While some investors avoid these companies due to their high current emissions, others see them as opportunities to influence management towards achieving a lower carbon footprint. Here, we delve into the complexities of climate change, corporate decarbonisation, and the critical role shareholders play in this transformative journey.

Balancing energy needs and growth in Asia

Asia presents a unique challenge in the global effort to decarbonise. The region boasts impressive economic growth and burgeoning populations, and while per capita carbon emissions are relatively low, gross emissions are still among the highest in the world due to the large number of people. As these countries develop, their energy and electricity consumption per capita is expected to rise, potentially leading to significant increases in gross carbon emissions.

Consequently, the focus for these countries is on how to reduce their gross emissions while continuing to grow their economies. This is possible but challenging. Ambitious decarbonisation plans and net-zero commitments are in place across Asia, with countries like China and India making notable strides. China is rapidly transitioning its power sector by increasing the penetration of renewables. India is following suit, with a substantial portion of its new power capacity coming from renewable sources. However, achieving these goals must meet energy needs, uphold social welfare, and ensure energy security, all within a stable and predictable regulatory framework.

The role of governments and shareholders

The interplay between governments, regulators, and shareholders is crucial in driving decarbonisation. Given the capital expenditure costs involved in decarbonisation investments, it’s important to have stability between governments and regulators. This gives companies and their shareholders confidence that they will see a return on their investments.

In this environment, shareholders, as providers of capital, have a responsibility to steward and engage with companies, encouraging them to decarbonise. Over the past few decades, parts of the financial industry have moved towards decarbonising portfolios by divesting from high-carbon companies. However, this approach doesn't necessarily translate to real-world decarbonisation. Selling off coal-fired power plants or cement producers might lower the carbon intensity of a portfolio, but it doesn't change the operational reality of those companies. Therefore, shareholders must engage with these companies, fostering a genuine transition from high-carbon (brown) to low-carbon (green) operations.

Risks in the decarbonisation process

Two significant risks have emerged in the decarbonisation narrative: superficial commitments and transition washing. Some companies might present a compelling story about their decarbonisation efforts without substantial follow-through, posing a risk to unwary investors. On the other hand, some investors claim to support a company's transition but engage minimally, undermining genuine progress. Therefore, fund managers and their clients must ensure they are doing what they say and that companies are genuinely making progress.

Engagement is critical to mitigating these risks. Successful engagement with companies requires patience, tenacity, and a constructive approach. Investors must be on the ground, close to the companies in which they invest. This allows them to understand local contexts, regulations, and dynamics. Regular interactions with management are essential to foster meaningful dialogues about decarbonisation strategies. Additionally, a global network of analysts can help influence a company’s strategy by providing examples of what has worked in similar markets.

Importantly, there’s mounting evidence that a sustainable approach can positively affect a company’s bottom line. In Asia, investors are beginning to differentiate between high- and low-carbon companies in terms of valuations. Green companies, or those making significant strides towards decarbonisation, are starting to be valued more favourably. Consequently, while the capital expenditure costs of a more sustainable approach are significant, the financial benefits encourage more constructive engagement with high-carbon companies as they transition to greener operations.

A framework for investing in transitioning companies

Our team at abrdn has developed a comprehensive framework for investing in high-carbon companies on a transition path. This framework evaluates whether a company operates in a high-carbon sector, has a net-zero goal, possesses adequate climate governance, and recognises the necessary capital expenditures. Companies that meet these criteria and demonstrate potential for positive engagement are considered for investment.

After investing, a clear engagement plan is crucial. This plan involves collective engagement strategies, regular progress reviews, and potential escalation, if required. This approach ensures investors can demonstrate their commitment to driving real-world decarbonisation and achieving the desired outcomes for their clients.

Client perspectives on transition investing

Sophisticated clients increasingly recognise that simple divestment from hydrocarbon companies won't achieve the desired decarbonisation. Instead, they’re interested in transition strategies that balance environmental impact with potential returns. These clients seek assurance that their investments are contributing to meaningful decarbonisation while also securing financial gains.

Final thoughts…

The path to decarbonisation requires a collaborative effort between governments, regulators, and shareholders. By using a clear framework, engaging with high-carbon companies, and supporting their transition to greener operations, investors can play a pivotal role in achieving sustainable growth. This approach not only addresses climate change but also offers potential financial rewards. This makes it a compelling strategy for the future.

You can listen to David discuss this topic and more on a recent episode of The Emerging Market Equities podcast with Nick Robinson.