Take Five: New Model, New Hope
A selection of the major stories impacting ESG investors, in five easy pieces.
An innovative instrument issued by the World Bank this week offered investors an opportunity to profit from patience.
Outcome-orientated finance – This week, the World Bank launched a “new model” for private investment in sustainable development, with its first Amazon reforestation outcome bond. The US$225 million nine-year principal-protected transaction – the World Bank’s fifth outcome bond since 2021 – will remove carbon from the world’s largest rainforest by replanting native tree species in degraded areas. It is also designed to enhance biodiversity and foster socioeconomic development in local communities. Investors will forgo a portion of their ordinary coupon payments but stand to gain from the generation of high-quality carbon removal units (CRUs). The innovation comes partly from linking returns to carbon removal rather than the sale of carbon credits from avoided emissions. It also comes from the World Bank using its AAA credit rating to funnel US$36 million of private investment to Brazil-based Mombak, which will work with local landowners, partnering or buying land to realise the projects that deliver the CRUs. Microsoft, which recently admitted to higher-than-expected emissions, has already agreed to buy carbon removal credits from Mombak, representing an anticipated 1.5 million tons of carbon removed from the Amazon rainforest. If the firm’s projects generate high-quality CRUs, coupon step-ups over the life of the bond could offer investors a yield of 4.362%, well above the 3.928% currently offered by comparable nine-year US$-denominated debt issued by the World Bank. Strong demand came from US and European asset managers and pension funds, with Sweden’s Velliv Pension saying the deal goes “hand in hand” with its climate, biodiversity and social objectives. Is this the start of a new market? The World Bank certainly hopes so, but the bespoke nature of the deal could make its structure hard to replicate. The bigger challenge for other multilateral development banks may be unearthing the foundational commitments that bring in the very large investments needed to deliver more transformational deals, i.e. – well north of US$1 billion.
Known unknowns – Anyone concerned about the future of the US Inflation Reduction Act (IRA), which marked its second anniversary this week, would have paid close attention to Republican presidential candidate Donald Trump’s interview on Monday with Tesla, X, and SpaceX boss Elon Musk. The prospect of Trump returning to the White House has prompted considerable speculation about whether the IRA’s support for clean energy investments could be curtailed or reversed after 5 November, alongside other likely changes to climate-related policy and regulation. But there was no mention of the IRA in almost two hours of conversation, which offered precious little heat nor light on wider policy either. Indeed, there was more consensus than one might expect between the president who took the US out of the Paris Agreement and the entrepreneur who made his name disrupting the fossil fuel-addicted automotive industry, with both falsely claiming time is on our side in the fight against climate change. Musk’s endorsement of Trump may have less to do with his antipathy to Chinese electric vehicle imports than with other expected elements of the former president’s economic platform – including lower taxes for him and his businesses, and reduced levels of social media regulation. While his party’s wider anti-ESG agenda is hitting some bumps in the road – a federal judge this week struck down efforts by Missouri’s attorney general to limit ESG investment advice – the impact of a second Trump presidency on sustainable investment remains worryingly unclear.
Big tech break-up – Musk may well be right to worry about increased regulatory restraints on his social media platform, but for now, the US judiciary and regulatory systems have bigger fish to fry. After a judge ruled that big tech behemoth Alphabet had acted illegally to protect its Google search engine franchise, media reports this week listed the forced sale of its Android operating system or web browser Chrome among the remedies being considered by the US Department of Justice. Other measures might include data sharing with competitors or actions to prevent similar monopolistic developments in AI – the latter seeming highly likely given the antitrust cases being brought against Apple, Amazon and Meta, all big rivals in the nascent sector. As they prepare their cases for defence, the giants of big tech face mounting social and governance issues at home and abroad. AI-related regulation is developing apace globally, including guidance on its use in the finance sector, while legislation against online harms is having an impact in the EU and UK, and the influence of social media on democratic processes is under scrutiny in many countries in this unprecedented year of elections. Which brings us back to Musk, who ran into a row with the UK government after his comments on recent riots. In this context, cosying up to Donald Trump may not be enough to protect Musk or any of the other social media moguls from more challenging operating conditions ahead.
A sustainable merger? – One sector already responding to tough times is consumer foods, which are expected to witness a wave of M&A deals in the wake of privately owned Mars’ US$35.9 billion purchase of Kellanova, the Pringles-to-Pop-Tarts manufacturer spun off by parent Kellogg’s last year. The transaction, partly influenced by revenue inertia in an industry hit by high inflation, has both ESG drivers and outcomes – albeit the latter are hazier than the former. The deal will reduce Mars’ reliance on confectionary sales, which are vulnerable to consumer trends towards healthier options, and shield it from regulatory moves – from sugar taxes to increased labelling on nutritional content. Kellanova’s portfolio might not be the healthiest, given the high salt content of some of its brands, but its strong position in cereals and reach into Latin America and Africa have delivered strong results and promise future diversification for Mars. Further, all firms in the sector are concerned about the impact of faster adoption of weight-loss drugs that suppress appetite. According to AI-assisted analysis by Neural Alpha, the future ESG profile of the merged firm is harder to identify – albeit only partly due to lighter reporting requirements on family-owned Mars. The ESG solutions provider notes that Kellanova will diminish Mars’ exposures to Russia’s invasion of Ukraine, as the firm exited the former fully in July 2023 – but is substantially less transparent than its acquirer when it comes to reporting on the deforestation impact of its cocoa-sourcing processes.
Tough transition – If we’re talking about sectors with strong sustainability challenges, few face a harder net zero transition journey than steel. This week the UK government released “emergency” funding to help employees and supply-chain businesses in South Wales adjust to the long and complex process of Tata Steel switching its UK business from blast to electric arc furnaces. The funding is part of a £1.25 billion public-private transition support package, with around £100 million set aside for skills and local regeneration. The new Labour government previously sought to extend the life of one of the existing furnaces, with negotiations described as being at a “critical” stage. The passions aroused by the partial closure of an industry that has become part of the landscape reflect the difficulties of achieving a ‘just transition’ to net zero. The eye-watering costs have caused many steelmakers to seek to slow down the pace of decarbonisation, but the emergence of new technologies is increasingly making the transformation affordable on both the demand and supply side.
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