Global Macro Research Seeking a Sustainable Future an Interview with Sir Ian Boyd, Former Chief Scientific Adviser to the Uk Government on Food and the Environment

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GLOBAL MACRO RESEARCH SEEKING A SUSTAINABLE FUTURE AN INTERVIEW WITH SIR IAN BOYD, FORMER CHIEF SCIENTIFIC ADVISER TO THE UK GOVERNMENT ON FOOD AND THE ENVIRONMENT.

FEBRUARY 2020

R O C R A E M S

O H

• G IAN BOYD

Professor Sir Ian Boyd was Chief Scientific Adviser to the UK Government on Food and the Environment, a post he held for seven years, and is currently a professor at the University of St Andrews.

He previously served as the first Director of the Scottish Oceans Institute and as Director of the Sea Mammal Research Unit. Sir Ian is leading the move to sustainability at the University of St Andrews, chairing the institution’s Environmental Sustainability Board. As marine and polar scientist, Sir Ian spent 14 years leading a research programme in Antarctica and is a recipient of the Polar Medal and the Bruce Medal for Polar Science. He is Chair of the UK Research Integrity Office and a member of a number of other trusts and companies. He originally graduated from the University of Aberdeen with a degree in Zoology and gained his PhD at Cambridge University. He has also been awarded several honorary degrees. He was knighted in 2019 for services to Science and Economics in government.

SECTION 1: Climate change 3 • Why have attitudes to climate change shifted so dramatically? • Where should policymakers concentrate their efforts? • What role does the market play?

SECTION 2: Politics, policy and process 5 • What goes into deciding and setting government policy on environmental issues? • How might the growing focus on environmental issues translate into government action? • What is the role of lobbying, and how do subject-matter experts affect policy? • How do governments analyse whether to adopt a policy, on both the national and international level?

SECTION 3: The future of food 8 • What are the implications of a growing population and climate change on food production? • What are the main issues facing food producers today? • What innovations or technology will have the biggest impact on food production over the next 10 years?

SECTION 4: Consumption and resource availability 10 • What might make a difference to how we use resources in a sustainable way? • Is reducing consumption a realistic outcome? • How might the use of resources actually be reduced?

SECTION 5: The investor perspective 14 • What does this mean for the investor community over the longer term? • What might be the impact of a lack of proactive policymaking on these issues? The focus is sharpening on the environment. Extreme weather events are dominating the headlines, green policies are increasingly influential, and activists are growing more vocal. Joshua Kendall, Senior ESG Analyst, speaks to Professor Sir Ian Boyd, former Chief Scientific Adviser to the UK Government on Food and the Environment, about issues including climate change, the dynamics that underlie government policy, and the future for food production and consumption.

SECTION 1 CLIMATE CHANGE

• Why have attitudes to climate change shifted so dramatically? • Where should policymakers concentrate their efforts? • What role does the market play?

JOSHUA: Let's begin with climate change. This has been JOSHUA: The natural question is what action to take. There are recognised as a major risk for many years, of course, but many strong opinions out there about how to act, and clearly, it seems it is finally being recognised at the top level that government policy and policymakers are going to play a environmental issues are urgent and must be dealt with. critical role in any transition. Given the scientific evidence, For example, in January, the World Economic Forum's where should policymakers concentrate their efforts? annual risks report's top five risks were all environmental – SIR IAN: Having worked in a policy environment for a long time, for the first time in the report's history1. Why have attitudes I think policies are most effective when they're simple and quite changed so dramatically? high level, meaning they're driving systemic change and shifting behaviours in a very simple way. SIR IAN: I think there are four factors here. The first is that the evidence for climate change and environmental impacts is One of the highest-level policies you could bring in is a carbon tax, becoming stronger and stronger, particularly the underlying or carbon pricing in some form, which would drive the trade and modelling. It also suggests the implications are worse than we manufacturing system to shift to new ways of working. Such policies thought. The climate system appears to be more sensitive to need not be introduced in a sudden or abrupt way: they can be greenhouse gases than previously thought. introduced progressively over a long period of time – even decades.

The impact of activism is also pretty obvious. I work on a university We've done that quite effectively at a much smaller scale. For campus, and it's clear our students feel very strongly about this. example, with waste, a small number of countries have a landfill There's a real groundswell, particularly in the younger cohorts tax, which has risen gradually over many years. It's been very, coming through, that there is a major problem here and that very effective at reducing the amount of waste that goes to they will inherit the legacy of that problem. Of course, that drives landfill. Whether that's a good thing is another point. But it shows you can drive a whole system through fiscal measures. political ambition – in my experience working with politicians, they are only ambitious when they have a constituency behind On the other hand, while highly desirable and very effective, them driving a policy. the plastic bag charge (or ban, depending on the country) has probably made little overall difference to the use of plastics or I would say the third thing is that much more work has been done their impact on the environment. By contrast, taxing raw materials on the pathways to adaptation or mitigation, which means we produced from fossil fuels, or of a certain type of chemistry, understand a lot more about what needs to be done. The UK would create a market incentive to develop alternative and Committee on Climate Change, for example, has done a lot of very more degradable forms of plastic. good work on this2. We're in a better position to understand what the costs are, and the trade-offs associated with the things we need to do. The government can also regulate, and I think it needs to do so to provide a level playing field for the development of markets – for Finally, I think many of the negative voices around climate change example, for environmental or green bonds. And where there are are fading into the background. They are much less influential. market failures, the government needs to address those too.

