Sustainability in 2024: from net zero to a more holistic approach

Author: Virginie Derue, Head of RI Research AXA IM

Even though 2024 is widely viewed as likely to offer a more favourable backdrop for markets and investments in general2, including environmental, social and governance (ESG) related strategies, we believe that whatever the short-term financial performance, it just does not make sense to assume that sustainability and long-term performance cannot go together. We believe that sustainability is – and will be – a core driver of long-term success.

In some geographies like the US, political polarisation around ESG is extreme and it could take some time before this backlash wanes. A shift to the Republican party at this year’s US Presidential Election would certainly not be in favour of responsible investments - Donald Trump has explicitly announced he would scrap the green agenda in the Inflation Reduction Act were he to become President. However, at times when short-term performance can blur the picture in other geographies as well, it is important to remember what the data says. The data supports investments in various sectors, without straightforward allocation or geographical bias as long as ESG risks are adequately tackled and managed.

We believe that facilitating the transition to a lower carbon world is set to draw further attention from both responsible investors and regulators - echoing the call and outcome of last year’s United Nations (UN) climate change conference, COP28. Green investments are of course important, but what needs to be financed is the transition to a greener economy, and particularly investments which support the gradual shift of companies towards more sustainable business models.

However, from an investment perspective there is no market consensus around what could qualify as robust criteria for transition finance-labelled bonds, at either issuer or project level, that would allow companies in ‘brown’ sectors to raise capital to transition to greener activities. In that context, we believe that sustainability-linked bonds could be one potential route for investors to help meet those needs.
This is even more the case as companies in some sectors will have to contend with increasingly stringent emissions reduction policies that will raise operating costs going forward. The European Union’s (EU) emissions trading scheme currently in place - covering electricity, heat generation as well as energy-intensive sectors such oil refineries, steel works and aluminium - will be extended to maritime transport in 2024, and to buildings, road and transport from 2026.

This transition focus will bring multiple potential investment opportunities across many sectors including transportation, housing, food, construction and manufacturing. Infrastructure is also set to benefit amid the drive to treble the capacity of renewable energy - a key COP28 commitment.

Directly related to the transition, and echoing the interplay between climate and nature, we believe the integration of biodiversity and environmental considerations will continue to gain traction in 2024. This is of course supported by the recent release of the Taskforce on Nature-related Financial Disclosures (TNFD) framework, which encourages corporates and financials to disclose their most material risks, dependencies, impact and opportunities related to nature. In terms of engagement, while deforestation is already well integrated by investors, we expect to see greater engagement on water stress, waste and pollution. This will come alongside regulatory developments which will put pressure on companies to reduce waste, plastic packaging and increase recycling.

Investment opportunity: sustainability-linked bonds

Meanwhile, the greater the challenges, perhaps the greater the opportunities for companies to adjust their business models to more sustainable practises, encouraging solution enablers or innovation, that equity investors could potentially benefit from. Within fixed income, we believe that sustainability-linked bonds (SLBs) are a promising segment with regards to biodiversity, with companies in sectors including food and beverage, retail, and metals and mining putting in place targets and key performance indicators (KPIs) around waste and water.

We could still see more sovereign SLBs now that the International Capital Market Association has updated its KPI registry to accommodate sovereigns. More than 190 countries signed the Global Biodiversity Framework in December 2022 – by doing so, they committed to halting and reversing biodiversity loss by 2030, planned for $200bn of conservation financing per year, and will have to submit National Biodiversity Strategies and Action Plans towards meeting these goals. This may lend to future issuance of nature-related SLBs as the UN conference on biodiversity, COP16, in October this year is likely to trigger additional announcements.

This year should also see the food sector rise up investors’ agendas in line with its contribution to environmental degradation and climate change. Regulatory scrutiny will play a role on that front, echoing COP28 which saw 134 countries, representing 70% of the world’s land, integrating food into their national climate plans by 2025.8 This suggests more policies aiming to address greenhouse gas emissions, fertilisers, chemicals and land use in the agriculture sector. The EU deforestation rules which come into effect in late 2024 and which are aimed at banning the import of products that contribute to deforestation will also affect the food sector. Companies will face increasing operating costs to monitor and adjust their supply chains accordingly, while failing to do so will raise multiple risks. These developments bring further opportunities for investors to help finance the transition to more sustainable food production and consumption, targeting various fields such as regenerative agriculture, vegetal proteins development, reduced water use and pollution, as well as greener and recycled packaging and waste reduction.

Although many uncertainties remain for 2024, from economic growth to the outcome of political elections (especially in the US) and prominence of geopolitics, one thing is clear - appreciating the full dimension of the transition is becoming a must, shifting the lens from a climate-only focus to a more holistic perspective including nature, biodiversity and people. On that basis, engagement quality and effective impact are set to be equally scrutinised, as investors increasingly turn their focus away from simply net zero to a more holistic approach.