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Future winners integrate sustainability into their business models

“Integrating sustainability into a firm’s business model can lead to higher returns and create new strategic opportunities,” says Magnus Billing, CEO of Alecta, a 103-year-old pension company that’s regarded as one of the world’s most reputable. Alecta’s holding companies are well placed to take advantage of these new possibilities and have already started to integrate sustainability into their business models. But Alecta is also clear that the integration of sustainability must not adversely impact profitability.

We had the pleasure of meeting with Magnus on a warm, sunny day at Alecta’s office in Stockholm. It’s been an unusually warm winter in northern Europe and, according to the Swedish Meteorological and Hydrological Institute (SMHI), the increase in Sweden’s average temperature is approaching 2°C, compared to the global average increase of 1°C.

This is perhaps one reason why Sweden, and Alecta, takes the climate issue so seriously. Alecta assumes a long-term responsibility, which is why sustainability plays a central role. Magnus believes that sustainability is broader than just the climate issue, and Alecta uses both the Paris Agreement and the UN Sustainable Development Goals as objectives to guide its sustainability work.

Corporate governance is the primary tool

Alecta manages collective occupational pension schemes and works primarily with the ITP agreement, which is a supplementary pension for the industrial and commercial sectors. Their aim is to ensure a good return and provide security for current and future pensioners.

To do this, Alecta has a sophisticated investment strategy that includes long holdings in 100 listed companies, combined with other strategic asset classes. With almost SEK 1,000 billion in assets under management, Alecta is a significant player in the Swedish capital market, so has a great opportunity to influence the companies it invests in. More specifically, Alecta wants to influence their ability to take a long-term approach and promote sustainable development.

Magnus says Alecta’s sustainability work is contributing to a more sustainable pension system. His version of a sustainable pension system consists of three pillars that support a temple. The first pillar is to create a good pension for Alecta´s customers. The second is to secure a stable and trustworthy Alecta that can fulfil its pension obligations into a distant future. And the third is to invest the capital Alecta manages in a responsible way in line with customer expectations. Corporate governance is a central part of responsible investments and therefore fundamental to Alecta’s sustainability work. It’s a question of ensuring that companies have an effective board of directors and management team that can generate value over time.

Sustainability represents an opportunity

Sustainability presents an opportunity that requires careful consideration to seize. This is clear today in the automotive sector, Magnus says, where companies have taken different positions. The business models of tech-focused companies, like Tesla and Waymo, are designed to manage future change while traditional business models struggle with the changing landscape. Some car manufacturers today risk remaining in the fossil fuel world.

Along similar lines, Magnus believes that the climate issue today poses a risk that will affect the cost of capital for companies. This view hasn’t always existed in society and Magnus draws a parallel between cybersecurity and climate challenge. A few years ago, cybersecurity wasn’t considered a risk but today it’s one of the most significant that companies need to deal with. Although sustainability can represent a risk, its opportunities are even greater. The results of Alecta’s latest customer survey could not be clearer – most want Alecta to manage their money sustainably, and climate is identified as having the largest potential to contribute positively to investment returns over time.

The challenge of sustainable investing

As the demand for sustainable investments increases, there’s a growing risk of greenwashing, says Magnus. “The Green Bond market is growing at an incredible pace and we can’t be certain how the money is being invested due to the fact that feedback is received only after a certain period of time.” As a result, there’s a risk that bond issuers will use the invested money for a different purpose to what they originally communicated. So, there’s a need to increase transparency in the market as it relates to sustainable investing.

To encourage market interest, there have been discussions as to whether capital requirements should be lowered for those who invest in products that are classified as ‘green’. Magnus believes such incentives are a bad idea if they’re not risk-based. Lowering capital requirements for ‘sustainable’ products without a proper risk assessment will lead to financial instability in the long run.

Another complexity around this topic is the need to consider carbon pricing. There’s a large discrepancy in the market today around the future prices of carbon emissions. This means there’s a risk of inconsistent assessments of future profitability, which could mean companies receive incorrect valuations and risk ratings. This, in turn, can lead to systemic risks in the financial market, Magnus says.

“We’re well on our way to getting investors to steer capital towards more sustainable investments.”