1 Global Risks Report 2020, World Economic Forum. Available at https://www.weforum.org/reports/the-global-risks-report-2020 2 For more information, please see: https://www.theccc.org.uk/

3 JOSHUA: What role does the market play in effecting change in this area? SIR IAN: It's crucial these developments are delivered through the market, because we need a shift in the structure of the economy. Innovation in many forms is going to sit at the heart of solving the current problems and environmental challenges. This includes technical innovation, such as in energy storage, but it will also include innovations in how capital is diverted to solve these problems – such as how we incentivise and reward people for their contributions.

In the end, human imagination – which is what has got us in to the current difficulties in the first place – is going to have to power us out of the difficulties and top-down, command-and-control, approaches are proven not to be good at unlocking this resource. This is where the market comes in.

However, the market in an unsupervised form can produce odd and extremely damaging outcomes. This is where government intervention is needed, either to regulate for certain strategic outcomes or to address market failures when they happen. For example, we need to regulate so that we do not solve the problem of reducing carbon emissions by reducing air quality. Both improving air quality and reducing carbon emissions need to happen simultaneously. Also, the risks involved in delivering some major infrastructure and research investments to shift markets are often too high for the market to bear, and government would need to step in to drive change.

As an example over 60 governments have set the target of getting to net zero emissions by 2050. This is a strategic goal, but to achieve it, the institutions sitting within the economy are going to have to play their part. This may mean changing business models to cope with the transition, but it may also involve buying carbon offsets. However, there are just not enough offsets to cater for everybody’s needs.

By setting the strategic goal, government has established the background ambitions which call for financial instruments to be developed to supply offsets to cater for rapidly rising demand. We are still a long way from achieving such a market, but it's sorely needed. I think government needs to come together to work with those who are creating those sorts of financial instruments – such as green bonds – to come up with clear criteria by which environmental benefits will be judged.

The market in an unsupervised form can produce odd and extremely damaging outcomes. This is where government intervention is needed, either to regulate for certain strategic outcomes or to address market failures when they happen.

4 SECTION 2 POLITICS, POLICY AND PROCESS

• What goes into deciding and setting government policy on environmental issues? • How might the growing focus on environmental issues translate into government action? • What is the role of lobbying, and how do subject-matter experts affect policy? • How do governments analyse whether to adopt a policy, on both the national and international level?

JOSHUA: Setting government policy in theory, and last couple of years, certainly within environment departments, implementing it in practice, are very different things. For being carried through by the current governments. example, the scientific evidence in a particular area may JOSHUA: You don't think the growing focus on seem quite clear, but the policy implications – let alone the environmental issues will lead governments to take action? political calculations – can be complex. In your experience, what are the factors that go into deciding and setting SIR IAN: It could be hard for them to ignore the groundswell of policy in areas like this? opinion on these issues, but there is a question as to whether that groundswell is a neoliberal minority becoming more and SIR IAN: Governments have a tendency to take quite a short- more vocal. The current US government – and maybe quite a term view. I was in government for seven years: for the first five, number of others around the world – may believe it is actually the government never looked beyond about 18 months ahead. a minority who are becoming more politically active, but are Then we shifted to thinking more strategically and broadly not actually going to carry the day. about the environment, developing and publishing strategies such as the 25 Year Environment Plan3, thinking about the future The counterpoint is that other stakeholders are clearly for food and farming4, and considering areas such as resource interested in these issues. In the City, among investors, use and waste. These effectively took a systems approach to bankers and insurers, there is huge interest. This is partly how people interact with the rest of the planet. driven by the insurance industry, which is seeing the real cost In the background of these policy discussions, of course, is the of climate change beginning come in, and there are convincing inevitable short-termism of government, driven by the politics pieces of evidence coming through that our insurance costs behind it. I think the politics of the environment is changing, are rising because of natural events and other related matters. and the government is being forced to take a longer-term view. If there's going to be a genuine cost associated with that, it will affect long-term investment and the politics of financial But one should never underestimate the extent to which institutions – and that will eventually feed back to approaches within government – certainly with respect to the governments. I think they'll listen to that side of the opinion environment – are driven by the personal opinions of those in more than the activist side. leadership positions, and fundamentally the prime minister or president. I'm not sure the current UK prime minister and US For me, the jury is out at the moment on how this new UK president get the environment, and so I'm not that hopeful that government is going to react, and whether it will carry through we would see the head of steam that has been built up over the on the promising direction of travel of the last couple of years.

In the City, among investors, bankers and insurers, there is huge interest... I think the government will listen to that side of the opinion more than the activist side.

3 Available at: https://www.gov.uk/government/publications/25-year-environment-plan 4 Available at: https://www.gov.uk/government/publications/the-future-for-food-farming-and-the-environment-policy-statement-2018 5 JOSHUA: As you say, there are a lot of influential voices that can drive policy. How does lobbying on specific issues work and affect policy? And what is the role of subject-matter experts? SIR IAN: Lobbying works on a number of levels. It works partly through responding to trends within government thinking through the formal consultation process. Legally, if it's coming out with new policies, it has to consult, and there are ways and means of lobbying within that context. So there are policy and political contexts within which lobbying can be effective. However, lobbying tends not to be very effective if there isn't a willing ear within government. I certainly learned that if there is no political interest, it's almost pointless to push on the door that simply is not ready to be opened.

