Trade restrictions on Chinese cotton due to human rights concerns demonstrate how modern slavery issues directly affect investors. Regnan’s ALISON EWINGS explains

THE price of cotton is near a decade high as surging demand and lower supplies threaten to raise the price of our t-shirts and jeans.

Making matters more complicated for fashion producers, governments are increasingly implementing restrictions on cotton imports from the Xinjiang region in China, which accounts for around a fifth of the world’s cotton supply.

For the past five years China has faced international allegations of forced labour and worse abuses against the Uygur Muslim population in Xinjiang province. Beijing denies the allegations.

These modern slavery concerns mean manufacturers and retailers — and their investors — have to rethink supply chains, manage cost pressures and consider different products.

In Australia a Modern Slavery Act has been in force since 2019, covering “situations where offenders use coercion, threats or deception to exploit victims and undermine their freedom”. It includes forced labour, human trafficking, child labour, debt bondage and forced marriage.

Impact on investors

Trade restrictions on Xinjiang cotton demonstrate real-world consequences for investors.

“We are seeing a number of apparel companies pull their supply and production out of the Xinjiang region in China in response to concerns about potential forced labour activities,” says Alison Ewings, Head of Engagement at responsible investing leader Regnan.

Pendal’s small cap team recently engaged with ASX-listed fashion retailer City Chic Collective (ASX:CCX) which has moved to ban raw materials sourced from high-risk regions such as Xinjiang.

“The remaining global cotton supply is in high demand.”

Over this time the price of cotton has jumped sharply. Cotton futures are trading close to $US1.20 a pound. It was last that high in 2011.

Governments and corporates have stepped up efforts to address human rights concerns in Xinjiang in recent years.

For example, imports of tomatoes and cotton from Xinjiang province has been banned in the United State since January 2021 and in Canada since July.

The Better Cotton Initiative — a global organisation of more than 2000 suppliers, manufacturers, retailers, traders and community groups — has driven change in the industry.

The flow-on from the disruption is widespread across industries using cotton and other similar fibres.

“There is an opportunity for some businesses to rethink the materials they use,” Ewings says.

“They can consider the extent in which they use recycled fibres or alternatives, such as more sustainable fabric solutions including bamboo or other tree fibres.

Risks and opportunities

“It means solution providers with an alternate for cotton are a potential investment option. It also means there’s a potential risk to a company currently held that use cotton in its supply chain.

“If you’ve already got cotton in your supply chain, you’ve got higher risks, you’ve got greater regulation around modern slavery and greater expectations that you will be vigilant around it.

“You really want to be looking for companies that are managing that risk well and you want to look for companies that are looking for alternate opportunities,” she says.

Australia and the rest of the globe is only at the beginning of the journey on modern slavery, says Ewings.

“There’s much greater awareness as a result of modern slavery regulation around the world, including the Modern Slavery Act in Australia.

“Most companies have now done at least a cursory look through their supply chains. Better practice companies have gone deeper looking at their suppliers.

“But it’s still an area where many companies haven’t made a lot of meaningful progress.

“It’s a story where we expect to get more bad news before it gets better. And that, in fact, is a sign of progress. After all, companies can only act on issues once they have identified them.”

Investors need to work together to drive positive change since many pressing problems can’t be solved at a portfolio or company level, finds Regnan its annual Engagement Impact Report

• Climate change, modern slavery and Indigenous relations top issues
• 92% of Regnan’s active engagements demonstrate progress
• Download Regnan’s Engagement Impact Report 2021

RESPONSIBLE investing leader Regnan undertook 87 engagements with 44 ASX-listed companies over the past year, aiming to help improve business performance by addressing issues such as climate change, modern slavery and Indigenous relations.

Regnan supports some of the world’s most influential investors, investor networks and responsible investment initiatives in a number of ways, including via a company engagement program.

Regnan’s just-released Engagement Impact Report 2021 [PDF] shows that the 44 companies represented more than half the market capitalisation of the S&P/ASX 200.

“A quarter of the companies engaged were new to the current program — we continue to refresh and expand our influence, focusing on companies with material issues rather than relying on existing relationships,” says Regnan’s head of engagement, Alison Ewings.

