From East to West: the sustainability journey

July 07, 2023

Our European and Asian equity team members discuss sustainability topics that link East and West, including decarbonisation and regulatory shifts.

From East to West: the sustainability journey - Freddie Fuller, Chris Lai and Derek Au

Freddie Fuller: Welcome back, everybody. My name is Freddie Fuller and I'm the product specialist on the European Equity team. I'm joined today by two members of our Asian Equity team with whom we co-manage our international equity strategies, Chris Lai and Derek Au, who are joining us from Toronto and Hong Kong. We're spanning the globe this morning. Welcome both, and thanks very much for joining us.

Chris Lai: Thank you for inviting us, Freddie. I'm Chris Lai.

Derek Au: I'm Derek. We are portfolio managers on the RBC's Asia Equity team, based out of Hong Kong.

Freddie: Guys, our teams have worked closely together over many years now, and I thought this might be a good time for us to join on the podcast and have an East versus West look at a couple of key sustainability topics that link the two regions, perhaps starting with decarbonisation. It's a topic that's been prevalent in the West for many years now and is really starting to pick up steam, both at a corporate level and regulatory, within Asia too. I wondered if maybe, Chris, you could give us a brief look at how you view this transition in your region, as it stands today.

Chris: Sure, Freddie. This is actually something that's been brought up quite a few times and we actually did a deeper dive looking into this in our ESG report, which we published a few months ago. What we actually found was that Asia-Pacific accounted for 52% of global fossil fuel-related carbon dioxide CO2 emissions, as of 2020. This came as a bit of a surprise for us. I didn't realise that Asia made up over 50% – over half of global CO2 emissions.

If Asia doesn't really meet emission reduction goals, you won't see the world meet overall goals. Within Asia, I guess the two key countries that drive this emission would be China and India. China makes up 32% and India is 7%, at the moment. The next country up is Japan, with 3% emissions. What we're seeing as a development trend from 2020 to 2030 is that, overall, emissions are only growing by 5%, where the growth in emissions is largely coming from India, driven largely by economic growth as well as its demographics.

China, actually, will see a small increase in emissions at a much slower pace compared to India, and that's just reflective of the development cycle. The strong growth that we've seen in China since the 1990s has meant that a lot of the emissions have already been built in. Overall, in Asia, we've seen growth in China as well as India emissions. That's going to be partially offset by reductions in countries such as Japan and South Korea, as well as Australia. All this adds up to the overall growth of about 5% over the period, until 2030.

Freddie: Great. I guess taking your point, the key here is how to balance the necessary growth in total energy demand, as these economies you've mentioned are continuing to develop, with the need to offset the environmental impact. We've often talked on this podcast about the need for absolute emissions to be viewed in the global round, I suppose you could say.

Is there a concern amongst some parties that there is an overreliance in some corners on developed market reductions, which have obviously been very progressive in recent years, simply being used perhaps as an offset for less developed markets? Maybe, Derek, you could talk to that.

Derek: Yes, indeed, Freddie. Asian economies continue to develop. We estimate that the demand for energy, which traditionally has been sourced from fossil fuels will continue to grow. Within Asia, energy production has historically been dominated by thermal power, accounting for just over 70% of the energy source. That's mainly coming from coal. The burning of coal has meant that if you look at the most polluted cities globally, many of them are in China and India.

Now governments are responding to this by looking at alternatives. There have been large-scale investments into renewables such as solar, wind, and in certain countries, nuclear. Aside from renewable energies, a switch from coal and oil to natural gas will help with emissions. In general, we think that emerging markets cannot solely rely on developed markets to be cutting emissions on a global basis. They realise that if they don't take action, climate change will come faster than expected. Investing in green technologies and low-carbon renewable energy sources sooner will makes more sense than having to deal with the cost of climate change later. In Asia, we are already seeing water shortage and its impact on food production. We are seeing the impact of rising sea levels, which requires significant investments in infrastructure.

Chris: Actually, Derek, on the point of rising sea levels, you raised a good point. Indonesia has its capital currently in Jakarta and they're actually looking to move to Borneo, and that's because of rising sea levels. Jakarta is a sinking city and you're looking at one-third of the city that could be submerged by 2050. Given the costs of infrastructure and how you can't really stop the sea level rising, they've actually made plans and they're going ahead with moving their capital towards Borneo.

They're seeing this for two reasons. You have a new centralised planned city where you can actually lower the overall environmental impact, plan the infrastructure better and this is one of those cities where they're aiming to be carbon neutral by 2045. This would be a very interesting case study to monitor. It's very large scale and it's in the works, and it's something that we can look into.