JOSHUA: Are there any examples of areas in which you successfully influenced government policy? SIR IAN: Take waste for an example. For about five years of my tenure, waste was a deeply politically uninteresting subject. Nobody on the political side was interested in it; there was no point in doing anything on it or trying to make any changes. But as soon as the whole plastics issue arose, it suddenly became the opposite – it was the hot issue of the day and every minister wanted to have something to say about waste. And if you're an effective lobbyist, you need to understand that dynamic. For some things which are politically unacceptable or uninteresting now, at some point the window will open, and you need to be ready with all your arguments and evidence – because that window won't be open for very long. On waste, a colleague and I put together a major report on waste at a time when it was deeply unpopular. When it suddenly became popular, that report hit the desks, and it made a huge difference. It drove the government's resource strategy. You can't tell when those opportunities will come up, but you can plan for them and have all the evidence ready – that's how strategically, lobbying is most effective. But a lot of this is driven by personalities and personal relationships. Often, I would be aware that people were raising issues with government ministers, because ministers would bring points to me and ask me how we might deal with them. People clearly had the ear of ministers; the ministers listened; they took it seriously enough to want to seek advice. I think one of the most effective ways to work is for different sectors to be clear among themselves as to what they want of government, and then to approach government in unison, shoulder to shoulder. Government then can feel confident it can do something without some sort of backlash. Under those circumstances it can be more difficult for government to say no. Some industries are good at that – such as the car and aviation industries. Others are very poor, such as the farming industry.

JOSHUA: When governments and policymakers think about whether a policy is going to be successful, what kind of analysis will they undertake, and how do they decide how to measure performance? SIR IAN: Any policy in government needs an impact assessment, as defined in the UK by the Green Book published by the Treasury5. It's quite surprising to many people outside government how ministers' hands are tied by this. You may think these people are elected and then they can make decisions; but they can only

5 Available at: https://www.gov.uk/government/publications/the-green- book-appraisal-and-evaluation-in-central-governent

6 implement a policy if the impact assessment shows a positive outcome under a cost/benefit analysis. That impact assessment is driven by the economists within government, and there is a very well developed process, and economic models, underlying that. What is not done so well, however, is the post-implementation evaluation process. The government simply doesn't put enough resource into policy evaluation. The other thing about the impact assessments is that I think a lot of the economic models that underlie these are very questionable. Essentially, the power in government lies with the economists. They can say a policy is right, and if they put a tick in the box, the policy will probably go ahead. Or they can say it's wrong. As a group, they have huge power. I think that is not widely understood outside government. Of course, politicians can step over those bounds, but they have to write a letter to the head of the department stating that they are doing so and overruling the economic analysis. In all my time in government I haven’t seen that happen – the political impact of writing a letter saying "I'm going to ignore the evidence" is too much for any minister to risk.

The power in government lies with the economists… as a group, they have huge power. They can say a policy is right, and if they put a tick in the box, the policy will probably go ahead.

JOSHUA: How about international policymaking? Do economic assessments also influence how governments interact with each other? SIR IAN: The analyses done by the UK Committee for Climate Change are typical of the kind of analysis that would be done for any impact assessment. At an international level, the national analyses tend to be brought together and discrepancies are sorted out. But then a political overlay is applied. Take fisheries management, for example. There are very well-developed bio- economic models that underpin the decision-making process for how much fish you can take out of the sea. That work is done, the numbers are put in front of the decision-makers, and then a political overlay is put over the top of that. So in that circumstance, the economists and scientists are setting out the parameters for operation – the upper and lower bounds within which political decisions should be made. Unlike at the national level, it is easier for politicians to step over those bounds at the international level. That's why, with the climate talks for example, we tend not to get very far a lot of the time.

7 SECTION 3 THE FUTURE OF FOOD

• What are the implications of a growing population and climate change on food production? • What are the main issues facing food producers today? • What innovations or technology will have the biggest impact on food production over the next 10 years?

JOSHUA: A key area of concern is food production. As we face JOSHUA: So what are the main issues facing food producers today? a growing population and a sharpening focus on climate SIR IAN: I think there are three: change, the need to produce enough food for the world – • the continued growth in the cross-border food market, in a sustainable manner – is growing clearer. What are normally called the 'global food system', the implications here? • the impact of new methods of food production, and SIR IAN: The food system is technologically very backward • shifting consumer demand. compared with other sectors of the economy. Fundamentally, we produce food in a very inefficient way, and there are massive First, there is a lot of sense in growing specific types of food in efficiencies that can be built into that. If we reoriented our those parts of the world most suited to that form of production. Even if farmers and consumers like the idea of local production, mindset for food production away from agriculture and towards often it makes little sense if the climates and soils are not of manufacturing, that would be a significant step. the right type. Even trade barriers are not very effective at Compared to other sectors of the economy, the agricultural counterbalancing this globalisation of production because system is about three to four times less resource-efficient than the so much of our food is now in the form of derived materials next most efficient area of the economy. We need to get five to 10 or reformulated products. times the amount out of the material inputs we put into agriculture So long as the full life-cycle analysis shows that production by the middle of the century than we do at the moment. That is elsewhere, even when combined with bulk transport to market, is the massive transformation that has to happen if we're going energetically and environmentally sound then different places will to feed the world and not ruin the planet at the same time. increasingly be forced to specialise on those crops best suited to There is the trade-off: people are very focused on carbon, but local soils and climate. they forget that we have to work out how to feed people without However, to compensate, some farmers might find that they are ruining the planet. Food production consumes large amounts more suited to growing carbon stores than food crops and there of land, energy and material resources, and it's killing off is a lively debate about what the optimal design of land use should biodiversity, and affecting the quality of soil and water. be. In future, what we call farmers today perhaps might be seen Actually, consumption of food is really the biggest single issue. more as land managers within multifunctional landscapes.

People are very focused on carbon, but they forget that we have to feed people without ruining the planet… consumption of food is really the biggest single issue.