Regnan says the COVID-19 pandemic has revealed the interconnectedness of the world and highlights the vulnerabilities faced by a globalised world.

The insight for investors is the need to consider not only risks to their own portfolios, but also work to understand and have an impact at a systemic level.

For example, feeding a growing global population in a sustainable way, tackling climate change and modern slavery are all examples of issues that cannot be solved by a single company or at a portfolio level.

“Our engagement efforts are focused on key participants within the value chain,” says Ewings.

“The need to collaborate to enhance impact has always been a part our collective engagement model. But this year has seen us change the way we work with clients, increasingly working more closely together on issues of importance.”

Top issues ASX investors should look out for

What are some of the material ESG issues that Regnan finds most prevalent in its engagement work with ASX-listed companies?

This year saw a continued rise in social issues become part of engagements including political lobbying, cultural heritage and stakeholder relations.

Among key focus areas, Regnan highlighted cultural heritage and indigenous relations as important issues this year after Rio Tinto’s destruction of cultural heritage at Juukan Gorge exposed questions about the relationships between companies and Indigenous communities.

Regnan has been working with HESTA, the $60 billion health and community services superannuation fund, to engage mining companies facing similar issues. Companies engaged included Rio Tinto, BHP Group, Fortescue Metals Group, Alumina, Newcrest Mining and Evolution Mining.

The focus has been on the effectiveness of internal reviews and the need to include traditional owner groups in reviews of company performance. The approach recognises that communities are also impacted by unlisted and global stocks and therefore the role of both companies and investors in the public policy process is also an important one.

Other engagements over the past year included sustainable agriculture, climate change, modern slavery and the role of board overseeing the conduct of executives and culture more broadly.

Regnan is now widening its engagement focus to cover the perspectives of debt holders as well as equity investors.

“This has included seeking enhanced ESG performance from issuers, as well as the quality of disclosure and performance within sustainability bonds issued by ASX200 companies,” said the report.

Regnan is also expanding engagement to selected ASX300 companies where there are risks for investors and a strong case for change as many of them grow.

Here’s are some of the most common topics covered in Regnan’s company engagements:

• Climate Change
• Social (eg political lobbying, cultural heritage and stakeholder relations)
• Disclosures
• Human capital
• Remuneration
• Workplace safety
• Diversity
• Board issues
• Modern slavery
• Conduct

Read the Engagement Impact Report 2021 here.

Murray joined Pendal in June 2020 to provide fundamental credit analysis and integrate ESG across credit funds.

Before joining the team, Murray worked as an independent consultant measuring ESG for family offices and Private Equity firms. Prior to this Murray was a Research Fellow at the Institute for Economics and Peace where he led research for the Institute on the Sustainable Development Goals, violent extremism and engagement with business, which included projects determining the strategic priorities and direction of clients such as UNDP and the OECD. He has also worked as a management consultant and for a welfare organisation.

Murray holds a Bachelor of Arts in Politics and International Relations, a First Class Honours degree and a Bachelor of Law from the University of New South Wales.

The latest UN climate change report offers important clues for investors seeking to understand portfolio risks and investment opportunities. Pendal’s Edwina Matthew explains

Key points

THE UN’s latest Climate Change report made headlines this week with predictions of irreversible global warming, rising sea levels and climate change affecting every corner of the planet.

But it also provides evidence-based information to help investors better understand portfolio risks and identify investment opportunities such as carbon capture and methane-reduction technologies.

The 3900-page report from the UN’s Intergovernmental Panel on Climate Change (IPCC) — the United Nations body for assessing the science related to climate change — is the gold standard for research on the science of climate change and options for adaption and mitigation.

Government and corporate decision-makers worldwide rely on the IPCC’s findings to inform their climate risk assessments and emissions reduction strategies

The report — which was unanimously endorsed by the governments of all 195 country members including Australia — is based on a three-year analysis of 14,000 peer-reviewed scientific studies.

It will be the central terms of reference later this year at COP26 — the upcoming United Nations climate conference in Glasgow.

The report shows unequivocally that human activities are responsible for the warming world. This warming is increasing the frequency and severity of extreme weather events such as heatwaves, droughts, cyclones and heavy rain.

