Top 10 global ESG issues for 2019

Environment, social and governance (ESG) issues are a crucial part of our investment process. They affect the way we invest and where we invest. They also inform our global engagement agenda, which is the list of issues that we target in an attempt to change companies’ behaviour for the better.

In this article, we share the ESG investment issues that we expect to be prominent in 2019. They include the following:

1. Climate Change
2. Regaining community trust in banking
3. The ethics of investing in social media
4. Access to medicine
5. Investing for impact
6. Palm oil and deforestation
7. The war on plastic
8. Modern slavery and supply chains
9. Child labour in cocoa
10. Antibiotics in our food supply

1. Climate change

Three years ago, global action on CO2 emissions seemed imminent. The Paris Agreement signed at the United Nations (UN) Climate Change Conference in 2015 adopted a global goal to keep global temperature rises to below two degrees celsius.

One year later, US President Donald Trump dismantled legislative action aimed at implementing the Paris Agreement¹.

In the face of inconsistent global regulatory action, businesses have taken the initiative and investors have started preparing for the risks by calculating how exposed their investments are to changes in global temperatures.

The investment risks can be grouped into four key categories:

Engaging with companies on climate change

Investors are increasingly active in engaging with investee companies. We expect this to continue in 2019. For example, our Responsible Investment Leaders (RIL) funds have two clear goals on climate change:

1. A clear path to a lower carbon economy, as quickly and sensibly as possible; and
2. Clear commitments and disclosures from companies on their path to lower emissions.

These funds are working towards the first challenge by participating in engagements with other large investors all over the world, and the second by asking companies to comply with the UN Taskforce for Climate-related Financial Disclosures (TCFD). The TCFD is a useful framework for investors because it requires companies to disclose their scenario plans, as well as their efforts to transition to a world that keeps temperature rises to below two degrees.

We expect the degree of scrutiny of disclosures under the TCFD to increase in 2019, as investors delve deeper into the adequacy of recently disclosed transition plans.

2. Regaining community trust

In Australia the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has eroded trust in banks and financial services organisations.

This is not a new theme for financial services companies. Banks in other countries have faced similar challenges. In 2016, one of the largest banks in the US was accused of opening approximately two million customer bank and credit card accounts, in many instances without customers’ knowledge².

In the UK, banks mis-sold insurance products known as ‘payment protection insurance’ for decades³. About £33.6 billion in premiums have been repaid to customers since 2011⁴.

In 2019, investors will be focusing on governance issues including culture and remuneration. To the extent that misconduct and errors have resulted from systems, processes and culture in the financial services sector, investors will be examining the degree to which all three are being changed.

Remuneration will also be a focus for 2019, particularly if it is suspected that sales, revenue or profit targets have incentivised companies to profit at the expense of customers’ best interests.

3. The ethics of investing in social media

In 2018, our eyes were opened to the use and potential abuse of our personal information by the world’s large social media companies. In 2019, governments will respond with regulation and users will decide whether social media companies can be trusted.

Social media companies typically make money by selling advertising to companies, with the advertising targeted based on user data. The more targeted the advertising, the more the companies pay for the privilege to reach specific users.

Users are typically happy to provide their personal information in exchange for free use of the platform, providing their information is handled and used in ways they expect.

It is in this context that trust is key. If user data is sold, stolen or mishandled, consumers question the safety of their information, undermining the social media companies’ business models.

The way social media companies respond in 2019 to the laws and regulations being passed by governments all over the world to deal with privacy and the protection of users’ data will be critical. Investors will be watching the response of these companies carefully.

4. Access to medicine

In some countries affordable access to medicine is a given, but residents of other countries are not so fortunate. Even in developed countries like the US, life-saving drugs like the EpiPen can cost an inordinate amount of money⁵, making it out of reach for many.

In emerging markets with vast numbers of people living in poverty, access to medicine is even more of an issue⁶.

Fair drug pricing is likely to be a hot topic in the US in 2019. It is one of the few areas currently receiving bipartisan support⁷.

Some investors have been supporting a right of access to medicine for many years. AMP Capital signed the Investor Statement on Access to Medicine in 2016, an initiative that ranks global pharmaceutical companies on their efforts to balance profit with purpose, acknowledging the tension between affordable access to medicine, the need to cover expensive research and development costs, and a financial return to shareholders.

Another reason access to medicine is likely to be a hot topic in 2019 is the UN Sustainable Development Goals (SDG). SDG 3.8 is to provide “access to safe, effective, quality, and affordable essential medicines and vaccines”. The US Sustainability Accounting Standard Board Standard also lists access to medicine as a material topic for pharmaceutical companies.