8 As for new methods of food production, new technologies – which may be cheaper, have less of an environmental impact, and which also create a high-quality product – are likely to transform how we produce food in future. This could enable local production of foods which are not suited to local soils and climate, where transport costs are high, and where there is a premium in freshness.

With regard to changing consumer tastes, price will mainly drive patterns of consumption and the viability of different food production systems in various locations. But we should not underestimate the sensitivity to the idea that foods contain chemical residues from pesticides or to the idea that food production causes pollution of the landscape and the air. There is a growing appreciation of these things and consumer demands are likely to change – witness the recent rise of veganism.

JOSHUA: What innovations or technology will have the biggest impact on food production over the next 10 years? SIR IAN: I think we will start to see fully scaled controlled-environment production systems coming online in places close to market. Here, the business model is to bring the energy and nutrients to the consumer and to grow the crops close to where they are consumed. This will start out being especially viable for fresh produce, but eventually it will become so refined and efficient that systems will move towards the commodity end of the spectrum. These need not be close to consumption but might be in places where energy and water are abundant, such as in association with hydroelectricity, geothermal or solar energy in coastal desert regions.

9 9 SECTION 4 CONSUMPTION AND RESOURCE AVAILABILITY

• What might make a difference to how we use resources in a sustainable way? • Is reducing consumption a realistic outcome? • How might the use of resources actually be reduced?

JOSHUA: What initiatives or approaches might make JOSHUA: Can you explain how carbon emissions are a meaningful difference to how we can make use of shifted into different forms? the resources available to us in a sustainable way? SIR IAN: Much is said about the virtues of the 'circular SIR IAN: The climate problems we have are due to how we economy', whereby materials are recycled and reused; but it consume resources. is very easy to substitute carbon emissions for the emissions (usually in the form of waste) of other materials. In any physical system, you have inputs and outputs. In this case, the outputs are waste. But the only way to reduce that This happens because we invest energy in the transformation overall waste, which includes carbon, is by reducing inputs of materials at every step in their life cycle, from source into the system. We can increase circularity within the (mining) to sink (waste). In order to maintain materials in the system – in other words we can reuse or retain materials economy for longer, which is the objective of the circular within the economy for longer. But so long as we consume economy, we need to inject more energy to, for example, them at current rates, the waste products are going to come recycle, remanufacture or refurbish materials. In some cases, out the other end of the economy in some form or another. such as plastic, the carbon emissions from the energy What's more, we tend to ship those waste products into required to re-use materials might be greater than the types of materials that give weaker and weaker immediate carbon emissions from mining new raw materials. feedback on the potential impact, and maybe create longer In such cases it would be easier and cheaper to throw plastic and longer feedback. So that's why we're going to end up away and manufacture new plastic from virgin fossil fuels. with carbon in the atmosphere, which is going to take This causes more plastic to go to landfill or, more likely, to hundreds of years to feed back on us. be incinerated, thus driving up emissions. (At the opposite end of the scale would be a material like aluminium, The fundamental problem is that we need to cut where recycling uses as little as 5% of the energy of mining consumption overall to reduce carbon emissions. There is no the virgin materials.)6 indication whatsoever that we are curbing the consumption of resources, even if there's an indication that we're actually This goes to the heart of the problem of consumption. There in some cases being able to reduce the rate of increase of is no free lunch. Everything we do – even eating, sleeping carbon emissions. All that we're doing is shifting those and breathing – uses resources. And even when we try emissions into different forms, which will probably have to think hard about using fewer resources, we often fail, negative feedback on us in other ways in future. because we simply shift how resources flow into pathways which produce weaker and weaker direct feedbacks on us as Net zero by 2050 is a great thing, but I expect we'll find when individuals. This means we are getting better at translating we get to 2050 we haven't actually solved the problem, our emissions from unsightly, problematic solid waste in to because we've effectively shifted it somewhere else. So hard-to-see gaseous emissions which can float away in to that's why I think that demand-side policies are going to be the atmosphere – out of sight and out of mind. We share the way to deal with this – because we need to change the problem, rather than face up to managing the problem behaviours and expectations to reduce consumption. of our own emissions.

6 Global Aluminium Recycling: A Cornerstone of Sustainable Development, International Aluminium Institute, 2009. Available at: http://www.world-aluminium.org/media/filer_public/2013/01/15/fl0000181.pdf

10 This is why I believe the only way we will ever deal adequately with our emissions is by reducing the gross consumption of raw materials. Our adeptness at shifting emissions to apparently more benign forms, like CO2 or methane in the atmosphere, creates an impression that we are actually making progress when, if one looks at the consumption statistics, we are making no progress whatsoever.

JOSHUA: Proposing a policy to reduce consumption doesn't sound like a votewinner. Is there any likelihood of consumption being reduced? SIR IAN: That's a very fair question. It's hard to introduce demand-side policy because essentially, as a politician, you're saying to people you want something – but I'm not going to let you have it. But if we don't face it up that fact, we will reach a tipping point of resource availability. At some point that is going to feed back very, very rapidly on us in ways which are very hard to predict and which could be extremely damaging. Moreover, the way these feedbacks happen is inherently unpredictable – how we imagine these consequences will almost certainly not be the actual, realised outcome. Part of my background is in researching large ecological systems, which are not actually very different from large economic systems in the way they're structured. Highly networked processes have a way of flipping once they're put under stress: they essentially bifurcate so they go into a chaotic state, and then settle out in a different equilibrium. The danger we face is that if we keep driving our consumption up, we will see some form of crisis or economic collapse, which will be severe for some segments – or all – of the global population.

