ESG explained, 7 essentials you need to know
ESG is the use of environmental, social, and governance factors to inform investment decisions.
ALIGNING INVESTMENTS WITH VALUES
In a fast-changing world, sustainability is a growing concern for our clients. Many investors have twin goals: to generate returns, and to do so in a way that aligns with their values.
We are committed to incorporating the management of risks associated with environmental, social and governance (ESG) factors across our entire investment platform. For investors who want to express their values explicitly in their portfolios, we offer a broad range of sustainable investment capabilities.
But let me start by talking a little bit about sustainability. It's not a new terminology to us anymore. But it has swept away conventional thinking in investment management, and it has created a new wave of capital that is seeking to both do well and do good. If you look at the last decade, our industry has gone through incredible transformation-- the barbell investment with passive investing and a shift to alternatives, robo-advisory and digitization of portfolio delivery, and more recently, the focus on environmental, social, and governance.
Some people call ESG a fad. Like many other things that we have seen in our time in the financial industry, that this too shall pass. But I'm sure you would agree with me that ESG is more than just a name that we use to label a fund. ESG is about reorienting the core focus of investment, to go back to the basics and ask the question, what makes a company successful?
ESG is about aligning the capital market to the real economy, looking at issues such as, what would happen to a company sales as a result of bad reputation? And one of the most important phenomenon that's changing the basics and having a real impact on the real economy is climate change.
We hear so much about it. We have young people in the street protesting trying to raise awareness. We now have politicians waking up to the fact and putting together measures to fight against climate change. But what's surprising is that if you unpeel the oranges and you look at how much has changed with the way how professionals invest, as well as how individuals choose what to invest, climate change hasn't really played a critical role, despite the magnitude of its potential impact.
Today, I'm going to challenge the status quo, and I'm going to explain to you why this is fast changing. I will walk you through tangible risks and opportunities that are shaking the foundation of our investment views.
So let's start by a few facts. Last year, there were about $14 billion climate related disaster events that took place in the United States of a total cost of $45 billion. In 2003, less than 300 companies around the world report on GreenHouse Gas, or what we call GHG emissions data. Today, more than 8,000 companies around the world report that data voluntarily.
So as you can see, we're at a junction whereby the capital market is finally getting to align to the real economy. And why is that important? As we all know, capital market and its behavior is not determined by some unchanging physical laws. As you all know, stock market behaves just like our mutating economic and social conditions as a reflection of investors' expectations. And climate change is that one thing that is changing those expectations and conditions in such a fundamental way that we cannot ignore it anymore. And it does that through four specific ways.
First of all, physical climate change. Some assets will be forever written off because of natural disaster. We already saw earlier how much it's costing our economy and, potentially, someone's retirement savings. Secondly, technology advancement. New technology will replace old ones once the price is right. And we're not just talking about electric vehicles, renewable energy, we're also looking at heat resistant crops, carbon efficient steel making. All sectors will go through transformation.
Thirdly, regulations and policy. In Europe, this is the biggest thing that we're living through. And it's not just Europe. If you look at the cross-border carbon tax and how that's going to impact companies who operate at a global scale, companies will start to ask questions about who their suppliers are outside of Europe and how energy efficient they are. And last but not least, changes in societal norms. Consumer behaviors are changing, and so are retail investors. This will have an impact on company sales, as well as how capital flows.
So now let's dig a little deeper into one of those four pillars that I just described-- regulations and policy. Globally, Europe is clearly leading the charge with its first climate change climate law, European Green Deal, commitment to really achieve and pursue a net zero emissions target that is trying to keep the temperature rise at below 1.5 degrees Celsius. In the financial market, we have the EU climate benchmarks that is helping to define the parameters of climate transition and Paris aligned investment strategies.
But as I mentioned earlier, it's not just about Europe. We're starting to see new emerging proposals coming out of other parts of the world. In the US, for example, in the upcoming presidential election, one of the candidates has announced a $2 trillion package to fight against climate change. In Asia, regulators and policymakers are racing to catch up with their counterparts in Europe.
Stock exchanges in Hong Kong, Shanghai, Japan, and Taiwan are now starting to make disclosure of ESG information, including climate data, mandatory for companies. And what this means is that since most companies now operate at a global scale, if there is any change in regulation in one part of the world, that is going to impact the profit and loss of the companies.
So now that we know how climate change is changing the conditions and expectations of the real economy and the capital market, the question is, what do we do? And how should we think about it as part of investment? Is climate change all about risks? Well, the good news is that climate change is more than that, it is also about opportunities. And this is why it's very important when you combine climate change with investment, it's not enough to only focus on screening or excluding companies and sectors.
So the question is, what do we do then? Today, I would like to introduce to you two pieces of research that we have done this year at JP Morgan Asset Management to translate climate science into investable solutions, so that we can help our clients to preserve their capital and generate better return. As you all know, the two cornerstones of investment management are asset allocation at the top level, and then stock picking to build a portfolio with a bottom-up approach. Our research shows that climate change needs to be a core part of both of these approaches.
So let's start off with the top-down view looking at macroeconomic impacts by climate policies. As we know, that to respond to climate crises, policies are key. And there is growing momentum for ambitious policies in many countries around the world. What is really important for us as investors to think about is, what would policymakers do to determine who's going to bear that cost?
In order for us to analyze the impact, we looked at the wide range of policy options, including carbon tax, carbon credits, an emissions trading scheme, new environmental standards, as well as green subsidies. We also incorporated notable pathways and scenarios, such as the forecast policy scenario developed by the United Nations PRI, to better understand the trajectories of the different options.