To date, 84 investors, with more than US$11 trillion of assets under management have signed the Investor Statement of the Access to Medicine Index, which commits these investors to use the Index in their investment research and engagement with pharmaceutical companies.

5. Investing for impact

Impact investing is one of the buzz phrases in the investment community right now. It is an exciting time - institutional investors are starting to look for investments that deliver a positive social impact as well as a financial return. The Global Impact Investing Network reported in 2018 that there is now US$228 billion in impact assets under management globally, double the funds under management of the previous year.

The majority of the money is invested in three key sectors: food and agriculture, financial services and energy. Projects include renewable energy generation and storage, the restoration of forests, and the provision of loans and insurance in communities that don’t have access to banks. Many projects are in emerging markets including Asia and Africa. But there are a growing number closer to home. The next frontier in Australia is likely to include affordable housing.

The rise in demand for impact investing reflects a few important trends - asset managers are increasingly committed to being responsible investors⁸, and end investors (such as superannuants and retail investors) expect their asset managers to be both generating a return and making a difference. In fact, 75 per cent of retail investors surveyed by Morgan Stanley in 2017 said that they were interested in “investments in companies or funds which aim to achieve market-rate returns while pursuing positive social and/or environmental impact.”⁹ In Australia, nine in 10 people expect their superannuation or other investments to be invested responsibly and ethically¹⁰.

One of the challenges for this emerging sector is how to measure the impact of an investment. Investors understandably want to know what has changed as a result of their capital allocation. There remain many challenges involved in measuring impact – how should we measure social outcomes like better education, more engaged children, equality in the workforce, or the health benefits of lower pollution?

How reliable are these measurements? Comparisons across projects are also difficult because there isn’t a common measurement framework¹¹.

This measurement challenge will be a hot topic in 2019, particularly as concerns about ‘impact washing’ gain pace. Some are aligning their measurement system to the UN SDG, which are 21 global goals that governments have agreed to target by 2030. These include poverty, hunger, health, education, climate change, gender equality, water, sanitation, energy, the environment, and social justice.

6. Palm oil and deforestation

Palm oil is the most commonly used vegetable oil in the world. It is also the most controversial.

It is a popular ingredient because it has a long shelf life, can be used in everything from detergent to chocolate, and is higher yielding than other oils¹².

It is also produced in tropical rainforests and has led to some significant rainforest and biodiversity destruction in Asia¹³.

The removal of natural forests for plantations has led to a range of negative environmental impacts: carbon dioxide emissions, loss of pristine forests, soil erosion, air pollution as forests are burned to make way for plantations, loss of habitat for animals including the orangutan, elephants, critically-endangered rhinos and tigers and social conflict¹⁴. Some local landholders in Indonesia have also been victims of land grabs¹⁵.

These issues have been well known since the 1990s and a few global initiatives have been put into place since then to try to limit the deforestation. For example, the Roundtable for Sustainable Palm Oil (RSPO) certifies palm oil as sustainable and deforestation free and some large consumer goods companies have committed to buying ‘sustainable palm oil’ that has been certified by programs like RSPO.

However, challenges remain. 

Certification is also expensive and time consuming and small growers – which produce up to 40 per cent of the world’s palm oil - receive little of the premium paid for certified palm oil, so at first glance, there are disincentives to obtain RSPO certification¹⁶.

The flipside is that farmers who comply with RSPO produce yields that are up to three times greater within three to four years of obtaining certification because of their improved understanding of farming and working with the land¹⁷.

There are also challenges with the large palm oil traders that supply the big consumer goods companies. Some have committed to no deforestation or exploitation, yet they source as much as 80 per cent of palm oil from third parties without auditing or assessing those suppliers¹⁸. It is also practically difficult to separate certified and noncertified palm oils tracing and accountability is a challenge.

Not-for-profit groups like Greenpeace and World Wildlife Fund have recognised these challenges and are increasing the scrutiny of the entire palm oil supply chain and calling out companies that source from unsustainable producers, directly or indirectly. Investors are also calling for the following:

1. Programs that tackle poverty and educate small landholders on sustainable farming practices.
2. Evidence that the companies they invest in are tracing palm oil all the way back to the plantations and that the palm oil used is in fact certified as sustainable.

These dynamics mean that palm oil and deforestation are likely to remain important issues for ESG investors in 2019.

7. The war on plastic

In 2018, waste became a key environmental issue in Australia. China stopped taking Australian recycling¹⁹, leading to huge stockpiles in warehouses all over the country or the dumping of recycling in landfill²⁰.

Around the same time, Australia’s largest supermarkets - Woolworths and Coles - banned single-use plastic bags. In addition to this, Woolworths stopped selling plastic straws and removed plastic packaging from 80 fruit and vegetable lines²¹. This is an important shift in strategy by some of Australia’s big retailers. Efforts are being made to stop waste from being produced in the first place.

