In January, along with many peers, your author predicted three big sustainability themes for 2025: climate impacts, ESG maturing and impacts of AI. This feels longer than six months ago with the Trumpian geopolitics, FCA-EMSA-SEC regulatory flows, AI-powered technology and climate impacts since. Now is a good time to reflect on progress – a midyear checkpoint – and consider what investors need to do in order to manage the risks, or gain from the opportunities, that these sustainability themes present.
Invisible greenhouse gases lead to visible climate impacts
The effects on economies of a high concentration of greenhouse gases in the atmosphere are becoming increasingly evident. Look at the floods in Spain or wildfires in California.
Some progress at the last two COPs helps a little; fossil fuels were mentioned for the first time, but phasing ‘down’ instead of ‘out’. A couple of more bright spots for climate watchers were India (number three for emissions after China and America) planning to tax emissions, and emissions potentially peaking for China. But there are clouds too with no credible plans in the US for a carbon policy or for taxing carbon, except in California. Or the risk of UK government spend on sustainability being cut for other areas (read: defence and welfare), with Defra and the environment a lower priority in the autumn budget. And the risk to the UK’s commitment to net zero, legally binding in the 2008 Climate Change Act, in parties’ manifestos for the next election.
The results therefore are not a surprise. The concentration of carbon burned and released as carbon dioxide, the greenhouse effect measured in parts per million, continues its relentless upward march over 420ppm. And it’s similar for the rate of deforestation and land use change. Extreme weather events continue. Right now it’s wildfires in Greece, extreme heat (over 45°C) in Iberia, lives lost from heat making existing medical conditions worse, floods in Texas, and the urban heat effect making cities a few degrees warmer.
For investors, reporting emissions for their debt or equity holdings (called scope 3 or financed emissions) and disclosing climate strategy and governance is now commonplace. But there are opportunities that go beyond this. Increasing the energy efficiency of a building can enhance valuation or rental income, and avoid it becoming ‘stranded’. Engaging with equity or bond holdings can show impacts to future cash flows and to dividends or credit risk. Imagine a carbon tax of $100 per tonne added to a company that emits thousands of tonnes, and this cannot be passed on to customers. Carbon dioxide removal is a new sector emerging. Reducing emissions is a priority for many countries – and the IEA, with big forecasts for solar – which means opportunities for renewable energy. There is capital for actual private, real assets or for accessing the energy transition through public markets. So expect more physical impacts, but matched by investor allocations and engagement on climate.
ESG matures
There have been criticisms. A lack of impact, collusion against fossil fuels, and not aligning with strict fiduciary definitions of shareholder primacy. The name ‘ESG’ might not survive. But what it stands for will survive. Investors’ fiduciary duty means all stakeholders must be considered to protect and enhance asset values: shareholders of course, and also communities, colleagues and the environment. There will be more extreme weather as we just saw, but more investment, innovation, policy, technology and competitor activity in sustainable investment. After one year, around 130 funds have gained a label for sustainability under the FCA’s new regime: Impact, Focus, Improver, Mixed Goals. And Morningstar data still shows net flows into sustainable funds.
For investors, this requires clarity of purpose and why they are acting responsibly, and then sustained conviction. This means integrating material sustainability factors to investments, being active owners and empowering investees to achieve positive change, and transparently reporting the outcomes achieved.
The rise of AI
This has had two significant implications for sustainability. First, energy. Language models and machine learning are adding to the digitisation of everything that was already happening. If this is powered by renewable energy, or nuclear, then all the better. But concerningly, some climate scenarios still include coal, oil and gas increasing, including for AI.
Second, data and privacy. This is a common Governance factor in investments – ask anyone who holds shares in M&S plc. If a company is pursuing an active AI integration strategy, where is the data coming from, especially if it’s personal data? Licensing with users’ permission is fine (eg, medical records), scraping from public sources (eg, social media) might be grey, and without permission or awareness (‘this is my face!’) will likely lead to an ESG controversy.
For investors, AI and data can be handled like any other ESG factor in analysis and engagement dialogue: Is there evidence of responsible AI? Is there awareness and a policy? Who on the board provides oversight of AI and are they qualified to do so? Are greenhouse gas emissions reported, with plans to reduce? Are social risks being created? Is the company lobbying for, or against, legislation on transparency? Results then form part of the investment thesis and asset valuation.
The world is changing, and so is ESG
Come December, we will have seen more evolution in these trends, and the themes for 2026 will be forming. Lots of geopolitical activity next year can be expected: trade wars and tariffs, MAGA, wars in the middle east and Ukraine, populism, inflation, costs of living and high interest rates. Sustainability will feature too, with net zero and more focus from asset owners on implementation and outcomes. It is the investment managers that are genuinely and authentically integrating sustainability, and have a thorough awareness and response to climate impacts, that can meet their fiduciary and moral obligations, and respond to the ESG themes in mid-2025 and beyond.
To discuss these themes and how Ilex Associates can help, please contact us here.
