Transcript provided by Kensho.

Lindsey Hall: Hi. I'm Lindsey Hall, Head of Thought Leadership at S&P Global Sustainable1.

Esther Whieldon: And I'm Esther Whieldon, a Senior Writer on the Sustainable1 Thought Leadership team.

Lindsey Hall: Welcome to ESG Insider, an S&P Global podcast, where Esther and I take you inside the environmental, social and governance issues that are shaping the rapidly evolving sustainability landscape.

I'm just back from Baku, Azerbaijan where last week, the UN Climate Change Conference COP29 wrapped up. And one key outcome was the new collective qualified goal on climate finance, an agreement to provide USD 300 billion in public finance annually to developing countries by 2035. The goal also includes a broader investment target of USD 1.3 trillion a year by 2035, and that's from both public and private sources. We'll be back next week with more coverage of key COP29 outcomes.

For today's episode, we're leaning into the topic of climate finance. This year's conference of the parties has been dubbed "The Finance COP." And on this podcast, we've been talking with financial institutions around the world about their approach to climate finance. Last week, we heard from the Chief Sustainability Officer at Mastercard, one of the world's largest payments networks. In September, we talked with the world's largest asset owner, Norway's sovereign wealth fund, Norges Bank Investment Management.

Esther Whieldon: Today, we'll hear the perspective of another large investment firm. We'll talk with De Rui Wong, Senior Vice President in the Sustainability Office of GIC. GIC is Singapore's sovereign wealth fund, which has over USD 100 billion in assets under management.

De Rui talks about GIC's approach to sustainability. He also discusses how the firm is focused on understanding the physical risks of climate change. 

First up, here's De Rui talking about how GIC was founded and its investment approach.

De Rui Wong: GIC is a leading global investment firm that was established in 1981 to secure Singapore's financial future. So as the manager of Singapore's foreign reserves, GIC takes a long-term disciplined approach to investing and is uniquely positioned across a wide range of asset classes and asset strategies globally. So these include asset classes like equities, fixed income, real estate, private equity, venture capital and infrastructure.

GIC is headquartered in Singapore, but we do have a global talent workforce of over 2,300 people in 11 key financial cities. And if I could perhaps share a little bit more about GIC's core strength as an investor. We have a long-term orientation in terms of the way we invest. We have a flexible investment mandate that allows us to take significant stakes in the companies and assets that we invest in.

We are a values-driven investor, and that means being focused on sound governance, providing strong oversight and accountability in our investments. And we act in terms of our investment activities and operations according with our core values of prudence, respect, integrity, merit and excellence.

We are a collaborative and committed partner. We don't just invest alone. We also have both local and international partners to expand our opportunity set. And lastly, we have global operations, a global network with on-the-ground presence in the key markets that we invest in.

Esther Whieldon: De Rui went on to describe GIC's approach to sustainability and ESG.

De Rui Wong: So I would distill GIC's approach to sustainability and ESG into our three core beliefs. I think first is that we believe that companies with strong sustainability practices offer prospects of better returns over the long term. And the reason for that is given sustainability issues, particularly such as those involving climate change, that is an issue that affects not just the physical world, but the economic world and the financial world as well as the investments that we have. And hence, that is something that we need to pay very close attention to.

So that's number one, right, that companies with strong sustainability practices offer prospects of better returns over the long term. And number two is that when it comes to sustainability, we believe that there is no one-size-fits-all approach. Different countries, different markets, sectors, industries and companies are at different stages on their sustainability journey. So there's a need to be more calibrated and nuanced in terms of how we assess their sustainability efforts in the context of the operating environment that they work in.

The third core belief then is the focus on real-world impact or in the context of climate change, real-world decarbonization. We believe that when it comes to portfolio decarbonization, that's really just an effort on paper. It is easy using various financial engineering methods to have a portfolio that looks optically green. But the question we need to ask is what is the real-world decarbonization impact that you're having in the real world?

And for us, we believe that by focusing on the real-world impact, especially in terms of where we can unlock long-term value, that is where we think the best opportunity set for us to deliver good financial returns is best. So that's the third core belief, right, focusing on real-world impact, real-world decarbonization rather than on paper or portfolio decarbonization.

