The Sustainability and Climate Trends to Watch for 2025

Join us as we cover the sustainability and climate trends that our team thinks will shape the year head. We talk about the energy transition opportunities that are emerging in private markets, rising social risks and the tech giants, falling data access for AI models and much more. Here’s to a big, intriguing 2025!

Host: Bentley Kaplan, MSCI ESG Research
Guests: Liz Houston, Namita Nair & Jonathan Ponder, MSCI ESG Research

Transcript

ESG Now Podcast

The Sustainability and Climate Trends to Watch for 2025

Transcript, 13 December, 2024

Bentley Kaplan

Hello, and welcome to the weekly edition of ESG Now, the show that explores how the environment of society and corporate governance affects and are affected by our economy. I'm Bentley Kaplan, your host for our last episode of 2024. And it's going to be a banger, because on today's show we're going to give you a sample of our flagship research paper of the year, the Sustainability and Climate Trends to Watch, 2025 edition. Our research team has picked six trends that they'll be keeping tabs on through the upcoming year. And if you're an investor, you might want to keep these on your radar too.

From the way private markets can unlock opportunities in an energy transition to the investment case for climate adaptation solutions. From the way that social risks are edging onto center stage, as tech giants take up a bigger slice of global equity indexes and what's going to happen when the wave of AI enthusiasm crashes against the rocks of data access and regulations. And also, about how shareholders at US companies are pushing for a more definitive role in choosing directors. And whether 2025 is going to be a watershed year for carbon markets. Whichever way you slice it, we think it's going to be a big, intriguing year. So, for one last time in 2024, thanks are sticking around. Let's do this.

"In a world that feels ever more uncertain, investors everywhere are looking for information that can give them an edge. The latter half of this decade will bring profound shifts driven by a geopolitics, disruptive technology breakthroughs, and environmental challenges." So writes Laura Nishikawa, MSCI's head of ESG Research and Climate, R&D. And that's in her note that opens our paper on the trends to watch for the upcoming year. And our first trend really talks to this, we called it “Private Party: On the Hunt for Energy Transition Solutions.” And the authors of this trend, Gregory Coles, Xinxin Wang, Abdulla Zaid, and Chris Cote looked at how investments in private markets that were linked to renewable and low carbon power, green mobility and energy storage, so-called transition technologies, have outstripped their public market counterparts.

Now, the overall opportunity set in public markets was of course much bigger, but between September 2019 and June 2024, these public market investments grew at a compound annual growth rate of just a touch under 12%. Not bad, but well short of the 17% growth that we saw in private market investments over the same period. And this difference in growth translated to higher relative returns as well. Now to be clear, a direct comparison between public and private markets comes with a whole bunch of caveats. Their dynamics are very different.

Figuring out quarterly returns, for example, in private markets means comparing exited and active investment holdings, which is subject to lack of liquidity, irregular cash flows, subjective valuations and smoothing. But even with these caveats, it's clear that something interesting is happening in private markets. And for investors either wanting to benefit from an energy transition or to more actively support such a transition, these markets and their assets are worth a closer look. And you can read more on that in our first trend. The authors thankfully are far more eloquent than me.

And from opportunities in energy transition technology, we'll move onto our second trend where we look at another opportunity set. But this one is linked to the physical impacts of climate change. Because investors seem fairly well aligned in thinking that physical climate change will have impacts, in a survey of 350 financial market participants in July and August, the MSCI Sustainability Institute found that 84% of respondents thought that over the next 10 years, extreme weather events would damage infrastructure and impact the regional economy. And we've spoken at length on this show about the risks associated with physical climate impacts, things like floods and hurricanes and heat waves.

But in our second trend, which is called “Facing the Reality of a Changing Climate”, we look instead at what opportunities might arise from physical climate impacts, and whether companies providing adaptation solutions or services are seeing rising valuations. And when I say we, well, it's very much the royal we, I'm talking about, Katie Towey, Mathew Lee, Paribesh Pradhan, Umar Ashfaq, and Liz Houston were the real co-authors behind this trend. And I managed to grab Liz to get her hottest snappiest take on why this trend should matter to investors.