JOSHUA: Is there anything you find encouraging when you consider these issues, and how they might be dealt with? SIR IAN: Not really. We're very focused on carbon emissions, and that is not a bad thing. But the idea of trying to reduce consumption is not taken seriously at all. The International Resource Panel, part of the UN Environment Programme, provides statistics around resource consumption7. They have been talking for many years about decoupling economic growth from consumption. The evidence to date suggests we're being very unsuccessful at doing that. There are some areas where relative decoupling is beginning to happen, where we're able to grow the economy without exponentially increasing consumption, but consumption is still going up for the relative amount of materials being used.

7 For more information, please see: https://www.resourcepanel.org/

11 The trouble is that, whether it's light bulbs or television sets, we JOSHUA: You said a lack of resource availability is already use less and less materials to build and run them, but we make evident in some areas. Could you provide some examples? more and more of them. So we need to reduce the number of light SIR IAN: We live within a bounded system – the planet. The only bulbs we have and reduce the number of television sets, and so significant inputs to the system come from solar energy. Any on. Otherwise we won't bank the advantages of producing them materials we use which are not created using solar energy with less resources and using them with less power. must come from within the bounded planetary system. We're very good at supply-side solutions, but not at demand-side As consumers of this limited planetary resource, cumulatively, solutions. But we can think much more broadly about what how much of these resources have we consumed to date and demand-side solutions might look like. For example, people are are we approaching the limits? This is a hotly argued topic – there becoming more and more conscious about the environment: but are those who claim that, relative to our rate of use, planetary do they have the information in front of them to understand the resources are effectively unlimited. But I don't think the evidence relative environmental impact of the choice in front of them. If supports this. you were to buy flights, it would be useful to know what the One issue is that most economic models assume smooth environmental impact of that was. But we do not supply enough of transitions as resources become scarce, because the laws of that information so people can make rational judgments. Once we supply and demand will force us to innovate to use resources supply that information, I think people might start down that road more sparingly. They assume that the cost-curve of resources of potentially reducing consumption. Another approach might is vaguely linear. be pricing differentially depending on environmental impact. However, this does not account for our ability to divert the costs The mode of thought at the moment is around a technological of resource consumption into environmental impacts which we do solution. Somehow, science is going to come to the rescue here, not pay for. Essentially, our resource consumption remains high and come up with lots of great things like wonderful batteries even when resources are becoming scarce because we do not for cars and fusion energy. These might let us off the hook – but pay the real costs of consumption. We are very innovative when it's a high-risk strategy. There is even evidence that the rate of it comes to transferring those costs away from our own accounts innovation is declining relative to the investment in science so – essentially by placing them out in the environment by forcing there may be diminishing returns from R&D. The necessary them to be shared. Private costs are transferred into public costs, innovations might not come about. Are we going to get the meaning cost curves are highly non-linear. technical solutions in place before a collapse occurs?

We're very good at supply-side solutions, but not at demand-side solutions. People don’t have the information in front of them to understand the relative environmental impact of the choice in front of them.

12 Despite the costs of resource use being somewhat disguised up in the Earth’s crust, which is released suddenly as an by these mechanisms, there is evidence of resource constraint earthquake or a volcanic explosion – is that a system becomes kicking in. Global fish stocks are being increasingly overfished8; unstable and breaks down before settling out in a very different by 2050, over a quarter of global energy needs may be absorbed equilibrium state. If this was to happen to the global economy, simply by mining metals needed for goods production9, and there it would be devastating. is a shortage of substitute metals for those likely to be in short In reality, we may be inadvertently building up these kinds of supply10; the energy return on investment in oil has declined pressures because of increasingly high consumption and substantially11; and while land use for agriculture peaked decades emissions. They will eventually reach a tipping point; a step- ago, as intensity of land use has risen, so has use of mineral function in non-linear responses. In a very small way, the 2008 resources as fertilisers12. I would also note that the UK Ministry of Defence and US Department of Defense note that resource financial collapse showed how quickly these things can happen constraints, and access to resources, are a significant part of their in highly networked systems and, relative to what I am talking assessment when it comes to rising global tensions. about, I think the 2008 crisis and its aftermath will be trivial. All that said, the most profound evidence of resource constraint For example, does the current global food system bear the is rarely recognised: the large-scale decline in biodiversity, which characteristics of an inherently stable or and inherently unstable is the manifest cost of the consumption of land, energy and network? Most economists assume that smooth supply-demand minerals (together with emissions) for food production. transitions create equilibrium corrections, but how much of a shock would it take to cause the global food system to collapse? In ecological systems, we see these processes in action. The We do not know – but we should. consequence of non-linear responses – a bit like pressure building

8 The state of world fisheries and agriculture 2018, Food and Agriculture Organization of the United Nations. Available at: http://www.fao. org/state-of-fisheries-aquaculture/en/ 9 Resource Demand Scenarios for the Major Metals, by Ayman Elshkaki, TE Graedel, Luca Ciacci and Barbara K Reck; Environmental Science & Technology 2018 52 (5), 2491-2497. Available at: https://pubs.acs.org/doi/abs/10.1021/acs. est.7b05154 10 On the materials basis of modern society, by TE Graedel, EM Harper, NT Nassar and Barbara K Reck; PNAS May 19, 2015 112 (20) 6295-6300. Available at: https://www.pnas.org/content/112/20/6295 11 Long-Term Estimates of the Energy-Return-on-Investment (EROI) of Coal, Oil, and Gas Global Productions, by Victor Court and Florian Fizaine; Ecological Economics, Elsevier, vol. 138(C), pages 145-159. Available at: https://ideas.repec.org/a/eee/ecolec/v138y2017icp145-159.html 12 Linking global crop and livestock consumption to local production hotspots, by Zhongxiao Sun, Laura Scherer, Arnold Tukker and Paul Behrens; Global Food Security, 3 October 2019. Available at: https://www.sciencedirect.com/science/article/pii/S2211912419300276?via%3Dihub

13 SECTION 5 THE INVESTOR PERSPECTIVE

• What does this mean for the investor community over the longer term? • What might be the impact of a lack of proactive policymaking on these issues?