The need for a CO₂ emissions strategy

Under the Paris Agreement, countries are aiming to keep the increase in global average temperatures below 2°C compared to pre-industrial levels. A total of 184 countries have ratified the Paris Agreement and more than 40 governments are pursuing policies that will increase carbon prices, either through taxes or cap-and-trade programmes that put a cap on carbon emissions aggregated per market and permit the trading of emissions allowances.

About ten countries have introduced market-based cap-andtrade programmes. The European Emissions Trading Scheme (ETS), which covers major industries, energy companies and aviation, has previously had relatively low emissions prices. However, the European regulatory framework was reformed in 2018 with a significant tightening for the upcoming trading period of 2021-2030. This, combined with investor speculation, resulted in a significant price increase in 2018, with prices more than tripling from €7 to €25 per tonne of CO₂.

Twenty countries, including Sweden, have introduced a carbon tax where the polluter pays for the external effects of their activities. The Swedish carbon tax is the highest in the world at €106 per tonne of CO₂. However, the Swedish carbon tax comprises rebates and excise duties depending on the industry, and sectors covered by ETS are exempt.

CRU, a commodity market analysis firm, predicts the price of emission allowances will increase to €40 by 2028. Within the Environmental and Social Risk (ESR) framework, the EU aims to reduce emissions by 40 per cent by 2030 compared to 1990 levels. The EU Commission’s proposed Green Deal, introduced late last year, suggests an even more ambitious target of reducing emissions by 50-55 percent by 2030. The aim is to achieve this with further tightening of emissions ceilings.

The EU has also set a target of reducing emissions by 60 per cent by 2050 compared to 1990 levels. Higher emissions prices mean that both investors and companies will need to consider the carbon footprint of businesses when evaluating their investments, risks and strategies.

Collaborating to effect change

Imposing high sustainability requirements on companies can be costly in the short-term as it can lead to distorted competition. To drive change in complex issues such as sustainability, there must be collaboration. Alecta is therefore active in several Swedish, European and global forums to contribute to a comprehensive approach to sustainability. “It requires multiple parties to work together on the sustainability issues in order to create the right conditions and standardisation in capital markets,” says Magnus.

Magnus was one of 20 experts in the High-Level Expert Group (HLEG), which the EU Commission asked to come up with recommendations and reforms to transform the EU financial markets to become sustainable. The HLEG found, among other things, that pension companies, with their long commitments, are particularly suited to sustainable finance. Despite this, the report points to the fact that only five per cent of pension companies handled the challenge of sustainability in their portfolios in 2018. Two important conclusions in the report are that the market needs to increase transparency and that investors need to take a clearer responsibility for sustainability. A first step is to create a common taxonomy for sustainability to be able to make consistent comparisons between companies.

Swedish Investors for Sustainable Development is another important forum that Alecta is involved in. It aims to explore the investor’s role along with the sustainability risks and opportunities linked to the UN’s Sustainable Development Goals.

More specifically, the Forum is the result of the 17th UN Sustainable Development Goal, Implementation and Global Partnership. “All authorities have a responsibility to integrate the goals into their activities,” Magnus said. Members of the partnership, including institutional investors, pension companies, investment companies and the Swedish aid authority SIDA, participate in working groups linked to the global goals. Because of their work, the UN drew attention to the initiative and was so impressed by the collaborative nature of the forum that they started a similar one, the Global Investors for Sustainable Development (GISD) which was convened by the Secretary General in September 2019.

To demonstrate that Alecta takes contributing to climate change seriously, they became co-founder of a UN-backed climate investor alliance in 2019, the Net-Zero Asset Owner Alliance (AOA). The objective of the initiative is for investment portfolios to be climate neutral by 2050 (setting milestones for each five-year period). Therefore, the members of the AOA have a common objective to make a clear shift in their investments.

The above forums and alliances are just a few examples of the sustainability initiatives that Alecta is a part of. Magnus concludes by saying that we’re well on our way to getting investors to steer capital towards more sustainable investments that provide positive returns and minimise risk. Eventually, this will also encourage companies to establish more sustainable business models.

And when we followed up with Magnus in April, in the midst of the COVID-19 crisis, he reiterated that it is absolutely crucial to not lose the longer perspective and the challenges that will still be here when we get through this pandemic.

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