Esther Whieldon: So what does that third piece - the focus on the real-world impact - look like in practice?

De Rui Wong: Yes. So there are -- we have a 3-pronged approach to that. And maybe it's helpful to also think about the sustainability opportunity set when it comes to the investment universe. So if you look at a standard sort of global equity universe as a proxy for the investment universe, there are 3 broad categories of investments.

So one is on the decarbonization solution providers such as renewable energy, battery storage or green hydrogen producers. These constitute, call it, roughly about 7% of the investment universe. On the other hand, on the other far end of the spectrum are carbon-intensive assets with a high risk of becoming stranded. So these are assets that comprise probably about 10% of the investment universe.

And then you have everything else in between, and these are assets that need to transition and companies in this transition bucket account for over 80% of the investment universe. So that's a state of play in terms of the different categories of sustainability investments that one can engage in.

So when it comes to the green or decarbonization solution providers, what GIC does is to direct capital to companies already involved in the green economy to commercialize or scale up. So for example, we have dedicated investment portfolios across public and private markets to capture these opportunities such as the climate change opportunities portfolio, the sustainable solutions group as well as the transition and sustainable finance group.

Most recently, we have also launched an investment program for green assets, which offers scale-up capital for nascent or maturing climate solutions such as green steel or long-duration energy storage often find themselves caught between traditional buckets of capital. So that's on the category of decarbonization on green solutions.

When it comes to the assets that need to transition, for this category of investments, the work is usually more nuanced, but also equally important as these assets, as I mentioned earlier, make up most of the investment universe. And what we have observed is that companies are often decarbonizing at different rates and along different trajectories, depending on the regulations, the availability of technology as well as the market opportunities in the locations that they operate in.

And at GIC, we support companies' transition efforts by providing capital where there are good commercial risk-adjusted returns through active engagement and by voting responsibly. And in the third category, for the companies that are particularly vulnerable to transition risk, we assess the following: one, does the company have a credible transition plan? Has it committed to specific and meaningful emissions reduction targets? And is it taking concrete actions to achieve those targets? And are those actions well integrated into its overall business and operational plans?

The second part then is does the transition make commercial sense for the company, right? Does it strengthen its resilience to climate risk and in so doing, improve its value over the long term. So for some technologies such as solar and wind, they have already become more cost competitive compared to fossil fuels.

And investments in energy efficiency measures or new capabilities in sustainable product solutions may actually be accretive to the company's profit margins. And in those instances, it makes commercial sense for the company. But there are other sustainable solutions, which might require governments to introduce incentives or regulations to make it commercial for firms to adopt.

The third part of the assessment then is whether there's a governance process to support the company's transition strategy and whether there is sufficient transparency for accountability, such as either through public reports or through disclosures to investors.

Now we recognize that the transition is not an easy task for companies among the many challenges out there includes things like commercial viability, data availability as well as the capital-intensive nature of projects. And oftentimes, when it comes to regulatory developments, that can sometimes be uncertain depending on the geography that you operate in.

So there are sometimes short-term trade-offs with some of the decarbonization opportunities that we need to achieve. But for GIC, we are willing to work with companies that are prepared. They have credible transition plans, they have commercially viable transition initiatives and that have robust governance processes to facilitate the transition in a commercially viable way and we are prepared to invest alongside them.

Now for assets where the stranding risks are elevated, these are carbon-intensive businesses or business models that currently pose certain environmental concerns and eventually economic risk, where those businesses are unable or unwilling to transition, we would choose to divest or avoid investing in them.

Esther Whieldon: Have you made any decisions to divest or avoid investing in any particular sector or technology?

De Rui Wong: Yes, that's a good question. So I think for us, we believe in taking a nuanced approach, I think it -- for us, it doesn't -- it's not constructive to take a one-size-fits-all approach to exclude entire technologies or entire sectors. I think what we need to ask ourselves when we assess as a stranding risk is, what is the prospects of that company's product being substituted over time by cleaner, greener alternative? Where does this particular company sit on the industry cost structure as well?

Because if -- I think for any particular industry, the lower on the cost structure you sit, you probably face lesser stranding risk, but the higher you sit on the cost structure and if your industry is facing certain transition risk, you are likely to be the most vulnerable.

