Biden’s war on climate change
The five policy commitments from the Biden administration that we believe are of relevance to investors focused on environmental, social, and governance (ESG) issues are, in short: to recommit the US to a more proactive stance on tackling climate change, to adjust the rules on sustainable investing, to accelerate a range of energy transition rules, to strengthen sustainability-related priorities for corporate America and to set significant long-term and aspirational environment goals.
We expect these to broadly affect corporate issuers of bond and equity securities, governments and potentially even asset-backed securities.
Climate leadership is a genuine possibility under the new administration. In 2017, President Trump withdrew from the 2015 Paris Agreement, driven by concerns that the Paris Accord would undermine the US economy. President Biden orchestrated the original involvement of the US, and so it is hardly surprising that we have seen an early recommitment by the US government to the Paris Agreement.
Because this agreement is not legally a treaty, no Congressional approval is needed. As a result, this year’s United Nations Climate Change Conference taking place in the UK in November is likely to take on new importance. The conference could be an opportunity for the US to again take the lead on climate change, a role which over the last four years has been assumed by the European Union (EU). International eyes will also be on Australia, who at the last meeting in Madrid in 2019 was widely criticised for blocking climate action.
One area likely to gain increasing attention is a carbon border adjustment mechanism, colloquially seen as a carbon tax. Exporting nations with high carbon (led by China) will be most negatively impacted. More than 3,000 US economists and all living former chairs of the Federal Reserve have endorsed a carbon tax, making it possible a Biden administration will seek to advance this policy to align with an expected EU carbon border tax. Company carbon-intensity metrics will become more important for investors, and sectors with higher intensity metrics, such as utilities and materials, are most likely to be impacted.
We also expect climate change to form a key part of foreign policy, including trade. Many development banks are strongly focused on environment and social impacts and President Biden has committed to ensuring the new US International Development Finance Corporation significantly reduces the carbon footprint of the investment portfolio.
Most tellingly, the US will look to introduce ‘green debt relief’ for developing countries that make climate commitments, a timely initiative with growing COVID-19 related debt issuance and need for poorer countries to undertake climate mitigating action. While details are lacking, this will require close monitoring by emerging market debt investors.
ADJUSTING RULES ON SUSTAINABLE INVESTING
Five days before the US election, in one of its last policy initiatives, the Department of Labor (DOL) approved new rules for fiduciaries of Employment Retirement Income Security Act (ERISA) plans.
When originally proposed, these rules were interpreted as limiting ESG investment strategies for US ERISA investors. However, this may not necessarily be a complete obstacle to ERISA investors effectively integrating these factors to a degree within portfolio design and investment analysis. We welcome the fact that the DOL did not recommend banning the inclusion of ESG factors as relevant factors within investment decisions. Rather, the policy focus is on explicit and implicit pecuniary objectives within pension-scheme allocations.
We anticipate that President Biden’s administration will encourage sustainable investment to support his climate-change investment plan. We believe that, while it is possible that newly appointed officials at the DOL could seek to propose or alter rules to facilitate such investments, at this time it is difficult to predict whether any such changes are within the intermediate or even long-term priorities of the new administration.
Separately, we note that momentum appears to be building for the US Securities and Exchange Commission (SEC) to require ESG disclosures to be standardised. In May 2020, the SEC Investor Advisory Committee called for the SEC to “begin in earnest an effort to update the reporting requirements of Issuers to include material, decision-useful, ESG factors.”
ACCELERATING ENERGY TRANSITION POLICIES
President Biden argued in the final presidential debate that he expects the US to “transition” away from fossil fuels. While we expect economic factors will determine the speed and trajectory of that transition, we anticipate President Biden to focus policy initiatives on stricter emissions rules. Australia, the world’s third largest exporter of fossil fuels and the largest in the OECD , has come under pressure to put an end to new gas and coal mining facilities in a bid to curb fossil fuel production.
These rules come at a time of record-low energy prices and profitability, and so the cost to industry could be material. The low-hanging fruit will involve setting pollution limits, especially around methane pollution on existing oil and gas operations. This would be a reversal from the previous administration, which loosened energy rules.
The president has also promised to strengthen the Clean Air Act to accelerate emissions reductions across industries. Transportation is a primary target. Weaker rules under the previous administration, have contributed to lower electric vehicle (EV) sales compared to other nations. Under a new administration EVs could grow to 25% of total sales by 2026, compared to just 5% under President Trump, according to BloombergNEF.
