The UK is officially set to move from a fossil fuel based energy sector to net-zero carbon, meaning it will be powered by energy sources that produce no man-made greenhouse gas emissions (GHG).
The development of infrastructure needed to enable the switch, as well as policy and technology changes to support it going forward, is just as crucial.
This move from traditional fuel sources to renewable is known as an ‘energy transition’, and while it may seem like a new concept, it’s actually the third time we’ve changed our primary source of fuel. The third energy transition is well underway and gathering pace, but switching to energy generated by renewables is only part of this transition. The development of infrastructure needed to enable the switch, as well as policy and technology changes to support it going forward, is just as crucial.
Managing these risks and delivering a gradual transition to a clean, resilient and environmentally sustainable economy is going to be an essential step in delivering a sustainable future. But it hasn’t always been about the future - or has it?
The ongoing energy evolution
Imagine jumping in a time machine and going back to the late 19th Century and finding yourself in the midst of the Industrial Revolution.
The world was busy transitioning from traditional biofuels such as wood and sawdust to coal, driven by the marvel of the steam engine’s introduction. It was about this point in history that investment markets were created, primarily to fund infrastructure through the allocation of capital, and to address concerns that were arising from changes in the world’s manufacturing processes.
It was pretty much all about investing with a long term lens - but if you were to leave the grandeurs of the Industrial Revolution behind and come back to 2020, you’ll find that many asset managers are shifting their focus to the short-term by focussing heavily on generating returns for investors.
That’s not to say that the industry doesn’t care about the long-term future anymore - for from it; in fact as extreme weather events and sustainability issues grip global headlines, responsible investing has quickly become part of the ‘norm’.
A return to a long-term view
A report from Morningstar revealed that in Europe, 290 ESG-oriented open-end and exchange-traded funds were launched in 2018, and assets under management grew 40 per cent over the four years to the end of 2018 to stand at EUR 684 billion.
There were also more than 170 ESG-related regulatory measures proposed globally in 2018, more than in the prior six years combined. There is an increased regulatory focus with a raft of further changes proposed at a European level impacting MiFID II, UCITS and AIFMD, and we also know that there are proposals for asset owners, asset managers and adviser firms to integrate sustainability risk and ESG factors within various processes.
The FCA has also proposed that it is going to mirror the various rules at European level.
We’ve seen new regulations introduced by the DWP for trustees of occupational pension schemes, as well as the FCA confirming that it wants IGCs to report on their firm’s policies on ESG issues for the products they oversee.
Then, of course, there’s all of the various top-down initiatives pushing responsible investment further into the mainstream. That includes the UN Sustainable Development Goals, the Taskforce for Climate Related Financial Disclosures (TCRD) and the UN-backed Principles for Responsible Investment (PRI) to name a few.
It’s clear that regulators and policymakers are using responsible investment and ESG to help inject a long-term focus back into investment activity, but aside from the obvious environmental impact, there is also a financial impact to all of this.
What does investing in a net-zero economy look like?
The transitions from wood to coal and subsequently oil and gas were long-term structural changes.
It’s estimated that Britain’s first fuel crisis, when a shortage of wood resulted in astronomical price inflation and a consequent move to coal, took place between the years 1500 and 1660. Given that the Government’s legally binding commitment to net-zero is a mere 30 years away, phasing out fossil fuels will have to happen at a much quicker pace.
This third transition is happening faster than ever, but this doesn’t mean it will be a straightforward transition. It will be messy, the risk of mispriced assets will be high and active managers will find themselves well placed to take advantage. Advisers not offering a service and proposition pre-fitted with a responsible investment lens could find themselves missing out on this opportunity. Unfortunately, time machines don’t exist - so acting now could be the catalyst for a return to the sustainable future.