Liz Houston

So the climate survey that you mentioned, the one thing that really stood out in terms of what people agree on is that extreme weather poses a significant threat. It's unusual that everyone agrees, so that was interesting. What does it mean for 2025? It means that we expect just more focus on both the related risks and also investment opportunities. In terms of risk management, it means understanding physical risks at the portfolio, their company, and the specific location of an asset, and specific location does matter because being centimeters out can make a big difference to something like flood risk, for example. The flip side is where there's risk, there's also investment opportunity. We looked at publicly listed companies that offer related adaptation and resilience solutions as a potential investment theme. Now interestingly, on average, their valuations don't yet appear to be pricing in any benefit from this adaptation spending.

Bentley Kaplan

So adaptation solution providers are out there, but it looks like they haven't really felt a valuation bump yet. So maybe something to keep an eye on in 2025. And whether it's adaptation solutions or physical risk or opportunities from an energy transition, a lot of investor eyes will be focused on climate change. But we've picked other trends too, ones that don't naturally have big bold headlines, but ones that are undeniably shifting the risk profiles of portfolios. And I've held onto Liz because she co-authored our third trend called “Feeling Social: The Changing Shape of Sustainability Risk in Global Equity Markets.” And she partnered up with Guido Giese, Zoltán Nagy, and Drashti Shah for this one. Here's Liz.

Liz Houston

The first thing I will say here is that global equity markets are not the same as the real world. So we understand that climate change is the greatest challenge humanity faces right now. In the slightly weird world of global equity markets though, the sustainability risk landscape just looks a bit different. Over the last 10 years, we've seen a big rotation away from the heavy emitting heavy polluting sectors like energy or utilities, largely into, well, as we know, it's all been driven by the tech giants.

So essentially global equity markets have moved from guys wearing hard hats on rigs somewhere to Californians wearing cashmere hoodies. And because of that, the risks a global equity investor faces are different. It's less about pollution and more about things like can they attract and retain the right employees? Do they have the best talent? Are their privacy and data security up to scratch? And we think that this is worth highlighting for a couple of reasons. One, people may not be aware of that. And two, it raises some interesting questions about where we go from here because there's this small thing called AI, not sure if you've heard of it, but it has the potential to change things quite dramatically. Will it continue to drive the growth of the tech giants? Possibly. It could also start changing the climate risks that those sectors are exposed to.

Bentley Kaplan

Yes, AI, maybe you've heard of it. The growing importance of tech firms in global equity indexes is changing the relative contributions of different sustainability risks. Liz was telling us very much about the risks that you maybe didn't know were there, but when it comes to AI, well, it's more like the risks that you just wish weren't there. Which brings us to our fourth trend titled, “Attention Gen AI Models: The Data Buffet is Closing.” Because we're in a delicate middle ground for this new technology. The hype that came with AI's arrival in the form of large language models and generative AI is now needing to give way two more sober things like return on investment figures. And as my colleague Namita Nair explained, there are some slightly shaky foundations sitting underneath this new technology, which may take a little wind out of AI's sails.

Namita Nair

AI has been the talk of the town, promising to change everything. But as we step into 2025, the reality is starting to set in, and it all comes down to one thing – data. So that buffet of endless data that AI models had been feasting on is finally starting to shrink. Now, we also understand that regulation like the European Union's AI Act are tightening the rules. So it's going to make it harder to access data that companies actually have come to rely on, and it's not just about regulations. There are also big questions about things like consent for the usage and the distribution of data, copyright and the implicit bias in the training sets of data. In 2024, the availability of high quality data dropped by 25% as websites started blocking AI from scraping their content. So what does this mean for 2025? Investors will want to see proof. Proof that companies have solid sustainable data foundations and they can turn all this excitement around AI into real results. At the end of the day, success isn't just about fancy models. It is about building on a very strong foundation.

Bentley Kaplan

Exactly. And Namita told me that transparency is also something the team will be keeping an eye on. Because if we look at the world's biggest 50 companies operating in sectors like communication services, healthcare and information technology, sectors where AI is expected to play a big role, well, half of these large companies don't report any AI policy, something that investors may be increasingly grumpy about. And in research from earlier this year, my colleague Harlan Tufford, estimated that around 83% of directors at companies in the MSCI ACWI Index had no AI related expertise. And investors might well take an interest in that statistic. 