Derek: That's a great point, Chris.

Freddie: Great. Thanks, both. I think a crucial aspect and one that you've both hinted at within your comments is, of course, demography. It seems particularly pertinent to this topic to highlight how the change in the absolute emissions that we've talked about is likely to measure up against changes in emissions intensity for Asia in particular, given its very different demographic profile to Europe and indeed much of the developed West.

Chris: In our region, we're still looking at population growth. Asia is growing from about four and a half billion (this is 2020 numbers), to about five billion in 2030. The key growth is actually in two countries. It's India and Indonesia, which is offset by some population decline in places such as Japan. India and Japan have very young populations and you're looking at solid GDP growth. The overall emissions for these regions will grow but, as we mentioned quite a few times, the overall emissions for Asia are only going to grow at 5%.

Given India as well as Indonesia are investing in infrastructure and there's strong demand, they're investing in public transport. These examples would be electrified public transport, which generate emissions far below that of private vehicles and are a lot more efficient. When you're actually looking at trends such as urbanisation, it only makes sense to invest in public transport.

The overall population, they're very, very keen, and the population as well as the government are very keen to invest in public transport, for climate change, economic reasons and population density. There's action taken from both governments as well, as the population is demanding that they invest in infrastructure (to address environmental risks) and climate change, as well as urbanisation.

Freddie: Great. Perhaps for the final segment, we move away from decarbonisation and maybe talk about another area, and one that Europe particularly is having to contend with at the moment, which is how, as a supernatural body, do you react to the Inflation Reduction Act that was implemented by the United States last year. Now, the repercussions of this legislation are really just starting to be felt in Europe. The US recently announced its plans for the proposed green industrial plan and this, with a relaxation of state aid rules and plans for increased funding in distinct areas, the European Union is really making a play, I suppose, to mirror the US' preservation of not only its supply chain security but also its industrial objectives. Maybe, Derek, how do you think this regulatory shift in these regions might impact Asia more broadly? Actually, do you think this is going to be a negative trend?

Derek: Sure, Freddie. We have seen quite significant investments to broaden the supply chain away from China with manufacturing investments in North America and Europe. Asian companies have participated in the reshoring of manufacturing, or what we call ‘China plus 1’, in areas such as auto manufacturing, semiconductors, and retail products, such as textiles and clothing. Within Asia, we have seen new manufacturing facilities being built in India, Japan, and Indonesia.

Having said all of that, China remains an integral part of manufacturing, given existing advantages in the supply chain, and in particular, the labour force. Aside from export growth, there is strong intra-Asia demand, given the growth in regional economy. While there is a shift within Asia for the region as a whole, we continue to forecast significant investments.

Freddie: Chris, maybe we could talk on that point a bit more. We've talked about potential frictions between regions so maybe it's a good time to look at some areas of investment where there are synergies and a positive take on it, particularly at a corporate level. As I said at the start, our teams have been working together for many years now and we are increasingly seeing this crossover in a number of sectors, for example, particularly in the metals and mining sector, utilities, and increasingly the industry that everyone's talking about, which is semiconductors. How do you think companies and businesses in both regions can benefit from one another, and how do you think they have a role to play at a multiregional level?

Chris: Actually, they all have their different strengths. For example, using semiconductors, like you mentioned, Asia is strong on the production side. Over 70% of global semiconductors are produced in Asia, and Europe has an advantage in intellectual property, in terms of design, as well as testing. A lot of the materials require parts from both European, as well as Asian, suppliers. For products such as semiconductors, this is a secular growth story. It's not cyclical. They need to collaborate on both sides because they have different strengths. For the example of semiconductors, one is on production and one is on design, as well as testing.

If you look at another example, aside from semiconductors, green mobility, which means products such as electrical vehicles, which requires responsible mining of metals and materials, these are all areas where Asia, as well as Europe, need to work together in order to drive the targeted net-zero, as well as to deliver economic growth and benefits for both these regions.

Like you mentioned, we are currently going through a phase of friction between Europe and Asia, as well as the US and Asia. Ultimately, over time, we're going to see these political flare-ups come and go. Ultimately, they need to work together because we have different strengths. Together they will be able to drive higher economic growth and stable economic growth.

Freddie: Agreed, and I think sometimes it's easy to forget that political action is often temporary, and ultimately will be swayed and driven by demands on both individual economies and their relationships on a global scale. Unfortunately, that's all we have time for, so thank you very much to both Chris and Derek for joining me. Thank you very much to our listeners for tuning in.

Chris: Thanks, Freddie.

Derek: Thank you, Fred. Great to be here.

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