Hi folks! Happy belated Earth Day, but shouldn’t it, as Katherine Hayhoe says, be every day? It’s been a quiet few weeks on this end, with exam prep and the developments in a certain part of the world keeping me fairly busy when I’m not sleeping, or looking after the two kitties. There’s some interesting content coming up in the next couple of months so stay tuned!
🗽 For those Stateside I’ll be at Adapt Unbound in New York, 21 May. I’m very excited to learn about how companies are accelerating climate adaptation solutions and meet leaders in the field. If you’re going too, stop by and say hello!
I had the opportunity to delve more into ESG-related concepts - which I only had a limited knowledge of before - and how they are pushing the sustainability agenda for many companies and funders (and the pushback against it!). How these concepts translate into reporting frameworks and investment screening criteria, for instance, have made them an increasingly material and integral factor across the investment value chain - from startups and VCs to pension funds and corporates.
That got me thinking, where do security and perhaps more importantly, geopolitics, fit into that universe, and vice versa? Well, a lot really! I wasn’t able to find a tonne of thought leadership and solutions in place (this was interesting, so was this, this and this), so why not offer a perspective here?
Disclaimer: it’s on the bottom of this post, and every other post, but just to clarify: the below are my personal views only and not necessarily those of my employer. OK, brill.
ESG + Geopolitics as the new G…ESGG?
A couple of years ago there were a handful of thought pieces like this one that sought to tie in the concepts of ESG and geopolitics, as the world was beginning to emerge from the pandemic - a globally disruptive phenomenon that brought into focus what it means to navigate uncertainty for the benefit of their shareholders and social licenses to operate. And multiple surveys have shown that geopolitics is a top 3, if not top, macro risk cited by C-suites impacting their balance sheets and operations. But more unclear is how those risks and responses overlap, dovetail, clash etc with sustainability / ESG “state of play” or CEO surveys.
It’s increasingly clear that ESG, as a subset of the broader sustainability universe, is closely linked with geopolitical risk, sharing underlying drivers, risk transmission channels and feedback loops. To offer a flavour of how these play out:
🇺🇦 The Russian invasion of Ukraine has had a devastating impact on human life, economic productivity, and GHG emissions. One study estimated over 120 million tonnes of CO2 equivalent were emitted in the first year of the war - comparable to Belgium’s net emissions for 2022 - largely from fuel consumption by the Russian military. As the Ukrainian military has since received billions in military aid, with over $60 billion this month from the US - the war’s emissions footprint are likely much higher. The procurement / supply chain to enable the fighting - including their emissions footprints - inevitably lead back into the private sector - defence firms, steel and cement manufacturers, logistics providers, etc.
⚾️ The rising anti-ESG push in some parts of the US and Europe is already having an impact on legislation and industrial policy, with ripple effects on flows of capital and the impact of legislation like the Inflation Reduction Act. More nefariously, reports of astroturfing are rising - artificial “grassroots” groups, often created, funded and operated by anti-green political groups or hydrocarbon firms, to push specific agendas e.g. restrictions on solar on rural land. A recent panel hosted by Bloomberg discusses the underlying politicisation of ESG another wedge issue across the deepening ideological divisions seen in the US and Europe - and how corporates and investors have responded (tl;dr: can do better).
⛏️ I wrote a few months back on how the big players, including US, EU, China, India, have all incorporated climate change into their national security strategies and resulting policies - notably in the space of shoring up their critical national infrastructure supply chains and safeguarding access + exploitation of critical minerals. That’s ultimately why firms are mining lithium in Nevada.
Human rights abuses are probably getting more attention than ever (e.g. the treatment of the Rohingya), but what constitutes human rights abuses is ever more divisive, and frequently in the eye of the beholder (politician, activist, investor, shareholder, take your pick!). With trust in governments, civil society institutions and media at all-time lows, the task of identifying, applying and defending normative judgements become far more difficult.
And yet, companies and investors - and people who work / pay / invest in them - can’t back away from engaging with these risks. We may not like to deal with climate change or geopolitics, but they will deal with us.
How does geopolitical risk transmit into sustainability / ESG issues
It’s Saturday afternoon so no Microsoft Paint infographics this time, but geopolitical risk flow into climate and sustainability issues which can inform ESG-related screening criteria, ratings and commercial decisions. Here are, in my personal view, the most likely channels (that’s not to say there are others):
Regulations: perhaps the most obvious way it shows up. The IRA, Carbon Border Adjustment Mechanism, EU climate disclosure frameworks like CSRD and SFDR, the Critical Entities Resilience directive - can be seen in one light as industrial policy which while protecting acceleration of energy transition within their markets, may end up increasing the cost of energy transition at a global level at the decade-level scale and beyond. As many of of the regulations are at least partially motivated by protecting critical sectors, and increasingly those involving the energy transition, how these regulations and their enforcement evolve will be interesting to watch, especially when it comes to the injection of “foreign” investment and M&A activity. Regulatory divergence could also impact everything from project selection, how startups position themselves re fundraising, where VCs look for targets etc. Over time, divergence can have a distorting impact on the progress of the energy transition across geographies, perhaps with countries and regions where accelerated decarbonisation is most necessary.
