ESG is a broad area, covering e.g. equality issues, human rights and the environment. The elements are value-laden and there is no reasonable way to determine which ESG issues are more valuable than others. However, I think it is worthwhile for investors to follow at least two ESG areas. The first is climate targets set by the company and the second is the polarized taxonomy percentage. Interesting in climate goals is how the company intends to achieve its goals. The key for taxonomy is to understand why the taxonomy percentage reported by a company is at its current level, how the figure develops over time and what effects the taxonomy will have on the capital markets in the future.
Climate goals bring costs as well as opportunities
With regard to climate goals, it is essential for the investor to understand the costs and possible business transformations that are necessary for a company to achieve the goals. Reducing emissions from production facilities, logistics chains, product use or subcontracting does not happen in the blink of an eye. At best, measures to reduce emissions can lead to a competitive advantage. At worst, failure to plan measures adequately will result in unexpected costs and slipping from emission targets.
In addition to climate goals set by the companies themselves, legislation and policy decisions will also have an interesting impact. For example, the expansion of the emission trading system, which has just taken a step back in the EU but continues to be under preparation, as well as carbon tariffs, would affect more and more industries directly or indirectly. It is important for the investor to understand whether and when the legislation or achievement of the set objectives have financial implications on companies. It is also important to understand whether climate change itself has concrete physical effects, for example, in terms of the risks associated with the location of production facilities. A value-based investor is naturally also interested in whether a company's climate work has a relative environmental impact and whether the company stays within its goals.
Taxonomy provides a framework for the debate on sustainable products and investments
In case of the taxonomy percentage, it is essential to monitor the development of the figure and the description built around taxonomy as to why the number is what it is. Taxonomy describes the turnover from, as well as OPEX and CAPEX allocated to so-called sustainable activities The EU defines the solutions and products eligible for taxonomy. The EU aims to channel capital into sustainable activities, such as renewable energy. Taxonomy plays an increasing role in, for example, ESG funds. It remains to be seen what sort of role taxonomy will have when broader ESG-related policies are built. The list of sustainable activities is still in its infancy, politicized and incomplete. There has been debate around the fact that, for example, nuclear power was not originally on the taxonomy list. Eventually, certain types of nuclear power plants were added to the list. Regardless of how the list is built, the taxonomy provides, however, from an investor’s perspective, a framework with which companies can clarify the sustainability of their product portfolio, or the market potential in a low-carbon society. I do not see a situation where a complete global list of activities that promote sustainable development would exist. A list that would give an indication of whether the companies' products would succeed in a market that requires more environmentally friendly operations. The taxonomy is the initial version of this type of a list, and as such allows the company to open up the sustainability of its products, and the investor to assess the sustainability of the products and thus the growth potential. The impact of climate change on companies’ business is undisputed. For investors it is essential to know how and when climate work and climate goals prevent various risks associated with climate change and, on the other hand, what sort of business opportunities will arise. The development of the taxonomy percentage and the description built around it provide a pale indication on how sustainable the company’s product portfolio is. From the point of view of risk management and return potential, the development of both areas is already worth monitoring, at least occasionally.
The author of this article, Karoliina Loikkanen, is head of ESG solutions at Inderes. She has an extensive background on ESG issues and is passionated to develop the dialogue between investors and companies on ESG further.