The Dichotomy Between Transition and Exclusions

    Stockholm (NordSIP) – One of the tensions at the heart of sustainable investing is knowing when to offer a carrot and a helping hand and when to use the stick and strike laggards. For investors looking to draw a line in the sand, exclusions and divestment are the tool of last resort in handling companies and sectors that are simply not compatible with a sustainable and carbon-neutral vision of the future. However, for companies that have correctly understood the direction in which the winds are blowing and embraced the need for change, sustainable investors can be supportive during the transition.

    However, threading the needle between one and the other is not always evident to the untrained eye. The subtleties of exclusions can be tricky. Seldom do investors apply blanket bans on entire sectors. Given the interconnectedness of the global economies, exclusions are normally applied to companies above a certain threshold of revenue or ownership. This can create confusion to the general public who expect exclusions to be absolute and total.

    Exclusions and Transition

    The issue became evident this week on Swedish media when the Handelsbanken Hållbar Energi fund was singled out for investing in Chinese energy company Longyuan, which specialises in wind power, but has assets in other types of power production. While the fund was criticised for the fact that Longyuan has two coal power plants in operation since 2008, its portfolio manager, Patric Lindqvist (Pictured), noted that the share of coal power in Longyuan’s turnover small and has decreased to 7% and is forecast to decrease to 6% by the end of the year.

    The fund applies a wide range of exclusions, but these work on thresholds. In addition Handelsbanken Fonder may invest in companies that exceed the thresholds, provided they are actively contributing to the energy transition

    When looking at exclusions, fossil fuel companies are excluded if their participation in production and mining or if they contribute to the distribution of fossil fuel to a degree equivalent to 5% of turnover or more, which is fully in line with current industry practice. Companies are also excluded if they participate in activities associated with fossil fuel services to a degree equivalent to 50% of their turnover. “ The forecast is that the number will go below 5% by 2023. By that point they will no longer  be a fossil fuel company by the standards of the industry, ourselves included,” Lindqvist explains.

    Transitioning companies and Transparency

    According to Lindqvist, Longyuan has been independently assessed by Handelsbanken Fonder’s Sustainable investment committee to be a company in transition. According to Handelsbanken Fonder, asides from contributing in a significant way to reducing climate impact, transition companies need to fulfil three requirements. “The company’s planned growth should be in line with a global warming of a maximum of 2˚C.  The company’s current business operations may not consist primarily of fossil fuels. The company’s current rate of investment supports the transition from fossil fuels to renewable energy.”

    Discussing the issue with NordSIP, Lindqvist was keen to emphasise that there is no attempt to confuse potential investors in the fund. “We are extremely clear that we are investing in transition companies. We are not trying to hide the fact that we are investing in these companies but rather being forward-leaning in order to help drive change. The perfect is the enemy of the good. We need to work on every lever we have. A hybrid car is good, even if it is not perfect,  the key is that its impact on the climate is good.”

    A Holistic Approach

    “My mandate is to invest in services and products that produce climate impact, not just to exclude those companies that operate in problematic sectors. We follow a solutions-oriented investment style. Not just to exclude and walk away but to support companies that are driving transformative climate solutions,” Lindqvist explains.

    “Over time I am sure that the thresholds will continue to fall. It might be zero or it might be slightly above that. There’s an argument to be made either way. However, it is very clear to me that I should support companies that are aligned with and seek to facilitate the UN SDGs. That what we are doing in this case,” he concludes.

    Image Courtesy of Handelsbanken

    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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