And then also what are the transition prospects for the company, right? And that boils down to whether the company itself has a credible transition plan, whether it has commercially viable transition initiatives and whether it has no robust governance processes in place to support and facilitate that transition.

Esther Whieldon: I asked De Rui, what sustainability challenges and opportunities financial institutions like GIC face. He mentioned data gaps and limitations on different models. He also talked about how geopolitics can influence sustainability strategies more broadly.

De Rui Wong: I think increasingly, with the number of political elections that were happening in various markets, most notably in the US, it does create certain uncertainty in terms of the policy measures that we put in place to support issues like climate change mitigation or even adaptation.

I think investors need to start to have a better appreciation of not just domestic politics, but also broader geopolitics and how that presents tailwinds or headwinds to various sustainability issues and how that potentially also creates more complexity in the way we deploy capital as well.

I think for us at GIC, I think where we want to be in is to invest in opportunities where there are policy and regulatory tailwinds, where there is market demand for some of the sustainability solutions in the companies that we invest in, where there is also sustainability projects that are commercially viable and accretive to the companies that we invest in, right?

So I think it's not so easy to be able to untangle all the noise that sometimes both the macro and geopolitics presents to sustainability-oriented investors. But I think it's important that even as we invest in the sustainability theme that we don't forget the interplay of the different forces in the environment that we invest in as well.

Esther Whieldon: To what extent are you factoring in social issues when you're thinking about climate risks and strategies?

De Rui Wong: So for us, the social issues is particularly salient when it comes to understanding transition investment opportunities, right, particularly when it comes to carbon-intensive assets, they are looking to transition towards lower carbon business models.

For example, when you look at a country like South Africa, for instance, where 85% of its electricity is fueled by coal power stations, right? Now even as the power utility may have plans to decarbonize over time, it does beg the question, right, in that transition process, what is the social implications thereof in terms of the local communities?

Are livelihoods being displaced? And if so, are they able to transition to jobs that no longer be stranded, right? So shifting from jobs in carbon-intensive industries towards the greener industries? Can that reskilling happen? Also about local government fiscal revenues as well, right? Because for a lot of these communities, the entire fossil fuel ecosystem is also a source of tax revenue as well.

How then do these tax revenues, if you are transitioning the carbon-intensive industry, how do you then replace it with other forms of tax revenue as well? So there are social implications of the transition, and those have implications as to whether or not the transition can happen at a cadence that is commercially viable as well.

Esther Whieldon: So we've heard GIC's approach to the low-carbon transition, including the potential social implications. Now let's turn to our discussion of how GIC is thinking about the physical risks of climate change. GIC and S&P Global Sustainable1 in September published a report about climate adaptation measures. We'll include a link to that in our show notes. The report analyzed the projected increase in physical climate hazards for global real estate properties held by companies in the S&P Global REIT Index.

A REIT or a real estate investment trust is a company that owns, operates or finances commercial real estate or real estate assets. This can include office buildings, hotels, shopping malls and apartments. And many REITs are publicly traded on a stock exchange. Here's De Rui talking about some of the report's key findings.

De Rui Wong: So I think for us, it's important to remember that climate change has moved from threat to reality. It's not a risk in a distant future, but a risk to us today. And in the past, I had to maybe dig up in the historical record. So what happened -- what were the economic damages when certain extreme weather events happened?

But frankly, these days, what I would do is maybe just a day before and look up the latest news and you already see an extreme weather event, right? For instance, we saw Hurricane Helene hit the Southeastern United States, right, bringing more than 42 trillion gallons of rain and that -- which is 60 million Olympic size swimming pools in 1 week. And that caused by some estimates about $250 billion of economic damages or 1% of U.S. GDP.

So in just a week, we saw an extreme weather event that had such massive economic impact. And that's not even talking about the social impact as well, right, the lives lost, families displaced. I mean those are very current, very real issues to us. And as investors, this should be a signal to us, right, that climate change is a reality.

It is creating a new environmental norm, a new economic paradigm that we need to understand how to navigate, which is why I thought it was very important that GIC and S&P Global Sustainable1 team that we work together on a publication to help advance the industry's understanding on how can we think about improving the physical risk models that we use in our investment assessments and monitoring processes.

