ESG and the Brazilian Stock Market – Time to Wake Up

ESG is probably the most used acronym in the investment world today. Although Social and Governance considerations are of great importance, we believe that the Brazilian stock market is increasingly becoming exposed to Environmental risks, both from a macro standpoint and as well as at the company level.

Our concerns are not just theoretical. Domestic and foreign investors, as recently as last week, are raising red flags about the recent escalating deforestation trend, combined with reports of a dismantling of environmental and human rights policies, which are creating widespread uncertainty about the conditions for investing in Brazil.

For the European Union, Brazil’s second-largest trading partner and a huge importer of the soy and beef that drive deforestation, these issues might complicate the upcoming ratification of the EU-Mercosur free trade agreement. The Austrian, Wallonian and Dutch parliaments have already rejected the Mercosur deal in its current form, and the highest political representatives of France and Ireland have expressly criticized it.

Moreover, due to the intrinsic structure of the Brazilian economy, these risks are expected to increase as climate change takes its toll with more extreme weather events such as droughts and flooding. According to the Grantham Research Institute on Climate Change and the Environment from the London School of Economics (LSE), Brazil and Argentina are the countries in the G20 most exposed to the tightening of climate and anti-deforestation policies within the next 10 years due to their reliance on soft commodities such as soybeans and livestock that rely on natural capital in their production.

The same macro risks are trickling down at the company level due to the composition of the local indexes. In the last few years, Latin America has already lost a lot of ground to Asia in the Global Emerging Markets indexes, due to is reliance on natural resources and lack of big technology companies. In fact, our analysis shows that the Brazilian stock market is almost twice as exposed to sectoral ESG risks than the MSCI Emerging Markets Index (62% of the IBX100 market capitalization is in sectors with higher ESG risks – such as mining, O&G, agribusiness, manufacturing industries, etc. – vs. 35% of the MSCI Emerging Market Index market capitalization).

Going forward, we believe the company-level risk is two-fold: some companies’ business models will be challenged by a new generation of consumers’ tastes and especially values (meat producers, fast fashion, auto parts, among others); and some companies may face huge off-balance sheet liabilities due to the tightening of environmental rules and the internalization of non-financial externalities such as pollution and social impacts. 

For instance, carbon pricing remains the favorite policy to internalize the societal costs posed by the emission of greenhouse gases. According to the World Bank, more than 60 carbon pricing schemes exist worldwide, covering close to one quarter of the world’s population. European countries are even discussing imposing a carbon border tax on imports coming from non-carbon-taxing countries, such as Brazil. For a carbon-intensive economy such as Brazil’s, the financial consequences can be important. Savvy investors are increasingly calculating a shadow price of carbon when analyzing a company’s value, so it is definitely in a company’s interest to disclose to their investors and consumers how they plan to manage that risk. For instance, a company could participate in the voluntary carbon offset market while devising their long-term GHG mitigation plan. 

Petrobras, for example, emits 60 million tons of CO2 equivalent yearly (considering solely scope 1, that is, its direct emissions). Right now, Petrobras could offset and neutralize its emissions for probably US$ 180mn, and US$ 540mn for the next 3 years. If Petrobras were in a regulated market, it could cost the company up to 10x more, or US$ 1.8 billion PER YEAR. That’s an NPV of US$ 20 billion or 40% of the company’s market cap, according to estimates from Moss, a carbon credit Fintech.

The ESG risks for certain sectors such as mining or oil and gas are straightforward to understand but the services sector, and in particular the financial sector, have been increasingly in the spotlight. Mark Carney, the outgoing Governor of the Bank of England, has been very vocal about the role of the banking sector to address climate change. He points that banks may be forced to raise capital to face write-offs from natural disasters or flooding of costal properties. The various investor-led divestment campaigns are also putting pressure to slash funding for environmentally damaging industries, which can have important consequences in a resources-based economy.

Despite the grim picture, we painted so far in this text, not all is lost and it’s not too late for Brazilian companies to act and show some leadership on the issue. What is clear is that companies should not wait for the national government to help them in their quest to become more sustainable. To the contrary, they need to take the issue in their own hands and prove to their consumers and investors that they are serious about addressing the ESG risks they are facing. One way to be proactive is to start immediately to participate in carbon-offsetting schemes and also to provide a clear path to carbon neutrality.

The market can be patient and forgiving to companies who show goodwill and are serious about tackling tomorrow’s challenges. Companies who act accordingly will trade at premium valuations, therefore lowering their cost of capital.

Félix Boudreault is an ESG analyst at OMNINVEST, Sub-Advisor to FRAM Capital on an ESG Brazilian Equity Fund, and Co-founder of Sustainable Market Strategies, a cutting-edge ESG independent research firm.

Roberto Attuch 25 has years of experience in Latin American equities (Credit Suisse, Barclays). Currently, CEO/founder of OMNINVEST. Master’s degree in Risk Management from NYU; Diploma in Corporate Governance from Insead. 

Gostou do texto?

Então cadastre-se gratuitamente para receber em seu e-mail nossas novidades e ofertas exclusivas.