Global temperature rises of between 1.5 and 2 degrees Celsius are expected unless deep reductions in greenhouse gas emissions occur in the next few decades. Regardless of action, changes already occurring due to past emissions are now likely to be irreversible for thousands of years.

Low likelihood, high-impact events such as ice sheet collapses, ocean current changes or Amazon dieback cannot be ruled out.

“It’s a sobering read,” says Edwina Matthew, Head of Responsible Investments at Pendal.

“And remember that these are averages – different regions, different countries, even different states will be impacted to a greater or lesser degree than this average.

“For example, the report finds that average global warming is 1.09 degrees Celsius above pre-industrial temperatures. Australian land areas are already 1.4 degrees Celsius above pre-industrial averages.

“This is going to increase the probability of extreme weather events, heatwaves, sea surges and drought.”

Risks and opportunities for investors

What should investors take out of the IPCC report? What does it mean for portfolio construction?  And how can investors ensure they understand the risks and opportunities posed by global warming?

Matthew identifies three headline risks and opportunities for investors to consider:

1. The IPCC report increases the risk of climate activism or litigation against companies and governments

The most high-profile litigation so far has been a Dutch court ruling that the multinational oil giant Royal Dutch Shell must reduce its emissions because its contribution to global warming violates human rights.

Previous IPCC reports were referenced in the court case and this latest one will likely be used in the appeal hearing.

A number of Australian cases have also referenced IPCC findings.

Sharma v Minister for the Environment [2021] found the federal environment minister owed a duty of care to children who might suffer potential “catastrophic harm” from the climate change implications of approving a NSW coal mine extension.

Investors also need to watch for governments being the target of litigation which could affect regulatory approvals and business permissions in their investments.

2. The report’s heightened focus on methane is of interest for investors

A “strong, rapid and sustained’ reduction in methane emissions is required to help reduce greenhouse gas emissions and hopefully avoid the catastrophic impacts of climate change, the report finds.

Methane is not only a vastly more potent greenhouse gas than carbon dioxide, but its concentration in the atmosphere has been increasing rapidly.

Importantly, it is short-lived in the atmosphere meaning controls on methane can rapidly reduce atmospheric concentrations.

Governments are already acting on methane. The EU is proposing curbs on methane emissions while the US is planning tighter emission rules.

But it’s a tricky problem to solve. Some gas production emits methane. Raising livestock for meat and nitrogen-based fertilisers are major sources. Rotting waste in landfill also emits methane.

“All of these are important challenges that investors can play a part in,” says Matthew.

“Investors can engage with companies to better understand how they’re thinking about these issues, what they’re doing to mitigate the risks and how they’re transitioning to thrive in a low-carbon economy.

“Investors can also direct funds to solutions. For example, CSIRO is working with the private sector to commercialise a livestock feed additive made from seaweed, which has been shown to reduce methane emissions in cattle by up to 80 per cent.”

3. Carbon removal solutions can also play a role in investor portfolios

“Carbon removal is a vital net zero tool which has a place alongside absolute emissions reductions,” says Matthew. “It covers a range of investable methods, from afforestation to wetland restoration to carbon capture and storage (CCS) and ocean fertilisation.”

However carbon removal technologies such as CCS need more development to work at the scale required. We need more co-ordinated efforts to advance these sorts of emissions reduction solutions in sectors with harder-to-abate industrial processes such as cement and steel production.  

Future climate scenarios are becoming clearer

We now know more than ever how possible climate futures could play out.

The report is very clear that without “immediate, rapid and large-scale reductions” in emissions, curbing global warming to below 2 degrees Celsius — the Paris Agreement goal — will be “beyond reach”.

These findings call on us all to accept and act on the reality of the situation, including policymakers, investors, businesses and consumers.

In the words of the UN Secretary-General Antonio Guterres the report is a “code red for humanity”.

Download the sixth assessment report from the IPCC here

About Edwina Matthew and Pendal

Edwina Matthew is Pendal’s Head of Responsible Investments. Edwina is responsible for maintaining our leadership position in the provision of sustainable and ethical investment products.