JOSHUA: What do you think this all means for the investor which are really promising. There are major companies – including community, when investing over a 10, 20, 30-year period? engineering companies – that are looking at that. And what might be the impact of a lack of proactive We need the financial instruments to allow airlines to offset their policymaking on these issues? carbon footprints, rather than expecting them to buy forests. SIR IAN: My very strong belief is that these problems are going to Instruments like this just don't exist at the moment, though there be solved by the market, but government needs to recognise that. I is progress being made – and there are a large number of think investors are beginning to realise there is money to be made institutions that would want access to them. Government needs here. I gave the example of food: food is produced so inefficiently to solve the market failure that exists in that area at the moment, that anybody with technical solutions that produce food at less and they're just not doing that. Perhaps the most significant cost is going to make a lot of money. There are such solutions challenge is to establish agreed methods for measuring and coming along, with controlled-system farming and bioreactors, crediting the value of financial instruments.

FURTHER READING

September 2019 IMPACT BONDS RESPONSIBLE INVESTMENT IN FIXED INCOME A BRIEF INTRODUCTION A PRIMER in fixed income: a primer INVESTORS ARE INCREASINGLY SEEKING MORE THAN FINANCIAL RETURNS: DEMAND IS GROWING TO HAVE A What are impact bonds, do you get what POSITIVE IMPACT WITH THEIR MONEY AS WELL. INTRODUCTION Industry initiatives are also generating research and encouraging further innovations in this area. One of the most prominent is the Our clients are increasingly seeking a responsible approach to PRI’s multi-year Credit Risk and Ratings Initiative, which aims to fixed income. This paper aims to answer these frequently asked Whether they are seeking to boost environmental projects or While the proceeds are typically used to support specific “enhance the transparent and systematic integration of ESG questions: social development, fixed income markets are providing new projects or developments, and progress on those projects or factors in credit risk analysis” by facilitating dialogue between opportunities for investors to do so. Impact bonds, also known targets may be reported to investors, these bonds will otherwise credit rating agencies – who are crucial players in global bond What exactly is responsible investment, and how does it as sustainability bonds, aim to use their proceeds to support operate like conventional debt, offering a coupon and/or markets – and investors.3 1 differ from sustainable and impact investing? environmental and social progress. The market has boomed in principal to investors. Perhaps the clearest demonstration of investor’s interest in ESG What is responsible investment and how recent years (see Figure 1), with issuance in 2019 set to hit a new you pay for, is there sufficient capacity QUESTIONS FOR INVESTORS What does it mean to invest responsibly factors and how they relate to their bond portfolios is the growth record, and demand, so far, has comfortably absorbed supply. 2 of the impact bond market, whereby bond proceeds are used to in fixed income? However, questions remain for investors who are considering 1. With impact bonds, am I getting what I’m paying for? support environmental and/or social progress. Impact bond sustainable issuance. There are no agreed industry-wide A primary concern for investors in sustainable issuance is How can fixed income investors actively engage with issuance in 2019 is set to hit a new record, and demand continues standards, leading to wide variation in quality and types of whether their investment is being used in an appropriate manner 3 corporate and sovereign issuers over ESG issues? to outstrip supply. available investments; demand for such debt is so strong that it as intended. A lack of agreed standards, patchy reporting and has raised concerns about whether there is enough supply in the weak commitments raise significant questions. BACKGROUND KEY QUESTIONS market; and as with any investment that incorporates some For example, green bonds from some property companies element of non-financial objective, investors may be concerned Investing responsibly in fixed income is now part of the As interest and activity are clearly booming, there are clear does it differ from sustainable and impact issued in 2019 have included terms that allow the proceeds to and how does performance compare over whether they will generate returns equivalent to traditional mainstream. Investors increasingly expect their bond portfolios to questions for bond investors to consider as they ponder the cover payments for other bonds with no green characteristics debt instruments. take environmental, social and governance (ESG) factors and risks possibilities ahead of them, including how to define a responsible — meaning the green bond proceeds would lead to no carbon into account – and asset managers have flocked to meet this approach, what it means to follow such an approach in fixed WHAT ARE IMPACT BONDS? reduction. demand. income markets, and how fixed income investors can proactively However, while examples like these rightly raise concerns, they engage with corporate and sovereign issuers over ESG issues. There are different types of impact bonds. Most in the market Signatories to the UN-supported Principles for Responsible are green bonds, which aim to use their proceeds to support reinforce the need for detailed analysis. There are many Investment (PRI), the world’s leading proponent for responsible excellent examples of impact bond issuance: the Netherlands Defining responsible investment environmental progress. There are also social bonds, which investment, account for tens of trillions of dollars of assets under recently issued a green bond with a clear framework, 1 Responsible investment is defined by the PRI as an focus on social development, and sustainable bonds which aim management, of which around 40% is in fixed income.1 Over 150 investing? What does it mean to invest aspirational targets and transparent reporting. You can read to traditional bonds? approach to investing that aims to incorporate ESG to support both environmental and social projects. investors with nearly $30 trillion of assets under management, about Insight’s sustainable bond analysis framework in our 2019 factors into investment decisions, to better manage risk and and 19 credit rating agencies, have signed the PRI’s statement on annual responsible investment report (see page 44). generate sustainable, long-term returns.4 ESG in credit risk and ratings.2 In other words, responsible investment is about managing risk. These statements of intent have led to significant progress in fixed Figure 1: Impact bond issuance has boomed in recent years1 It is not about putting specific ethical considerations ahead of income approaches that take ESG factors into account. Indices for 250 other criteria when creating portfolios. 200 Social bond/loan equity investors focused on ESG issues have been a long-standing 200 Sustainability bond/loan feature in the marketplace, but index providers have moved to 150 150 This sets it apart from approaches like sustainable or impact Green bond/loan 100 launch bond indices too: for example, in 2018, the JP Morgan ESG investment, which aim for non-financial, as well as financial, responsibly in fixed income? 100 50 index was launched, focusing on emerging market debt from billion ()