So if I had to cast my mind back in terms of how the financial industry has evolved its understanding in this space, we have seen a proliferation of climate-related physical risk analytics, right? You have a lot of different models that score physical risk that have some estimates of value at risk.

But if you look across many of these models, I think one of the key gaps that I observed is that there is an absence of incorporating adaptation measures that can mitigate the impact of physical risk. And this is important because in the real world, you will see some, if not several asset owners or building owners being proactive in implementing physical adaptation measures.

So when we screen a portfolio of assets or physical risk, overlooking the adaptation dimension may actually lead us to potentially inaccurate conclusions about the ranking of risk -- of risky assets in one portfolio and divert attention from where investors most need to focus on, right?

So for example, in the report that we worked together on, if you use the S&P Global REIT Index as a barometer of properties that are potentially exposed to climate hazards under a sort of medium-high warning scenario, we estimate that the costs incurred from climate hazards could be as much as $559 billion by 2050.

But if you just to consider two adaptation solutions such as cool or green rules for extreme heat and wet or dry floodproofing solutions for flooding. And mind you, these are just adaptation measures that are done at the sort of building level. We already reduced the impact by $45 billion net of the cost to implement the solutions.

So adaptation can have quite a significant effect in altering the true impact that arises from climate-related physical risk. I think as we become more climate physical risk aware, it's also important to not be overly mired in the doom and gloom of climate change.

I think the flip side of risk is opportunity and physical risk that presents opportunities for companies that provide solutions to help the world adapt to a harsher environment. So we estimated in our report that global nonresidential demand for green or cool roofs as well as flood-proofing adaptation measures could present a $726 billion revenue opportunity through to 2050.

And this is just the tip of the iceberg of the business opportunity for climate adaptation solutions. We haven't looked at a much broader range of climate adaptation solutions are needed in a newer, harsher environment, right? And this is, I believe, a new blue ocean area that investors can potentially look at in the future.

Esther Whieldon: So then how are you integrating these models and the information you're gathering about climate adaptation into your strategies?

De Rui Wong: Yes. So for us, I think I will use the example of real estate investment portfolio. The process that we undertake is we do a portfolio screening to assess where the potential pockets of physical risks are in our real estate portfolio, zooming it down to specific assets.

And where the risks are screening a little bit high or a bit more elevated, that's when we do deeper dive analysis and due diligence to assess what are the adaptation measures that are potentially required in order to preserve the long-term value of the asset. And that could involve working with engineers to size, right, what is the perimeter where we need to build certain flood slabs? What is the minimum height level that is required to gird the asset from a 1 in 100 flooding event?

So understanding where the physical risks are, that's the first step. And then also understanding what are the adaptation measures that's required in order to preserve the long-term value of the asset. That's how we go about integrating physical risk into our real estate investments.

Esther Whieldon: Okay. So then, I guess, for real estate, then it would be literally saying we're not going to invest in something unless we see you're using appropriate adaptation measures or that kind of thing. Am I understanding that correctly?

De Rui Wong: Yes. So I think there are a couple of, I would say, approaches. I think what you just described, that's correct. In the first instance, we assess what is the physical risk exposure of the asset, right? And there have been instances where we found a particular asset, for example, was built on fairly unstable cliffs that was facing receding shore lines over the very long term.

And while at face value, the valuation asset might look attractive. But when you take those physical risks into consideration, we felt that the risk reward around that opportunity was not so compelling, and we passed on it. So in some instances, when you look at the physical risk exposure in and of itself, we decided to step away. And then there are other instances like you rightly mentioned, right, are the physical risk hazard adaptable or mitigable? And this involves both prospective new investments but as well as existing investments as well, right?

Can adaptation when implemented in a proactive way, help us to preserve long-term value, because it's not just about ensuring that the asset is able to operate well when it's under our portfolio, but also when we choose to exit the asset in the future, the new value of the asset will also have the same calculus as well. So by having those adaptation measures proactively in place, that allows us to also be able to exit the asset at a future time and an attractive valuation as well.