Edwina is actively involved in the implementation of the UN-supported Principles for Responsible Investment. She also represents the company in working groups with a number of industry associations and initiatives relating to responsible investment.

Pendal Group is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

We believe sustainability considerations ultimately drive higher and more stable investment returns over the long term.

Pendal Group has a proud heritage in responsible investing, extending back decades. Our specialist responsible investing business Regnan includes highly experienced ESG research and engagement experts and offers a growing range of investment strategies​.

Find out about some of Pendal Group’s responsible investing strategies:

• Pendal Sustainable Australian Fixed Interest Fund
• Crispin Murray’s Pendal Horizon Fund
• Regnan Global Equity Impact Solutions Fund
• Regnan Credit Impact Trust

Contact a Pendal key account manager here.

Elise provides fundamental company analysis for our Australian Equity large cap strategies. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies. Prior to Cartica, Elise worked in investment banking and corporate finance at JP Morgan and Ernst & Young. Elise holds a Bachelor of Commerce and Economics from the University of Queensland and is a member of the Institute of Chartered Accountants Australia.

After decades as an underperformer among equity markets in the developed world, investing in Europe is once again looking attractive, says Pendal’s Paul Wild.

• Carbon-neutral push is moving the spotlight to Europe
• Major government spending on green initiatives is attractive
• Green Party likely to do well in September German election

EUROPE’S green credentials are well known, but a recent acceleration in the push to become a carbon-neutral continent in the next few decades has opened up investment opportunities.

“It’s irrefutably the largest and most important structural theme that Europe is exposed to,” says Paul Wild, a senior fund manager at Pendal Group’s London-based subsidiary J O Hambro Capital Management.

“Europe has the world’s largest renewable electricity players. On the industrial side, it has leadership in terms of buildings efficiency. Europe leads the way in terms of passenger vehicle technology. So, as well as being politically motivated, Europe is highly exposed to green business initiatives.

“It is one of the few areas that Europe can claim global leadership,” Wild says.

Europe’s evolution as a leader in sustainability has come relatively recently, notwithstanding parts of the continent have a long history in looking after the planet.

In December 2018, the European Union adopted the Green Deal which intended to map out the continent’s strategy to become climate neutral.  Fiscal spending was biased towards green initiative such as efficient buildings, clean water, biodiversity, more public transport and recycling.

Then in the middle of last month, the EU set itself a binding target of achieving climate neutrality by 2050, subject to individual parliaments ratifying the decision. As an intermediate step, the EU has raised its climate ambition to cut emissions by at least 55 per cent from 1990 levels, by 2030.

“Currently the European Union generates about 12 per cent of its energy from renewables but it’s targeting 40 per cent by 2030. That’s a big number,” Wild says. “Clearly Europe is serious.”

Where opportunities lie

“It involves everything from overhauling the carbon emissions trading system and introducing a carbon border adjustment mechanism for imports, through to a huge rollout of electric vehicle charging stations.”

“There’s opportunities around aviation fuel. The EU has a target of renovating 3 per cent of public buildings a year to make them more efficient. There are many opportunities,” Wild says.

The weight of state money going towards green initiatives is huge.

“It’s irrefutably the largest, most important, most structurally backed theme that Europe is exposed to,” Wild says.

“The region already has some of the world’s largest renewable utilities companies, best building efficiency plays, the largest wastewater recycling companies, expertise in the paper and pulp sector, and outside China, the biggest wind turbine manufacturing companies.

“The theme is politically motivated. There’s political impetus for change and laws are coming to bear forcing companies to be more green-aware. It has become an area where Europe is showing global leadership,” Wild says.

“And it’s likely to continue. The Green Party is likely to do well in the September German election. There is clearly a social awareness that is putting political pressure on countries.”

About Pendal Group

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out about Pendal’s investment strategies

Contact a Pendal key account manager

Rachel is an Investment Analyst for our Smaller Companies team, providing fundamental analysis on a range of companies within the ASX ex-100 universe. Previously, Rachel was an Investment Analyst covering smaller companies for NAOS Asset Management and First Sentier Investors, where she began her career in their graduate program. Rachel holds a Bachelor of Commerce (Actuarial Studies and Financial Economics) from the University of New South Wales and is a CFA Charterholder.