A few months ago, I published a piece arguing that ESG will become the new bottom line. This is not a politically motivated statement, and I don’t fully agree with the ESG approach. I do believe however, it is time to change, and it is time for executives, entrepreneurs, and investors to appreciate we are at an economic and societal transition point. This transition will force us to engage the consumer base more dynamically, while placing greater efforts to decarbonize our business operations. These issues are both good for business and good for society provided companies and investors are willing to take risk and change. Capitalism models should be leveraged to create profits while absorbing the societal problem-solving more systematically. Please note that I have adopted a rather broad definition of ESG in my analysis to ensure I capture the sustainability, clean tech, and climate risk investment trends.
The Carbon Cost
To decarbonize the global economy, and reach Net-Zero, we need to reduce the level at which the greenhouse gases going into the atmosphere are harmonized by their complete removal. Based on the COP26 Climate commitment of 2021, we should reach this level by 2050 if all countries deliver on their commitment. So, what will the cost of Net-Zero be? To reach Net-Zero we will need to invest at least US$ 10 trillion dollar per year between now and 2050. The price tag is clearly very high; however, the cost of unmanaged and unpredictable climate change (based on current business practices) would be much higher as climate events are projected to affect about 20 percent of global GDP by 2040. In the US alone according to the While House, natural hazards could cost the U.S. federal budget about $2 trillion per year, a 7.1% loss in annual revenue by the end of the century. According to Swiss-Re, the European Reinsurance heavy weight, by 2050 climate change could cause $23 trillion in global GDP losses corresponding to 11 to 14 percent off global economic output.
Despite the charged debate around ESG, climate risk and compliance, I believe that decarbonization and ESG represent the biggest business opportunity of our generation. I also believe the transformation has already started, and it will generate more business opportunity and societal change than the internet revolution in the 90s. Let’s look at the number for a second.
Who are the early movers doing?
Credit ratings, consulting firms and financial institutions are acquiring climate risk data analytics firms at an unprecedented speed to bring expertise, analytics, and climate risk knowledge to their clients. These early movers have understood that most firms are unable to perform physical climate risk analysis, geospatial analysis of future climate events, and broader sectoral stress testing and they want to capitalize on the future opportunity.
Entrepreneurs are also making big bets on the future of green-growth, and they are creating Unicorns at breaking neck speed. There are currently 43 private, $1b+ climate tech companies within the 1000 global unicorn club (energy, mobility and agribusiness are the key sectors to watch). These Green startups are growing faster than their conventional competitors, and they are taking an average of 4 years to reach Unicorn status, as opposed to the 7 years for startups in other sectors. Additionally, green start up are less affected by current market conditions provided adequate leadership is in place
On the financial sector side, asset managers, investment funds and pension funds are pouring billions of dollars towards ESG as they know the regulation changes will make disclosure and reporting compulsory. They are also making very lucrative fees in promoting ESG investments. According to Morningstar the asset-management industry earned $1.8 billion in fees last year from their sustainable funds, up from almost $1.1 billion in 2020. Asset managers are now convinced there is an untapped market potential, and they want to de-risk their operations while riding the sustainability wave. Assets are expected to reach $41 trillion by the end of 2022 according to Bloomberg and the growth will come mostly from the US and the EU where the regulation is catching up fast. Total ESG investment is expected to reach $50 trillion by 2025. This means that every $3 there will be $1 invested in ESG globally.
Most dealmakers and investment professionals are now accepting that all investment due diligence going forward needs to have an ESG and climate component. Additionally, investor scrutiny of climate risk is rising fast, and consumers and employees are demanding products and services that are green and socially sound. Investment committees are no longer approving investments without a gender balanced team and without clear climate disclosure and transparency. This will make fund-raising tougher if you are in the market for capital and you don’t have an ESG strategy. In other words, expect ESG and climate compliance to grow rapidly with the Central Banks and the stock markets regulators becoming the guarantor of climate regulation enforcement.
ESG requirements, will force companies and financial institutions to disclose their societally, corporate, and environmental credentials more systematically. Those companies that adjust early and accept the challenge will benefit in terms of revenues growth, market leadership and talent acquisition. As we start seeing stronger positive correlation between ESG, and financial/business performance, ESG and climate friendly investments will become the norm as they represent the best way to profit.
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