Ultimately, the Biden climate plan commits to “developing rigorous new fuel economy standards aimed at ensuring 100% of new sales for light- and medium-duty vehicles will be electrified”. Together with California’s declared 2035 deadline for fossil fuel-free vehicles, this would significantly alter the trajectory of US EV demand, and likely raise the US share of global demand for electric vehicles.
STRENGTHENING SUSTAINABILITY CRITERIA
We believe a new era of transparency on sustainability issues is likely. First, President Biden hopes to pass tax reform. This includes a 15% percent alternative minimum tax on book income for US companies. Further, all income earned overseas would be taxed at 21%, twice the current rate, with the previous administration’s corporate tax cut set for reversal. The caveat is the familiar challenging political climate: many attempts at tax reform often fail.
Putting workers first is an oft-used mantra in US elections, and the recent election was no exception. President Biden stated he would seek to strengthen the ability of employees to challenge discriminatory pay practices and hold employers accountable. Vice President Harris will likely focus on the role of corporate America in advancing gender equality. In May 2019, she proposed a new law compelling companies of 100 employees or more to prove they pay men and women equally or face fines equal to 1% of profit for every 1% of pay gap, though such a measure has very little chance of becoming law.
This focus comes as many large companies are promoting their diversity and inclusion policies, announcing targets and making investments in diversity hiring and training.
We therefore expect social development, particularly labour management, to become a greater priority for US issuers.
SETTING LONG TERM GOALS
Taking Europe’s lead, the new administration hopes to set a 0% CO2 target for the US power sector. President Biden aims for the US achieving net-zero emissions by 2050 through clean energy policy incentives, energy-efficiency projects and public works programmes. The plan does not address the role of natural gas, which generated approximately 40% of US power in 2019 and promotes nuclear power, which has proven technologically and politically difficult in other markets.
We anticipate large utilities will face significant pressure to reorient their power generation away from fossil fuels, creating potential credit risks.
CORPORATE ISSUERS HAVE A ROLE TO PLAY
To conclude, while the Biden administration is widely expected to introduce more ESG-related regulation impacting corporate America, we do not expect rules as ambitious as in other jurisdictions.
Australian public policy lags other major markets on broad issues, including corporate reporting according to Emma Herd, chief executive of the Investor Group on Climate Change, a local investor group. Further, Parliament’s Joint Standing Committee on Trade and Investment Growth launched an inquiry last month into the impact of the trend for excluding fossil fuels on export industries including coal mining from investors. US rulemakers postponed plans to create a ‘fair access’ rule, which would prevent the country’s banks from excluding controversial sectors such as fossil fuels and arms.
We expect corporate issuers to find a receptive investor base looking to support sustainability goals. More attention on green and social issues is an opportunity to issue green bonds, and the US market has seen a significant growth in corporate issuance of such debt. Australian issuers are not fairly represented on the global green bond stage. With more investors looking to create resilient and sustainability-focused portfolios, we believe companies may seek to make greater commitments towards sustainability themes, irrespective of any regulatory requirements.
The EU, for example, has prioritised sustainable finance and corporate action focused principally on climate change. Japan has advanced corporate governance initiatives. The Biden administration may aspire to replicate these, but a divided legislature will constrain efforts to introduce aspirational sustainable finance and corporate accountability goals.
Nevertheless, we expect corporate issuers to find a receptive investor base looking to support such goals. More attention on green and social issues is an opportunity to issue green bonds, and the US market has seen a significant growth in corporate issuance of such debt. With more investors looking to create resilient and sustainability-focused portfolios, we believe companies may seek to make greater commitments towards sustainability themes, irrespective of any regulatory requirements.
To manage the potential risks and opportunities highlighted in this article, we believe investors’ research should take a close look at issuers with high carbon emissions, utilities with material exposure to coal and gas generation, issuers with weak disclosure and transparency, issuers prioritising renewable energy and clean technology and issuers with weak environmental and social commitments.
Credit research that integrates ESG factors can help identify potential leaders and laggards, and so Insight’s analysts aim to process material ESG signals to support risk management. Issuers exposed to such risks may require closer monitoring and engagement to learn how disruptive sustainability factors can be to their finances, including profitability and cashflow.
Joshua Kendall is head of responsible investment research and stewardship at Insight Investment.
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