Untangling the knots in ESG
Making sense of the latest trends in property and economics from around the globe
5 minutes to read
The ESG-movement upended many of capitalism's norms.
It was once a commonly-held view that a company's core purpose was to maximise value for shareholders. It was then the job of regulators to ensure that companies pursued that mission without causing undue damage to society.
The rise of purpose-led investing led to a rapid push to go beyond regulatory requirements. While some view this as admirable, it has fuelled political tension - most notably in the United States where issues like the climate transition are highly politicised. Republicans are galled by the idea that so-called 'woke' asset managers can invest billions of dollars in voters' pensions with their own ethics in mind, rather than simply seeking to maximise returns within a set of rules drawn up by regulators that serve democratically elected officials.
Making brown firms browner
Setting the politics aside, there were always going to be risks associated with the rapid introduction of a new investing framework. Markets can be counter-intuitive, after all.
Research suggests that raising the cost of capital for high emitting activities like coal-mining, for example, actually speeds up those activities. Companies with a higher cost of capital tend to focus more on the short term - they extract as much coal as possible in as short a time as possible - rather than plan for a coal-free future like a company with a lower cost of capital might. "Sustainable investing that directs capital away from brown firms and toward green firms may be counterproductive, in that it makes brown firms more brown without making green firms more green," academics Samuel Hartzmark and Kelly Shue said in a November paper on this issue.
These flaws extend across high emitting industries, including finance, real estate and construction. Banks are under pressure to ditch polluting customers, which makes it harder for them to transition to net zero. Asset managers are under pressure to divest assets that are not considered green from a reputational perspective, even if the assets in question are consistent with a Paris-aligned emission trajectory. Property developers might like to retrofit existing buildings to improve energy efficiency, but there isn't the low cost finance available that matches the high up front capital requirements required to do the work.
Transition finance
I have taken the latter two examples from the Transition Finance Market Review, which yesterday launched a call for evidence as to how "the UK can become the best place in the world to raise capital, invest and obtain financial services to facilitate a transition to a net zero future."
The call for evidence acknowledges that greenwashing concerns have led to suggestions that transition finance should not cover certain high emitting sectors, "however transition finance, almost by definition, needs to include high emitting sectors, such as being applied to reduce emissions in a just and equitable manner, including by early retirement of assets. Exclusion of sectors may encourage rejection of the need for substantive transition."
It's an effort to bring order to an ESG-investing industry, that risks being pulled apart by its own contradictions. Fortunately, our ESG lead, Flora Harley, offers a timely potential solution in her latest note, which you can find here here.
A chill wind
Renewed uncertainty as to the timing of interest rate cuts sent a chill wind through the UK residential market.
Metrics covering agreed sales and near-term sales expectations in February's RICS Residential Market Survey softened a little, though both are running at a much improved rate relative to the past twelve months. Borrowers are switched on to what's happening in the mortgage market so news that a few major lenders have notched up rates feeds through quite quickly.
The outlook remains robust. Near-term sales expectations posted a net balance of +6% (anything above zero indicates an expansion relative to the previous month). That metric rises to +42% over the twelve-month time horizon. New buyer enquiries posted a net balance of +6%, identical to last month's reading and the second successive expansion. House prices continue to stabilise and are expected to return to growth over the course of the year.
Rate cuts
The trajectory of mortgage rates remains broadly flat. Repricing is being driven by volatility in the swaps market and a desire among lenders to avoid being inundated while they are the cheapest on the high street - colleagues at Knight Frank Finance have reported phone line queues of as many as 1,500 brokers attempting to secure rates for customers before they are withdrawn at short notice.
Policymakers at the Bank of England are understandably wary of cutting rates too early. The UK economy is probably already out of recession and the surprise strength of the housing market doesn't align with an economy cracking under the weight of elevated borrowing costs. "The recovery in growth and a recovery in the housing market suggests interest rates might not be quite as restrictive as the BoE has been assuming which means they might have a little less room to ease," Rob Wood at Pantheon Macroeconomics told Reuters yesterday. Policymakers must also consider April's minimum wage increase.
Still, all but three of 68 economists surveyed by Reuters between March 11th and March 14th expect at least one rate cut by the end-September (the piece is linked above). A firm minority of around 40% said the first cut would come as soon as the next quarter. Median forecasts showed the base rate at 4.75% by the end of September and exiting 2024 at 4.50%. It will then steadily fall to finish 2025 at 3.25%.
Buyers have taken a quick pause for breath, but there is a real sense now that people are eager to push on with moves that were iced while conditions were more volatile. This is perhaps best reflected by the RICS gauge of new instructions to sell. That net balance hit +21% in February, which is the strongest expansion since October 2020. Average stock levels on estate agents' books is running at the highest level since February 2021. Respondents also noted an increase in the number of market appraisals in the past month, suggesting we will see more supply available in the coming weeks.
In other news...
Just 10% of levelling up funds have been spent (Committee report), Blackstone says it's time to buy (Bloomberg), and finally, what is causing the growing divide in the US property market? (FT).