There is a great need to stem the tide of plastic production. Australians generate 53 million metric tonnes of waste every year²², or about four kg of waste per person per day²³.

There is also action taking place elsewhere. In Japan, the Ministry of Environment has, for the first time, set a specific target on reducing single-use plastic aiming for a 25 per cent reduction by 2030.²⁴ In September 2018, California became the first state in the US to ban plastic straws in sit-down eateries, passing legislation that “prohibits dine-in restaurants from automatically providing plastic straws” to customers²⁵, while a straw ban in San Francisco should take effect in 2019²⁶.

Elsewhere in the US, Seattle implemented a ban on all plastic utensils in July 2018, becoming the first US city to do so²⁷, while in 2014 California also passed legislation which prohibited grocery stores and pharmacies from distributing single-use plastic bags after July 2015 and enacted the same ban for convenience stores and liquor stores in 2016. It also provided up to $2 million in competitive loans— administered by CalRecycle - to businesses transitioning to manufacturing reusable bags²⁸.

In the UK, the Government announced plans to ban single-use plastics including straws, cotton-buds and stirrers in October 2018. The proposals are subject to a consultation launched by UK Environment Secretary Michael Gove. Subject to the views collected during consultation, the UK Government intends to introduce a ban on their distribution and sale, which would come into effect between October 2019 and October 2020²⁹.

This is a problem because so little of the world’s waste is recycled. In 2015, three academics found that 6,300 million metric tonnes of waste had been generated to date, of which nine per cent was recycled, 12 per cent incinerated and 79 per cent sent to landfill or left in the natural environment³⁰.

In 2017, the UN Environment Program warned that if global waste generation continued at the same rate, there would be more plastic in the sea than fish by 2050.

In response, businesses and investors are now talking about the circular economy - that is, a system without waste and pollution where materials are used and reused.

There have been some exciting initiatives. In 2017, Apple issued a green bond to fund the research and development of recyclable material for its iPhones³¹. Dell has announced that it will use recovered ocean plastic in some of its product packaging³². Coca Cola has committed to collecting and recycling the equivalent of all its packaging by 2030³³ and McDonald’s says all of its packaging will come from sustainable sources by 2025³⁴.

In the meantime, the economic scale is tipped in favour of single-use plastics, rather than recycled materials. The cost of collecting recycling, separating the waste, and breaking it down into other materials can be greater than manufacturing and using new plastic, depending on the prevailing oil price³⁵.

The disparity in cost is greater in western countries, where there is limited scale and relatively high wage rates. It’s likely that governments will need to intervene to change the equation, leading to increased costs for producers, and possibly consumers.

For companies prepared to commit to sustainable packaging, there may well be a competitive advantage. Investors can play a role here as well, in asking companies who manufacture packaging or outsource packaging to their supply chain, to commit to more sustainable practices and phase out the use of single-use plastics.

8. Modern slavery and supply chains

Six years ago, the treatment of workers in clothing factories in Asia was exposed when a factory in Bangladesh burned down, killing 1,100 garment workers. Encouraging progress has been made on worker rights and safety in the country since then, partly as a result of investor engagement. But there is much more work to be done.

Workers are still not paid enough to live above the poverty line and there are many barriers to union representation and collective bargaining. In China, the minimum wage for garment workers ranged from 93c to $1.93 in 2016. This compares with an estimated living wage of $4.63 an hour in China³⁶.

The Australian Government took an important step in 2018 by introducing a Modern Slavery Act for the first time. This effectively forces large Australian businesses to assess and address the risk of slavery in their operations and supply chains.

This Act was based on, and went beyond, the UK Modern Slavery Act 2015 which was the first of its kind in Europe, and one of the first in the world, to specifically address slavery and trafficking in the 21st century. It requires large commercial organisations who do business in the UK to disclose (in an annual Slavery and Human Trafficking Statement), the steps they are taking to address modern slavery in their business and supply chain.

Globally, some of the largest retailers and manufacturers have started auditing their lengthy supply chains. This basically means tracking all the factories they source from and checking the conditions in those factories.

Auditing is only the first step in the process. While we encourage companies to understand where they are buying from and openly publish factory lists, it is also important to consolidate their supply chains, understand the actual conditions in the factories they source from, engage with those factory operators to pay workers a living wage and enable collective bargaining.

We expect even more attention on the treatment of the world’s factory workers all over the world in 2019. The UN SDGs aim to eradicate slavery by 2030³⁷. With only 11 years to go until the goals reach maturity, more regulatory activity is likely to be required.