Esther Whieldon: So REITs are a clear way where you have some leverage, right? How do you approach the physical risk of climate change when you're engaging with the companies in your portfolios?

De Rui Wong: So again, I think that requires a nuanced approach. I think that is where I would say that ourselves, and I suspect many investors as well are still on a learning journey around this. I think partly because companies themselves have not disclosed a lot of information around their physical risk vulnerabilities.

So I think the first step in the engagement is working with companies to understand where those physical risk vulnerabilities are and understanding what is the action plan to be able to address those physical risk vulnerabilities. I think the way as we engage with companies and are able to pin together a mosaic of how exposed those companies are, I think the way we would try to assess the opportunity set in terms of physical risk and adaptation is threefold, right? One is that you will then have a better understanding of how companies are differentiated by their physical resilience to climate change.

For example, companies with supply chains that are more resilient to physical risk will over the long time, be more valuable because then they will have less business discontinuity risk. And this is not something theoretical. We have seen that in the past, for example, in 2011, when floods in Thailand disrupted operations and supply chains of both American and Japanese auto manufacturers, and we saw the impact of that manifest in quarterly earnings, right?

So that's number one, right, in terms of being able to differentiate companies in terms of their physical resilience and their ability to maintain business operations amidst rising climate change risk. And number two is the opportunity set in terms of adaptation solution providers. And these could be adaptation solution providers that are already fairly mature because they are producing technologies that we are already familiar with, right?

This is going to involve builders of sea walls, air conditioning or cooling solutions, right, which will see a structural shift in demand due to rising frequency and intensity of physical risk. And the third is new technologies that are required for adaptation such as precision agriculture or alternative proteins in order to make our food security more robust, right? So there are a lot of opportunities in this space, but they're relatively under research, and it is going to be an evolving learning process for us as we try to uncover investment opportunities in this space.

Esther Whieldon: Today, we heard from De Rui how companies with strong sustainability practices can offer better long-term returns. He also talked about how GIC takes a nuanced approach assessing each company's climate transition prospects and risks. We also heard how GIC is focusing on understanding and alleviating physical climate risks and integrating that into its engagement and investment decisions.

Lindsey Hall: And we heard today about the importance of considering social factors in the energy transition. The importance of a just transition was a key idea that came across in my conversations at COP29. Please stay tuned as next week, we'll be back with an interview with United Nations Assistant Secretary-General Marcos Neto, to hear more about key outcomes from COP29 and also what's ahead for climate finance.

Thanks so much for listening to this episode of ESG Insider. If you like what you heard today, please subscribe, share and leave us a review wherever you get your podcast. 

Esther Whieldon: And a special thanks to our agency partner, The 199. See you next time.

Copyright ©2024 by S&P Global  

This piece was published by S&P Global Sustainable1, a part of S&P Global.     

DISCLAIMER  

By accessing this Podcast, I acknowledge that S&P GLOBAL makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in this Podcast. The information, opinions, and recommendations presented in this Podcast are for general information only and any reliance on the information provided in this Podcast is done at your own risk. This Podcast should not be considered professional advice. Unless specifically stated otherwise, S&P GLOBAL does not endorse, approve, recommend, or certify any information, product, process, service, or organization presented or mentioned in this Podcast, and information from this Podcast should not be referenced in any way to imply such approval or endorsement. The third party materials or content of any third party site referenced in this Podcast do not necessarily reflect the opinions, standards or policies of S&P GLOBAL. S&P GLOBAL assumes no responsibility or liability for the accuracy or completeness of the content contained in third party materials or on third party sites referenced in this Podcast or the compliance with applicable laws of such materials and/or links referenced herein. Moreover, S&P GLOBAL makes no warranty that this Podcast, or the server that makes it available, is free of viruses, worms, or other elements or codes that manifest contaminating or destructive properties.  

S&P GLOBAL EXPRESSLY DISCLAIMS ANY AND ALL LIABILITY OR RESPONSIBILITY FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, CONSEQUENTIAL OR OTHER DAMAGES ARISING OUT OF ANY INDIVIDUAL'S USE OF, REFERENCE TO, RELIANCE ON, OR INABILITY TO USE, THIS PODCAST OR THE INFORMATION PRESENTED IN THIS PODCAST.