Spotting the opportunities in sustainable investment

By Cornelia Andersson
Group Head of Sustainable Finance and Investing, LSEG Data & Analytics

Sustainability is transforming the global economy. The green economy[¹] now represents 10% of global listed market capitalisation, larger than the energy and retail sectors and is fast becoming a significant strategic growth opportunity for investors, banks and corporates. And, whether driven by customer demand, regulatory developments or the materialisation of sustainability risk and opportunity, sustainable investment in becoming a central consideration for the investment community, evidenced by 80% of asset owners stating they implement or evaluate sustainability considerations in their investment strategy[²].

But for investment managers and asset owners, the resulting demand for new product ideas and the need to respond to regulatory mandates poses challenges.

As the sustainable investment opportunity set broadens and deepens, we are seeing growing demand among our client base for products and services that help them respond to climate risk, address regulatory requirements relating to sustainable investment, and understand and capitalise on growth in the emerging green economy.

Climate risk rises up the agenda...

Last year saw climate records broken around the world – with extreme weather events wreaking destruction in their wake. This is triggering a greater response from policymakers, with fossil fuel phase-out on the agenda at COP 28 and efforts to grow the green economy bearing fruit.

Nonetheless, according to our latest Net Zero Atlas report, G20 climate change policies to 2030 are putting the world on a trajectory for a 2.6°C temperature rise – well above the 1.5°C goal of the 2015 Paris Agreement.

The Net Zero Atlas analysis uses LSEG sovereign climate data, designed to bring sustainability to fixed income investing.

Beneath this headline figure lies a wide spectrum of corporate responses, with some companies moving more quickly than others to prepare for a net zero future and manage their exposure to climate risk.

A deep-dive into trustworthy corporate climate data is often needed to examine companies' preparedness for a net zero future. Last year, we launched our Climate Data Package, which provides almost 900 climate metrics for more than 18,000 companies worldwide. It includes company reported and derived data that is both historic and forward-looking, allowing investors to come to their own view on corporate climate risk.

Addressing climate risk at the source

Even companies on a pathway to net zero continue to face climate risk. For most, it will take time to decarbonise business models and deploy the necessary low-carbon technologies. Many of them plan to purchase carbon credits to offset residual or unavoidable emissions, but are struggling to source long-term streams of reliable, high-quality credits in the largely unregulated voluntary carbon market.

On the supply side of the market, project developers are struggling to attract capital at scale, given gaps in carbon pricing and investor concerns about transparency and governance.

The London Stock Exchange's Voluntary Carbon Market (VCM) designation aims to meet the needs of both buyers and sellers. Funds or operating companies listed on the Main Market of the London Stock Exchange (LSE) or on AIM are able to apply for the VCM designation, if they fulfil certain criteria, including around environmental integrity and disclosure. Because they are listed, VCM-designated funds and companies fall under the London Stock Exchange's market oversight rules, giving their investors reassurance.

LSEG also offers access to real-time market data, news, and analysis, helping you to understand carbon markets.

Regulatory pressure builds

Greater investor interest in sustainable investment has encouraged regulators to become more active in their oversight of this part of the market. Policymakers are also using regulation to encourage capital flows in support of their climate change and green economy priorities.

For example, the EU's Sustainable Finance Disclosure Regulation (SFDR) has imposed requirements on fund managers to raise their levels of disclosure around sustainability and their incorporation of ESG factors.

Meanwhile, dozens of jurisdictions are following in the steps of the EU in defining taxonomies outlining which economic activities can be considered 'sustainable'. While these taxonomies share some characteristics, most are also tailored to the specific preferences of the jurisdiction, creating complexity for investors.

We are helping our clients to navigate this complexity with trusted regulatory data solutions. We capture the Principal Adverse Indicators that underpin the SFDR within our Lipper funds database and within our company profiles. We have also partnered with Clarity AI to create an SFDR reporting tool to enable investors to create ready-to-use SFDR reports for compliance purposes.

Meanwhile, our EU Taxonomy solution captures company disclosures under the Non-Financial Reporting Directive and the FTSE Russell Green Revenues model, which measures corporate exposure to the green economy. This allows investors to identify and report on the percentage of their portfolios aligned with the objectives of the EU Taxonomy. And, in turn, it enables investors to identify exposure to climate transition risks and opportunities.

The green economy opportunity

Investors who navigate the evolving regulatory environment effectively will be well-positioned to capitalise on perhaps the largest investment opportunity of the 21st century: the transition to a sustainable economy.

However, within this opportunity set is the challenge of identifying those companies that are exposed to this megatrend. The green economy incorporates a surprising range of economic activities – ranging from IT solutions to water infrastructure, from sensors to sustainable agriculture, from environmental consultancies to advanced materials. What makes this challenge greater is that relatively few companies identify their revenues in line with a green economy categorisation.

That is why FTSE Russell has been tracking green economy revenues, and publishing an index based on green economy exposure, since 2008. The Green Revenues data is now available on LSEG Workspace, allowing a range of users to access the data required to identify and quantify balance sheet exposure to environmental impacts.

We also use this dataset as the basis for the London Stock Exchange's Green Economy Mark. This allows listed companies and funds that derive more than 50% of their revenue from the green economy to identify themselves as green stocks, helping to attract capital from investors focused on the theme. Last year, more than 112 companies and funds received the mark, bringing the total market capitalisation it represents to £172bn.

As our Asset Owner Survey found, fixed income is the leading asset class for sustainable investment allocation, with 44% of respondents incorporating sustainability considerations (compared with 37% in public equities and 29% in private equity).

In the past, equities have received more attention from sustainable investors. This is changing. The growth of the sustainable bond market has provided a means for issuers – whether corporate, sovereign or agency – to raise capital to fund sustainability initiatives. The London Stock Exchange's dedicated Sustainable Bond Market helps to bring investors and issuers together, offering a wide range of opportunities for green, sustainable and social bonds. It has over 500 bonds now active - supporting over 128 issuers in 41 countries and 6 continents, raising over $280 billion in 17 currencies.

Solving investors' and issuers' sustainability needs

The pace of change in capital markets continues to increase, and sustainable investment is no exception. Regulatory attention, client demand and increasing societal focus on sustainability are combining to drive focus towards sustainable investment.

LSEG is dedicated to enabling our customers to create sustainable growth. Our suite of products and services can help you mobilise capital for sustainable objectives, identify opportunities in sustainable investment, and meet your regulatory obligations.

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Footnotes:

[1] Based on FTSE Russell Green Revenues Classifications System
[2] FTSE Russell Sustainable Investment Asset Owner Survey – 2023