9. Child labour in cocoa

Ever wondered how the cocoa we eat in our chocolate is farmed? More than two million children are estimated to work on farms in West African countries Côte d’Ivoire and Ghana, the two countries that account for almost 70 per cent of cocoa production worldwide³⁸. While most of the world’s largest chocolate producers have committed to end child labour in the cocoa supply chain, a lot of work still needs to be done.

Carried out by a network of millions of small-scale family farmers, cocoa production is labour intensive. Farm wages are low and the use of child labour is widespread. Many farmers feel they have no choice but for their own children or children from their extended family to help on the farms, just to make ends meet. This in turn prevents children from attending school and obtaining an education³⁹.

Chocolate producers first started committing to take steps to combat child labour in 2001 when they formed the Harkin-Engel protocol. In 2010, the industry reaffirmed its commitment in a joint declaration to reduce the worst forms of child labour by 70 per cent by 2020⁴⁰.

Various programmes aimed at increasing productivity and improving the livelihood of cocoa-growing farmers have been scaled up over the years. Certification schemes such as Fairtrade, the Rainforest Alliance and UTZ Certified have spread, enabling large chocolate brands to demonstrate that their product is made using sustainably farmed cocoa. Systems to identify and remediate cases of child labour have been rolled-out in parts of the cocoa supply chain in Côte d’Ivoire and Ghana.

However, child labour remains widespread and more needs to be done.

Our RIL funds have joined a global investor initiative, signing the Investor Statement in Support of Combatting Child Labour in Cocoa in 2017. This collective of the world’s largest investors (60 in total), led by engagement specialist GES International, has been working with Nestlé, Mondelez, Hershey’s, Lindt & Sprungeli, Olam, Barry Callebaut and Cargill.

The investor initiative aims to:

• roll out systems to identify and remediate cases of child labour in the cocoa supply chain; and
• provide support and training to cocoa-growing farmers so that they may move towards a living income.

Due to the continuing prevalence of child labour and farmers being trapped in poverty, despite programs being in place for almost 20 years, we expect investors to be focussing more on companies’ efforts to address these issues in 2019.

10. Antibiotics in our food supply

Antibiotics have enabled the growth of large-scale factory farms all over the world, originally by limiting and preventing the spread of disease among animals kept in close quarters, then by stimulating animal growth rates and increasing productivity.

However, an alarming reality is emerging. Humans are building resistance to some of the antibiotics used in meat production, leaving vast numbers of people exposed to potentially fatal diseases that many assumed were treatable; for example, pneumonia.

The most recent studies suggest that about 70 per cent of bacteria globally have developed some level of resistance to antibiotics, leading the World Health Organisation and the World Economic Forum to declare antimicrobial resistance one of the biggest threats to health and human development in the world⁴¹.

About 700,000 people are estimated to have died from antibiotic-resistant infections globally in 2016⁴². The large majority of antibiotics by weight are used by the agricultural sector. In the European Union, two-thirds of the region’s antibiotics by weight are given to livestock. In the US, that number is 80 percent by weight⁴³. Australia appears to use very few antibiotics on food-producing animals, with antibiotics critically important to human health effectively banned for use in agriculture⁴⁴.

Humans are exposed to the antibiotics given to animals via:

• direct contact with animals;
• the consumption of undercooked or unpasteurised animal products; and
• effluent from factory farms which are absorbed into the environment.

Right now, antibiotic resistance is estimated to claim about 50,000 lives in the US every year, and another 50,000 lives in Europe. The numbers are much higher in developing countries with high rates of malaria, HIV or tuberculosis. By 2050, it is estimated that 10 million people globally may die every year because of antibiotic resistance. This exceeds the number of people who currently die from cancer every year.

The economic impact also appears large. A 2016 report commissioned by the UK Government, ‘The Review on Antimicrobial Resistance’, estimated the economic impact of antibiotic resistance would be a reduction of 2 to 3.5 per cent of global GDP by 2050 or US$100 trillion (A$134 trillion).

The size of the potential economic impact, as well as the escalating health concerns, mean that this is likely to be a key public health issue and a focus for ESG investors in 2019. We expect investors to increase their levels of engagement with companies in the food and agricultural industries, calling for the following:

1. Clear disclosure of the use of antibiotics in farming and food production.
2. Plans to phase out the use of antibiotics that are critically important to human health in agriculture.
3. Targeted reduction of other antibiotics used in agriculture.

Conclusion

The relevance of ESG issues has never been greater. Investors want data on, and progress around, some of the biggest ESG challenges globally, so that they can consider the investment impact of these issues and use their seat at the table to drive positive change. Expect to hear much more about these issues throughout 2019.

Learn more about AMP Capital’s Responsible Investment Leaders funds.