Contrary to the expectations of many who imagined that ESG matters would inevitably take a back seat in the face of COVID-19, if anything ESG achieved even greater prominence among investors and companies in 2020, with social issues caused or accelerated by the pandemic joining climate in the spotlight.
In 2021, while it remains to be seen how substantive the UK’s green initiatives turn out to be, the fact that the country is hosting the COP26 conference in November guarantees that climate change will maintain an extremely high, and by extension corporate, profile over the coming months.
While long-dated, national and supranational plans to reach net zero are already starting to have real bite, the EU’s carbon trading system, which was introduced in 2005, has seen the price of emissions allowances reach record highs as emitters and financial market participants respond to the EU’s plans, and the UK plans to launch its own carbon trading system later this year. There are also signs that central banks – widely criticised for including high carbon assets in their asset purchase programmes – are starting to look more closely at the climate impacts of their actions.
Less widely discussed than climate, but inherently interconnected and of arguably equal importance, is biodiversity. In the UK, the final report of the Dasgupta Review on The Economics of Biodiversity was published in February 2021 and has been likened in significance to the Stern Review on the Economics of Climate Change that was published in October 2006. It is a precursor to the UN’s COP15 Biodiversity Conference, which is now due to take place in October 2021.
It is against this background that L1 has introduced an ESG policy, which was approved by the Board in December 2020. L1 believes that to sustain long-term value creation, a company must understand the societal and environmental impact of its business, as well as structural trends that might affect future growth.
Capitalism is facing a period of fundamental change and challenge. Each industry faces an industrial revolution and is in significant flux because of changes in societal expectations, demographics, and technology. The speed of technological change and transformation poses huge challenges, but also presents huge opportunities.
As long-term investors, we assess each investment in relation to these global challenges and work with investee companies’ management to navigate these paradigm shifts and changes to their operating models, including the environmental and social impacts of their businesses.
By identifying and assessing relevant ESG criteria as part of our investment process and by ensuring that risks are properly managed and opportunities capitalised upon, L1 helps create more successful and sustainable businesses over the long term. This can enhance our investment performance through reducing reputational risks and minimising unnecessary costs while at the same time contributing to building a more stable, sustainable society and inclusive global economy.
Our ESG approach
L1 currently invests through majority or minority equity holdings in public and private companies or through structured equity. We invest our own patient capital in companies where we believe our sector experience, strategic and geographic expertise will improve performance. We are therefore, in some cases, in a position of control or significant influence on the strategic direction and operations of a company. In others, we are a minority shareholder, with limited ability to influence management.
Recognising that ESG issues can be an important driver of investment value and risk, as part of our investment due diligence process, L1 considers key ESG issues and the response to them, such as: climate, use of natural resources, waste management, human capital, diversity, supply chain and social capital, transparency, anti-bribery, and corruption.
Where L1 controls a company, it seeks to work with the company management to integrate and monitor progress on material ESG issues in areas of risk or opportunity. In order to encourage investee companies to embrace ESG, every investee company we control is required to have an ESG policy.
In companies where L1 has limited ability to influence and control the integration of ESG issues into the business plan, where possible, we will seek to monitor risks and engage management in order to persuade them to put ESG policies in place.
Pre-investment due diligence
As part of our pre-investment due diligence, L1 investment teams start by considering our Exclusion List to ensure that we do not make direct investments in companies that we consider incompatible with the UN Global Compact and our responsible investment approach.
We will not knowingly invest in companies that:
- manufacture or distribute or sell anti-personnel landmines, nuclear, chemical, biological weapons, or cluster munitions;
- have as their principal activity the manufacture of arms, ammunition, or tobacco; and/or
- are complicit in systematic abuses of human rights or labour rights (including child labour).
Where any of the following issues are identified as part of the due diligence process:
- direct involvement with thermal coal production;
- responsibility for deliberate environmental damage through their own operations or supply chain; and/or
- association with corruption, including extortion and bribery,
the investment in that company will not proceed unless these issues can be effectively mitigated.