment world is sprawling, there's so many different industries, so many different companies. Is there anything that investors should be prioritizing or is it down to personal preference?

SW: So deforestation is a really critical issue. The world's forests host approximately 80% of the world's biodiversity. So in some ways you can see that as a really important proxy for biodiversity loss as companies are going through that process of risk mapping and understand other drivers as well. For us also, would play a really critical role in sequestering carbon emissions from the world's atmosphere as well. So in terms of Schroder's priorities, deforestation is right up there. We've also set out, in our engagement blueprint, our expectations of companies on sustainable food and water and circular economy and pollution as well.

DB: Sarah, that's actually excellent. Andy, anything else to sum this up?

AH: No, I think, I mean, I'm slightly nervous that we've all been a bit bleak and downbeat, which is a real danger when you're talking about topics which are quite so existential. But I think, I mean, the other point that I would make is that whilst we've talked quite a lot today about companies and the exposures the different economies and industries face, I mean, we made the point earlier about it's not just about investing in companies that are having a positive impact. The reality is that the large proportion of the world's companies, the large portion of the world's economies, are having a negative impact. That's why we are seeing nature loss at the rate that we're seeing it. But you flip that around and you look at the opportunities. We talked a little bit earlier about the role and the relationship between nature and climate change. Over the next decade or so, around about 30% of the world's carbon savings or carbon emission reductions that that will need to be achieved to put us on track for Paris goals could come from investments in nature.

Today, that's about 3% of the world's climate finance goes into those nature-based solutions. The opportunity to significantly increase investment, make a real difference in terms of the challenge on climate change and reducing emissions globally, but also the opportunities that come from the increased value that is increasingly being attached to nature in those investments is a real opportunity for our industry, in terms of how do we think about connecting capital to the areas where it's needed most in the world, and there are a few areas where there is a greater need for more investment, for more action, than biodiversity and nature.

Authors

David Brett
Multi-media Editor

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