As the world grapples with climate change, businesses are set for a major transformation. Some companies would need to find new business areas (for instance, automakers’ move into electric vehicles). Others would have to deal with the looming physical dangers of climate change to their operations and assets. Most of all, it’s imperative that companies reduce their carbon footprint to attract sustainability-linked investments.
So, what is at stake for businesses?
Companies need to move fast—and early—to measure their carbon footprint and decarbonize their operations, or else they will lose their competitive advantage, their cost of capital will go up and they will end up as “losers”, MSCI chairman and CEO Henry Fernandez told The Morning Context in an interview on the sidelines of the UN climate conference (COP27) at Sharm el-Sheikh in Egypt. The New York-based global index provider’s 160,000-plus indices of stocks and other financial instruments are used as benchmarks for global investments worth $13.5 trillion. With passive index-based investing on the rise, the company’s index selection directly influences investment flows to firms. MSCI is already working with institutional clients to reweight their investments to factor in climate-related risks and opportunities, Fernandez said.
Excerpts from the interview, edited for brevity and clarity, follow.
How important is it for companies in India to start thinking about climate change and carbon-related data?
If you don’t have any visibility as to what is a big climate risk to the company, what is a low risk, you have no tools. It is like navigating a plane without any instruments. To understand what the altitude of the plane is, whether you are going up or down or are close to landing—it is all necessary and foundational to have a target, to know where you have to go, and therefore be able to make a decision.
If you ask any Indian company or any company around the world what their carbon footprint is, they don’t know. They have no idea. Because it has never been measured. It has never come into the dialogue. It has never been part of the equation. So the companies need to start taking stock and say, what electricity do we use? How much carbon emission does that electricity create? Where are our employees, what are their commuting distances from home to work and how much carbon emissions are they responsible for—these are estimates. A lot of companies have people travelling; what are the carbon emissions of those people travelling around the world? Then you say: Okay, let me understand if I am producing a good, what is the emission of that production process? If it is iron and steel, it is going to be high. If it is software in Bangalore, it is going to be low. Who are my customers? What do they do with my product?
The first step for a company is to take stock of a lot of this. It is not even action at this point. It is not even about changing. You’ve got to take stock to then say what kind of problem I have. Do I have a small problem, or do I have a big problem? Is my problem located in the electricity that I use, or is it in the supplier that I use, or is it in the use cases of the use case of products by my consumers. This is not new, but it is accelerating. Therefore, companies need to start taking stock to know how much to do.
The fortune will favur the prepared. It will favor the first movers. Right now, if you are an Indian company, with very old plants or very old operations, you cannot afford to drop everything you’re doing in order to go fix this problem. You’ve got products to sell, customers to keep and so on. So the earlier you can get going in trying to address the problem so that you can take your time, you can budget the costs every year gradually in order to get to the destination.
How soon should they start doing this?
Think about what banks are doing right now. Early parts of this pressure point are going to be in corporate loans. Regulators are very concerned about the climate risk of the industry. They don't want the capital of the banking industry to decrease. Think about the financial crisis [of 2008]. The biggest problem of the financial crisis was the decapitalization of the banking industry— meaning the capital of the entire industry went down. That’s very lethal in an economy.
Similarly, the capital base of insurance companies is going down. They’re very afraid of that. So they’re forcing banks to go through the climate risk in their loan portfolio, and the climate risk in the bond portfolio of insurance companies, and say “we want to reduce that risk significantly”. And they have not yet started putting capital charges, but they will start putting those soon too.
If my average loan book has a high risk, if my average corporate loan book in an insurance company has a high risk, and I have to meet certain targets in three or five years’ time, it’s going to be very hard to take the entire book and switch it. It is impossible. So, what you’re going to do is the incremental investments you make have to be in low-carbonizing entities in order to change the averages. So, what is common is a major capital rationing in banks and insurance companies, which are the largest providers of credit. That is not like 10 years from now. This is now. And it is going to accelerate in the next few years. The [European Central Bank] is pushing that; the Bank of England is pushing that.
In a lot of emerging markets—and I come from an emerging market—people are waiting for somebody to solve the problem for them. The government is going to tell us what to do. NGOs are going to tell us what to do. The World Bank will tell us what to do. Some of these organizations are going to tell us what to do. It doesn’t take a brain surgeon to know what to do here.
How will this affect equity investments?
The biggest early amount of work that we’re doing is for pension funds and sovereign wealth funds in looking at their listed equity portfolios. A lot of these people are benchmark or actively or passively replicating a market cap index. So a lot of the work we’re doing is taking that index, of, say, 3,000 or 10,000 companies, depending on the index, and then we’re reweighting the market cap of the companies according to certain climate criteria. When you move from one index to the other, you are going to sell a high-carbonizing company and you’re going to buy a low-carbonizing company. Therefore, the cost of capital—the prices of the equity securities, of those companies that are high-carbonizing—the prices will be lower or at the margin. And the cost of capital is going to increase. So if you’re one of these companies, not only is it a business competitive advantage of products and compliance and all that, but also a question of access to finance, access to loans of banks, access to capital markets and the cost of the access to equity markets, and the cost of your access to that.
What would be your message for Indian companies?
My advice to Indian companies is: You’ve got to wake up and see what’s going on around the world—not only in your country, [but] at all the climate change issues and physical risks. And to say “I’ve got to join the people that are going to be building competitive advantage.” Think about this: There would be so many changes in industries, dramatic changes. Think of the auto industry. The market cap of Tesla is bigger than that of every other auto company in the world combined. And that is just one industry. The question is, are you going to be the Tesla and General Motors of the world, or are you going to be the losers of this world? And if you don’t act now—this is not a question of voluntarily—if you are running a company and if you want to protect and enhance the shareholder value, you need to understand that there are a lot of risks here and also a lot of opportunities. And if you don’t move relatively early so that you can pace yourself, you’re going to get caught.
The world is a free world. You need to make a decision as a company—are you going to be a part of the losers over time who are not going to decarbonize their operations, or are you going to be a part of the winners? Because there will be major competitive advantages for those companies that position themselves for the new world and the new economy. And major competitive disadvantages that those that don’t.
This story was produced as part of the 2022 Climate Change Media Partnership, a journalism fellowship organized by Internews’ Earth Journalism Network and the Stanley Center for Peace and Security. It was first published by The Morning Context on 10 November 2022 and lightly edited for length and clarity.
Banner image: The Indian city of Bangalore, where many technology companies have their headquarters / Credit: satyaprakash kumawat via Unsplash.