The question that we're asking is, what is the impact on macroeconomic as a result of these different policies by 2030, which is around 10 years-- less than 10 years from today? What we have found is that it really depends on the decisions that policymakers will make, and that investors should pay attention to those decisions.
So if the policymakers decide to take, what we call, sticks approach, what that means is that businesses will have to comply with new environmental standards and pay carbon tax, this will decrease global GDP by about 1% by 2030. However, if policymakers decide to take a carrot-based approach, which includes subsidies for renewable energy, investing in green R&D or infrastructure, global GDP will actually increase by 1% by 2030.
What we know for sure is that it's not going to be enough to focus on just one or the other. Policymakers need to ensure that we reduce our reliance on fossil fuel and grow the economy in less carbon intensive ways. So like I mentioned earlier, at the aggregate level, the impact on global GDP may seem limited. What's very important for investors is to look at the differences between country, as well as within sectors. Because depending on where your assets lie, it could actually make a huge difference.
So we did that analysis by looking at regional level, sectorial level, and company level. So at the regional level, countries such as Russia, Australia, Canada, South Africa, India, and Brazil are likely going to be the hardest hit by the transition to a low carbon economy. But as you can see, there is a big difference between these countries, especially with regards to physical headroom and the capacity to raise debt to alleviate short term pain.
As a result, we believe that Australia and Canada will be able to weather the storm with much more ease than countries such as Russia and South Africa. At the sector level, there is going to be clear winners, such as renewable energy and green infrastructure. And when it comes to subsector level, energy, consumer cyclicals, utilities, and materials will be most impacted.
And it's very important for investors to dig deeper and look within these heavily impacted sectors. For example, we found that there is great diversions within the oil and gas sector, whereby you have companies that are embracing clean technology and future proofing their future business model, whereas some of the companies are not. And that difference is now being captured by the market.
So the bottom line is that while at the aggregate level in the near term, the impact on macroeconomic may seem limited, it is very important for investors to focus on differences between countries and sectorial differences. Because we believe that by moving in early, before climate related risks and opportunities are fully priced in by the market, investors can gain potential return as the prices continue to adjust.
Now let's turn to the micro-level. So how do we know which company is going to win, and which company is not going to be doing so well? Well, we already know that it's not just about one or two sectors. What we need to understand is, how do we identify winners across all sectors in a systematic way? So unlike many conventional low carbon transition framework, we go beyond carbon intensity and GHG emission. We develop a three pillar framework that allows us to be able to identify companies that will truly benefit from the transition.
So in our first pillar, we think about going beyond just carbon intensity and GHG emissions because we believe that it's not enough to only focus on companies who have low carbon emission today, or even have plans to reduce their emission tomorrow. The missing part in the equation is opportunity. For example, who are the companies that will actually produce the technology and products that will help other companies to reduce their carbon emission?
If we take a look at steel and cement, these two industries emit a lot of greenhouse gases. But the technology that they need may very well come from other companies in another sector-- for example, carbon capture and storage. And this is what our pillar one on emissions production and management is all about, focusing on the critical technologies that's going to be required for a low carbon transition. In addition to that, we also believe that it's very important for companies to look at their consumption of natural capital in a more holistic way, including electricity, water, and waste.
You may want to ask, why is water important for low carbon transition? Well, an energy company may be regarded as a winner if it continues to invest in solar power plants. As we all know, water is very important for solar power plants for cooling purposes. Therefore, if this company is not focusing on enhancing its water recycling efficiency, and it happens to situate in a location whereby there is going to be a lot higher water scarcity risk, our research may not regard this company as a winner.
To capture all of these information into one place is not easy, especially if you look at our final pillar around risk management whereby we want to understand, in addition to climate risk, such as coastal flooding and extreme heat, what are some of the other reputational and regulation related risks that companies may face?
We tapped into data science and leveraged our proprietary [INAUDIBLE] algorithms to help capture some of those really important signals. And they may include things like green patents, green capex that a company has, as well as Paris aligned transition plans and commitments. So with this framework that goes beyond just carbon intensity and GHG emissions, we are able to truly identify companies that will benefit from this transition across all sectors. And that is why I would like to share with you some of the highlights from our recent climate change research. And we would love to share more with you about.
Now, as you can see, climate change is creating lots of challenges for investors. The good news is that, on the other end of the challenges, there is a great opportunity. We know that this is still a space that continues to evolve. We are doing everything we can to understand the science and translate that into investment solutions, but we believe that there are some concrete steps that investors should take today. And we at JP Morgan Asset Management is actively incorporating those new research and insights into the way we manage portfolio and make decisions for investors.
We do that in three specific ways. Number one, ESG integration. As mentioned earlier, 2.1 trillion of our assets are regarded as ESG Integrated. And what that means is that climate change is part of the research that's conducted by our 200 plus analysts around the world. Innovative investing solutions, we're building new solutions to help our clients to decarbonize their portfolio and gain exposure to new investment opportunities arising from the transition to a low carbon economy.
Finally, investment stewardship. Climate risk disclosure is one of our five global investment stewardship priorities. We engage with companies whereby there is significant and material climate related problems. Earlier this year, we joined Climate Action 100+ to partner with other institutional investors on this very important topic.
Now this is your chance to challenge the status quo because climate change is real. Climate change is the paradigm shift of our century. It brings significant risks to our society. But it's also creating an unprecedented opportunity for us to invest for the long term and prosper. That objective, I believe, is top of mind for you and your clients. We at JP Morgan Asset Management are here to help you on this journey. Thank you very much.