objectives (see graphic on the next page). billion ($) 0 50 issuers with strong ESG practices.

Energy 0 staples Utilities

Materials 2015 2016 2017 2018 2019 (YTD) Financials Industrials Consumer Consumer Health care Technology Government

discretionary Green bond/loan Sustainability bond/loan Social bond/loan Communications  2015  2016  2017  2018  2019 (YTD)

1 Source: PRI signatory information snapshot, available at https://www.unpri.org/pri/about-the-pri. 2 For more information, please see https://www.unpri.org/credit-ratings/statement-on-esg-in-credit-risk-and-ratings-also-available-in-chinese/77.article. 3 For more information, 1 Source: Insight Investment. As at 30 June 2019. please see https://www.unpri.org/credit-ratings. 4 Please see https://www.unpri.org/pri/what-is-responsible-investment.

FOR PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY. FOR PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY. NOT TO BE REPRODUCED WITHOUT PRIOR WRITTEN APPROVAL. NOT TO BE REPRODUCED WITHOUT PRIOR WRITTEN APPROVAL. PLEASE REFER TO ALL RISK DISCLOSURES AT THE BACK OF THIS DOCUMENT. Insight ESG Fixed Income Ratings: PLEASE REFER TO ALL RISK DISCLOSURES AT THE BACK OF THIS DOCUMENT. ESG in fixed income: January 2020 October 2019 INSIGHT ESG FIXED INCOME RATINGS ESG IN FIXED INCOME CORPORATE METHODOLOGY SUMMARY NEW INITIATIVES AND ENHANCEMENTS AT INSIGHT, WE BELIEVE ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) FACTORS CAN HAVE A MATERIAL corporate methodology summary INSIGHT’S APPROACH TO RESPONSIBLE INVESTMENT IN FIXED INCOME HAS CONTINUED TO EVOLVE, WITH new initiatives and enhancements IMPACT ON INVESTMENT RISK. IN DEVELOPING OUR PROPRIETARY CORPORATE INSIGHT ESG SCORE, WE HAVE NEW INITIATIVES AND ACTIVITY SEEKING TO ENHANCE AND DEEPEN THE INTEGRATION OF ENVIRONMENTAL, CREATED A RISK-CENTRIC APPROACH USING ADVANCED QUANTITATIVE TOOLS AND AVOIDING SUBJECTIVE SOCIAL AND GOVERNANCE (ESG) RISKS ACROSS OUR INVESTMENT RESEARCH AND DECISION-MAKING. IN THIS ETHICAL BIASES. OUR APPROACH LEADS TO HIGH COVERAGE OF GLOBAL BENCHMARKS: OVER 650,000 PAPER, OUR PORTFOLIO MANAGERS AND ANALYSTS OUTLINE OUR APPROACH AND RECENT ENHANCEMENTS, SUBSIDIARIES FOR 2,600 DIFFERENT PARENT ENTITIES HAVE AN INSIGHT FIXED INCOME ESG RATING. AND CLAUDIA CHAPMAN FROM THE FINANCIAL REPORTING COUNCIL OFFERS AN UPDATE ON THE NEW UK STEWARDSHIP CODE. Our new Insight ESG ratings aim to be more dynamic and datasets. Common problems include fields being added, removed, complete, and to integrate our analysts’ research more effectively. or renamed, or the number of records changing drastically No single ESG data provider aligns with our house opinion on ESG month-on-month. Introduction: ESG factors have become increasingly We believe environmental, social and KEY HIGHLIGHTS credit risk, and so we have developed our new methodology using pertinent to our clients Once we are satisfied with the high-level reliability of the data, we Insight’s approach to responsible data from multiple third-party data providers. • The Financial Reporting Council’s UK Stewardship Code is being Lucy Speake, Deputy Head of Fixed Income use bespoke software and a modified Bloomberg dataset to assign revised and is due to be launched by year-end. The updated and Head of European Credit, Insight We reclassify, reweight and organise the data according to our global company identifiers, and ultimate parent identifiers to the code will impact service providers, asset owners as well as Investment analysts’ current views on material risks facing industries to generate data provided. In particular, this modified dataset deals with cases investment managers, and extend to include fixed income. The an ESG rating and momentum signal for a wide range of entities. where the ultimate parent of the issuer is sovereign (or a code aims to increase effectiveness, align roles and incentives Insight was an early adopter of ESG integration sovereign agency, central bank, etc), but the issuer’s credit is not of the investment community towards stewardship issues and Insight’s methodology involves five key steps (see Figure 1). into credit research; we were a founding UN-supported Principles underwritten in any meaningful way by the sovereign entity. The reflect the changing landscape of investment and societal for Responsible Investment (PRI) signatory in 2006, and this year Figure 1: Insight corporate ESG ratings methodology ‘mapped’ raw data is added to our ESG database, giving us a expectations. we achieved PRI ratings of A+ or A across all of our processes. Our governance (ESG) factors can have a consistent history of the raw data. • Our approach to responsible investment is underpinned by the responsible investment framework focuses on ensuring we take investment in fixed income has continued ESG risks into account alongside other risks in our fixed income Data Data Framework Ratings Quality FRAMEWORK DEVELOPMENT belief that environmental, social and governance (ESG) issues sources management development production control portfolios. are important drivers of investment value. We recognise that Each metric that contributes to an issuer’s Insight ESG rating has delivering superior investment solutions depends on the Over the last twelve months, ESG in fixed income has continued to DATA SOURCES two key elements: effective management of the risks and opportunities presented be a significant focus for Insight. In addition to developing new 1. A score (evaluating an issuer’s performance in that