The regulatory space also interacts with other mechanisms and doctrines ranging from national security investment review mechanisms (US’ CFIUS, Australia’s FIRB), to more defence-driven groupings like AUKUS. AUKUS’ Pillar 2 seeks to advance emerging technology partnership amongst allies, potentially opening the space for technology designed for the energy transition (e.g. battery storage, power grid virtualisation, advanced materials, geoengineering tech) to have dual-use applications. Defence can be a growing funder of offtaker of cleantech for the rest of the decade and into the 2030s as climate realities bite.
Supply chain: are geopolitical risks impacting a company’s ability to source, manufacture, distribute? Are shifting geostrategic conditions e.g. US-China relations in “managed decline” placing downward pressure on the general environment of American firms operating in China, with risks for greater regulator scrutiny, staff detentions, fines and perceptions of an uneven competitive playing field. And are these creating reputational issues at home and abroad for those firms?
Certain sectors are especially vulnerable to geopolitical risk and natsec considerations given the nature of their supply chains, markets and core technology / IP, including mining, steel manufacturing, semiconductors, agriculture, data centres and cloud services. These could create governance and reputational challenges among firms seeking to balance operational matters with societal pressures (e.g. the prospect of lithium mining in Kashmir near the source of the Chenab River, considered one of the five main rivers for Punjab on both sides of the India-Pakistan border)
Sanctions, export controls and tools of the foreign policy trade: we are past the era of free trade (when was the last time someone mentioned WTO in a serious manner?) and going “back” to a time of industrial policy and rising mercantilism. An interesting recent example of this includes the rather comprehensive US export controls regime on semiconductors, which impacts China in the short term but could harm the US-centered supply chain ecosystem in the long run. ESG scores for firms in the sector’s value chain are influenced by their emissions footprint, water usage, supply chain (sourcing, consumers and waste, “circular” economy). “Big picture” movers like US-EU-China tensions do and will continue to have these second-order impacts which will impact ESG considerations in future years.
Managing risk and opportunity
It’s often portrayed as a downside to business, but geopolitics as a risk is often biased because of the lens we use - that the post-1990s business community has thrived in a time of globalisation, increasingly seamless trade and flows of capital, labour and data. We’re not there anymore. The last 30 years are mainly a blip in a long history of fragmentation and rivalry in the international system. Multinationals and parastatals like the Dutch East India Company found ways to profit, if not thrive, long before modern globalisation.
As ESG is also moving towards being embedded in portfolio analysis and investment decision-making at the investment team level, should geopolitics be as well? I hope I’ve presented some evidence to say yes indeed - that the influence on ESG from geopolitical risk is already there. But how should companies manage it?
At the board and management level, some insight could be taken by lifting a page out of TCFD implementation guidelines and modern ERM frameworks:
Setting out governance, strategy, risk management and metrics / targets
Making sure the appropriate strategic risk assessments are conducted and understand where the transmission channels (flows of risk) are into key financial and operational risks for the organisation. SWOT analyses, heat / stakeholder mapping exercises, stress testing and vulnerability assessments are some of the kinds of work that could be undertaken.
Embed geopolitics as an additional high level, non-financial risk in the corporate risk taxonomy, where there are clear, recurring requirements around board reporting, the types of management information requested and periodic audits.
Build an in-house capability to be a centre of excellence - analysis, communications, designing suitable risk controls within operational processes and investment reviews.
Capabilities and processes shouldn’t be siloed but sit at least adjacent, if not integrated into other functions such as government affairs, legal, operational risk, cyber etc. because geopolitical drivers share close links with environmental and social themes, and investment or operational decisions - risk-wise - should be considered holistically (e.g. lithium mines may receive state backing under a country’s energy transition and security policies, but at the operational level create substantial negative environmental, labour and reputational risks)
The same risk assessments could also inform business strategy at the unit or corporate level. But where are the opportunities? While the nature of the opportunity could be quite niche to a firm, industry, country or political environment, the below represent “low hanging fruit”. What do you think are the opportunities?
Aerospace and defence
Nearshoring - supply chain, warehousing
Shored up or emerging moats backed by industrial policy, regulations, protectionism etc. US IRA on hydrogen, European high precision engineering. Future: desire (but willpower politically?) for small moats for energy transition supply chain for solar, EVs
Surveillance systems (frontier defence) and AI-enabled imagery / video processing
Energy transition-related technology with dual-use national defence, easy wins - supporting critical national defence infrastructure, software which encourages interoperability of key defence systems across allied governments.
Interesting bits and coming up next
🎙️ Programming alert: I’ve been speaking to a number of people in the private sector intelligence field on how the art of what they do is changing amid the increasingly VUCA world. Don’t miss next month’s edition for the first interview!
🌮 A couple of months ago the Center for Climate Security published a timely deep dive on the intersection + policy recommendations for food security. I got to hear from the authors recently and came away with a greater realisation that the current ags market are likely underplaying the near and longer-term food security concerns around grain availability, distribution, and caloric quality. There may be a space to explore how co-benefits of climate-resilient agricultural investments and practices could be further priced to reflect their value on food security.
⛏️💧A recent World Resources Institute piece on how mining for critical minerals can worsen water stress.
The Climate Change Resilient Investment entity’s legacy programme met back in February to discuss how to move forward on private investment in climate resilience. Would be keen to see what comes out of their discussions to produce systemic metrics to measure resilience in support of future financing efforts.
A new paper highlighting that terrorists are relocating due to climate change impacts. I haven’t read the paper in full, but I’m a little skeptical of the A-to-B relationship. What do you think?
Until next month, I’m out!