What does the Russian-Ukraine conflict mean for sustainable investment decisions?

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By Alexis Cheang , Partner, Acting Global Business Leader, Sustainable Investment and Nick White , Partner, Global Strategic Research Director

Armed conflict of any kind brings with it an?incalculable human cost. Our hopes for peace go out to the people of Ukraine and for a swift, just resolution to the current conflict.

War?exacerbates social injustice, poverty and inequality.

• Those worst affected by conflict are those without the means to avoid it, including the poor, elderly, children, and the disabled. Ukraine and Russia already rank among the lowest performers in Europe in the?Inequality-Adjusted Human Development Index? (45th?and 42nd?respectively), produced by the UN Development Program. The IHDI measures the level of human development when inequality is accounted for.
• The expected?impacts on inequality are likely to overflow the borders?as some of Europe’s poorest countries including Romania and Moldova absorb the masses of?refugees. While neighboring countries have, for the moment, welcomed their Ukraine neighbors warmly, for how long will they accommodate these visitors, in the face of?rising energy costs and food prices?
• In the case of the Ukraine conflict, the impact on?poverty?and?food security?is expected to have greater impact than may be immediately obvious. Together, Russia and the Ukraine accounted for 26% of global wheat exports in 20201, as well as 14% of corn exports2. Dozens of countries across the Middle East, South Asia, and North Africa that already suffer from food insecurity rely on Russia’s and Ukraine’s food exports to feed their populations. Experts at the World Food Program say the conflict could send food prices rising and increase global hunger far beyond Eastern Europe3.

Beyond the human cost,?the environmental cost of any conflict is significant.

• In addition to destroying lives, war levers a heavy price on the natural environment,?destroying arable land,?polluting drinking water and air.
• However, the environmental risks in this instance are particularly acute given the seizing of the decommissioned Chernobyl nuclear power plant by Russian forces on February 24 (monitoring data has shown a radiation spike recorded on the same day4). The site contains over?200 metric tons of highly radioactive material?which have been?contained using state of the art confinement technology. Ukraine also operates four?active?nuclear power plants, which contain fifteen separate reactors and generated over half of the country’s electricity in 2020. As nuclear policy expert James Acton of the?Carnegie Endowment for International Peace puts it “nuclear power plants are not?designed for war zones”5. He and other nuclear policy experts are warning that such technology has never really been tested in a conflict zone and thus, any disturbance decommissioned or active nuclear power plants could lead to unknown consequences on the environment and human health.

Governance going from bad to worse

• Neither Ukraine nor Russia was known for its good governance prior to the conflict commencing. Ukraine ranks 122nd out of 180 in Transparency International’s?Corruption Perception Index, ?and Russia ranks even lower, at 136th, the lowest in Europe. With people desperate for safety and basic goods and services,?corruption is anticipated to worsen?and further deteriorate what rule of law remains.
• Governance concerns had already led some sustainable investors, particularly in the Netherlands, to exclude or underweight holdings in Russian and Ukrainian stocks and bonds prior to the conflict, as highlighted in?this article? by IPE. Since then, others including the Norwegian Sovereign Wealth Fund have followed suit. However, in most global markets, unless sanctions require it, governance concerns, coupled with questions about the effectiveness of global entities such as the UN Security Council, rarely lead to wholesale country exclusions for institutional investors that are prepared to invest in emerging markets.

What impact might the conflict have on investors sustainable investment plans net-zero transition pathways?

• Mercer believes the?transition to net zero?will continue but?the current crisis,?depending on the severity and duration,?could impact the pace of the transition:Over the?long term, this conflict is?unlikely to change commitments?already made or under consideration by 130 countries? to transition?to net zero?emissions by 2050, as outlined in the Paris Agreement, and reinforced in Glasgow last year.
• Over the?medium term, the?conflict could actually accelerate the transition. The pandemic has highlighted the fragility of global supply chains generally, but the Russian armed conflict with Ukraine highlights the need for exposed countries to establish a firmer base of energy independence. Such a move would in many cases result in a move from imported fossil fuel-based energy to domestically generated renewable energy.
• Over the?short term,?the transition to net zero could slow?as certain countries prioritise response to the crisis, for example through:
• Political capital being redirected to address the conflict, through increased defence spending and provision of humanitarian support; or
• Exports of a supply constrained commodities6?like oil and natural gas (thereby increasing GDP).

In the face of the current Russian armed conflict with Ukraine,?Mercer recommends that clients:

• Comply with international sanctions, as required by law. Where official sanctions are widespread across multiple governments, investors should also give due regard to the heightened stakeholder expectations this introduces.
• Continue with development and execution of ESG integration, climate transition and stewardship plans including:
• Integrating ESG factors?and the potential financial impacts of the social, environmental and governance issues raised and the implications on a sector and company basis over different time periods. Mercer does not typically recommend wholesale divestment of any country or sector except where such an investment would be incongruous with an organization’s core mission or values.
• Utilizing?stewardship activities?(proxy voting and engagement), where possible, but particularly in relation to energy companies. Investors are seeking science based targets clear climate change strategy, and aligned capital expenditure (new Climate Action 100+ benchmark report due out 3 March) from all companies. However, better understanding the governance risks underpinning operations in in the region will obviously be key. For example, BP announced on February 27 that it would be selling its 20% stake in Russian energy company Rosneft.
• Scenario testing?multi-asset portfolios against a range of climate and geopolitical scenarios.
• Exercise?decarbonization at the right price.
• In this kind of environment, with energy prices likely to remain highly volatile, investors should be prepared to balance their need for long-term reduction in fossil fuel exposures in order to meet decarbonization commitments, with short-term return and risk management opportunities that may arise.