metric) by these issues. We continuously develop or update tools that tools (see Figure 2) that support the continued integration of ESG We incorporate ESG data from four sources. These comprise full 2. A weight (evaluating the materiality of the metric to the issuer) support the integration of ESG into our corporate credit work, into our corporate credit work, we have expanded the remit, ESG datasets from MSCI, Sustainalytics, VigeoEiris, and CDP climate and have built responsible investment processes into our building responsible investment into our emerging markets, change and water metrics. Both master datasets are then mapped onto one or more key material impact on investment risk and emerging markets, sovereign debt, money markets analysis, as sovereign debt, money markets and LDI solutions analysis. to evolve. In this paper, our portfolio We also use the Bloomberg legal entities for credit risk datasets to issues in our framework (see Figure 2 overleaf). well as our LDI solutions. Our key developments during the last twelve months have map the ESG records to all issuers within a credit risk tree. To generate a weight and a score at key-issue level we combine • We recognise that information on a company’s ESG risks is not included: increasing our focus on data in the ESG space and inputs from our credit analysts together with third-party averages. always available from third-party data providers, which is why We have created a robust data management infrastructure which expanding our ESG team; further exercising our stewardship role; The analysts’ views on the materiality of key issues facing each we believe it is essential for investment managers to carry out underpins our quantitative analysis – this is highly scalable, and building sustainable investment into our portfolios in order to industry group are merged with views of the data providers, and their own independent analysis. We have developed intended to support the evolution of our ESG ratings as we (i) add meet our clients’ objectives; and creating three ESG groups. the values are averaged (with a 1:2 weighting). proprietary Insight ESG ratings, streamlining the standard ESG new datasets over time, (ii) perform historical analysis and These groups each focus on a different area – either corporate framework and selectively customising the metrics to make the To ensure our ESG ratings are based on good data coverage, we credit, sovereign or Insight’s ESG products – and have a mandate back-testing of our ESG strategies, and (iii) implement enhanced have created a risk-centric approach data as pertinent as possible to our analysis. Our analysts use include only records which (i) have data under each (E, S and G) to review ESG risk factors that may impact investment and reporting and visualisations for analysts to dig deep into the ESG these ratings in addition to or instead of a third-party provider managers and analysts outline our pillar, which are based on (ii) five distinct data points and (iii) more business operations, in order to make sure we meet the demand profile of issuers, and portfolio managers to review aggregate to make an assessment on the ESG risk posed by the issuer. than five distinct data provider fields. of our clients and consultants. levels in portfolios. At present, around 99% of companies in investment grade indices have a quantitative Insight ESG rating. ESG continues to be a very important subject for our DATA MANAGEMENT RATINGS PRODUCTION clients; in the UK, ESG factors have become increasingly • More than 150 impact bonds we have analysed over the last Raw data is collected from data providers at the start of month Our methodology produces two separate ratings for every issuer: pertinent, particularly to pension schemes and local three years fully meet our requirements to be classified as an (or soon after it becomes available in the case of CDP). Preliminary an overall ESG rating and an overall momentum signal. authorities. Our dedicated ESG strategies have impact bond, while approximately 15% of impact bonds were checks on the datasets flag up any obvious problems with the continued to grow, with an increasing focus on using advanced quantitative tools and unable to sufficiently meet our threshold requirements. This exclusions, in particular. highlights the importance of looking beyond the impact bond approach and recent enhancements. label to discern suitability. avoiding subjective ethical biases.

FOR PROFESSIONAL CLIENTS AND QUALIFIED INVESTORS ONLY. NOT TO BE REPRODUCED WITHOUT PRIOR WRITTEN APPROVAL. PLEASE REFER TO ALL RISK DISCLOSURES AT THE BACK OF THIS DOCUMENT. Climate Risk Index 2019

2019 CLIMATE for corporate debt issuers RISK INDEX FOR CORPORATE DEBT ISSUERS The Climate Risk Index provides an annual DECEMBER 2019 assessment of 1,846 corporate fixed income issuers and analyses how they are managing the risks and opportunities presented by climate change. In this paper we outline our methodology and results from our 2019 climate risk index.

14 FIND OUT MORE

Institutional Business Development Consultant Relationship Management @InsightInvestIM [email protected] [email protected] +44 20 7321 1552 +44 20 7321 1023 company/insight-investment European Business Development [email protected] www.insightinvestment.com +49 69 12014 2650 +44 20 7321 1928

CONTRIBUTORS

Joshua Kendall, Phil Craig, Senior ESG Analyst, Team Leader, Investment Content, Insight Investment Insight Investment

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