Net Zero, or achieving sweet-zero?

In the wake of COP27, it is clear that the centrality of ESG, which is more prevalent in European markets, has slipped down the global agenda in favour of more immediate existential threats.

Jonathan Jay Co-founder of Conduit Real Estate, a UK and European debt and special situations capital advisory business established in 2020. Jonathan previously worked for a London-based pan-European investment manager and was responsible for capital raising across their equity and debt strategies, as well as debt origination on behalf of a sovereign wealth fund.

Jonathan holds an MPhil from the University of Cambridge and a BSc from Johns Hopkins University.

Hyperbole and misrepresentation haven’t helped the cause. At HSBC, Stuart Kirk, who was global head of responsible investing at the bank’s asset management division, was suspended after accusing central bankers and policymakers of overstating the financial risks of climate change in an attempt to “out-hyperbole the next guy”. Even the most high-profile campaigners have been accused of greenwashing by the use of carbon accounting tricks: Financial Stability Board Chair, Mark Carney, was forced to row back after claiming that his new home Brookfield was Net Zero. A report by EDHEC Business School concluded that so far institutional shareholders had “not reduced in a meaningful way their investees’ carbon footprint”. Ironically, before the 2021 introduction of Europe’s anti-greenwash rulebook, the Sustainable Finance Disclosure Regulation, asset managers in the region removed the ESG label from $2 trillion worth of funds, according to the Global Sustainable Investment Alliance, fearing their funds would not meet the criteria.

Like others in a growing chorus, we have long been sceptical of the ESG mania, “which often looks more like a new way to flog old underperforming products at a higher price point with little-to-zero discernible actual impact on the world’s pressing issues.” This chaoticism is exemplified by Elon Musk who recently tweeted: “Exxon is rated top ten best in the world for environment, social & governance (ESG) by S&P 500, while Tesla didn’t make the list! ESG is a scam. It has been weaponized by phony social justice warriors.”

The sheer scale of the response from the financial industry for ESG products (the United Nations-supported Principles for Responsible Investment says signatories have $121 trillion of assets under management) would suggest investment is making a huge contribution to making the world a better place, but sometimes ESG investing distracts everyone from the work that really needs to be done and investors should not fool themselves that their investment decisions will make much di erence to the world. Fundamentally, not investing in fossil fuels does not reduce their usage and incurring increased costs to pay higher wages or reduce their carbon footprint are just likely to lose companies their customers. The far more e ective way to achieve environmental objectives, they argue, is to use taxation and regulation. As the CEO of Patagonia, Ryan Gellert, entreats to end the “corporate doublespeak”, hold companies and our elected leaders accountable and to work collaboratively.

The scale of the change required by the built environment to reach net zero was laid out in research by JLL into decarbonising cities. In their survey of 32 cities, buildings accounted for 60% of overall emissions and over 70% in some of the large business centres. CBRE Investment Management estimate that 60-75% of non-residential real estate stock across Europe is in need of refurbishment to comply with EPC B standard, representing a stock of debt of an estimated €720-900bn, of which approximately half (€360-450bn) will be O ce, with an estimate capex requirement of 22% of asset value.

There is a question over how the cost of all stock meeting these targets be financed? Owners of such buildings requiring financing for such conversion may need to rely on non-bank lenders as bank capital requirements (Slotting, Basel IV) penalise such projects. Ironically regulation designed to stop the last financial crisis is preventing banks from tackling the current climate crisis.

The sheer scale of company commitments to ESG commitments means that it is essential that there is an alignment to the actual objectives. For example, to meet their pledge to be net-zero carbon by 2040 Amazon has ordered 100,000 electric vans to deliver packages. However, a typical EV battery contains twenty-five pounds of lithium, sixty pounds of nickel, 44 pounds of manganese, 30 pounds cobalt, 200 pounds of copper, and 400 pounds of aluminium, steel, and plastic. Inside are over 6,000 individual lithium-ion cells. To manufacture each EV auto battery, you must process 25,000 pounds of brine for the lithium, 30,000 pounds of ore for the cobalt, 5,000 pounds of ore for the nickel, and 25,000 pounds of ore for copper. All told, you dig up 500,000 pounds of the earth’s crust for one battery.” “Going Green” may sound like the Utopian ideal but when you look at the hidden and embedded costs realistically, Going Green may actually be more destructive to the Earth’s environment.

According to analysis by PIMCO, between 2005 and 2018, ESG was mentioned in fewer than 1% of earnings calls. By May 2021 it was mentioned in almost a fifth of earnings calls, after a surge in prominence over the pandemic. We really are still at the starting line. We believe greater traction will ensure a renewed focus on the commercial benefits of ESG for investors. McKinsey highlights that new sources of revenue will be created for the decarbonization of real estate, which will attract a significant proportion of the capital that has been committed to net zero and the thousands of tenants that have made similar commitments. According to a new report, early-stage investment into energy retrofitting technology has grown at a compound annual rate of 55% over the last 4 years, totalling $4.7bn+.

The histrionics around ESG misdirect from the crucial issues underpinning the need for e ective implementation of carbon o set and retrofitting strategies that are so urgently needed, but less spoken of.