In fact, as we move into our fifth trend, investors might well be taking a broader interest in directors generally, and who sits on a company's board and well, who doesn't sit on a company's board. Ahasan Amin and John Ponder were the authors of this fifth trend, and with some dry governance humor called it “Majority Voting for US Directors: The Silver Ballot.” And why we're talking about US companies specifically, is because at nearly 90% of those in our sample, there is no majority voting standard. 

Now, for those not familiar majority voting generally means that when company directors are up for re-election in an election where there are no other candidates vying for board seats, a director that doesn't receive a majority of shareholder votes in their favor, well, they effectively have to step down from the board. How that happens exactly varies by jurisdiction, but that's it in broad strokes. And in a lot of US companies, this isn't how it works. It can actually be a lot harder for shareholders to vote off directors. And what recent shareholder voting data shows that majority voting is gaining some sudden popularity. John told me more.

Jonathan Ponder

So, during the 2024 US proxy season, we observed a surge in volume of, and support for, proposals calling for majority voting and director elections. What this actually means is if approved, these will require directors to immediately resign from the board if they failed to receive majority support from shareholders at uncontested elections. Now, this shift is obviously significant on its own, but also in relation to two key findings in our corporate governance research earlier this year.

Firstly, we found that shareholder rights appear to be self-reinforcing. Companies with best practices such as majority voting tend to incorporate other beneficial shareholder protections and corporate governance best practices as well. But perhaps more importantly, we've also found that good governance is associated with financial outperformance, particularly when considering developed markets. In an analysis conducted earlier this year, governance leaders were found to outperform laggards on a cumulative returns basis, indicating that these enhancements may support greater returns across an investor portfolio. With that in mind, investors may want to keep an eye on this as concerted push to enhance shareholder rights at their portfolio companies appears to be underway, which stands to benefit all stakeholders with impacts potentially extending beyond election practices into company performance and ultimately, returns.

Bentley Kaplan

So the sands of corporate governance might be shifting in the US market, and while John and team keeps tabs on that, there's another shift happening in an entirely different market, the carbon market. Because in our last trend authors, Guy Turner, Tristan Loffler and Jamie Saunders lay out their case for why 2025, maybe a decisive turning point in voluntary carbon markets. 

You see more companies are committing to emissions targets and there are subtle but important improvements in the integrity of carbon credits available on the voluntary market. But the real key developments are happening in new sources of demand for those credits, including through the Carbon Offsetting and Reduction Scheme for International Aviation or the CORSIA Scheme. And notable progress at COP29 in November towards a Paris Agreement Crediting Mechanism, which would basically allow credits to be transferred formally between countries and companies under Article 6 of the Paris Agreement. So as all these pieces line up, 2025 may well be an interesting year for carbon credits.

And if you want to hear more about this changing new market, check out some of our recent podcast episodes. Just last week, Mike covered the CORSIA scheme in detail and a couple of episodes before that, he walked listeners through the Paris Agreement Crediting Mechanism because well, we don't mess around on this show.... mostly. 

And that is our six trends for 2025, or at least the crib notes. Because if you want to get it without a chattering intermediary and you've got an itch to get into the details the specifics and will some really, really great charts, then do yourself a favor and swing by msci.com to download the paper for yourself. It's freely available, a pleasure to read through, and once you've done so, well, you'll be all set to meet the upcoming year with some great ideas about where to look first.

And that is it for the week and the year. A massive thanks to Liz and Namita and John for their take on the news with a sustainability twist. And an even bigger shout out to everyone at MSCI who helped to make this paper happen. It's a production that draws on a widely talented group of amazing colleagues, nurturing the early shoots of some ideas, all the way through to a fully-fledged research paper. And for one last time in 2024, I sincerely want to say thank you very much for tuning into our show. It has been a big year, and if you've enjoyed what we've been up to, then let us know. Drop us a review, rate the show on your platform of choice, and tell a friend or a colleague about this episode. Thanks again. Enjoy the holidays and until next year, take care of yourself and those around you.

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