Impact of rates, cyber risks, and US backing of UN's plastics treaty

September was a busy month for central banks, with the Federal Reserve, the European Central Bank, and the Swiss National Bank all lowering interest rates. In our CIO base case, we expect rates to be lowered further this year, with additional easing in 2025.

The macroeconomic environment—including interest rates and inflation—matters to sustainability-focused investors. Higher interest rates often pose challenges to small- and medium-sized companies that need to borrow, as well as to high-growth companies, whose revenues are expected in the future but are today discounted by a higher factor for the purposes of valuation. However, higher interest rates support yields in the high-grade spectrum of sustainable investing bonds and favored companies with a more defensive balance sheet.

Going forward, we expect conditions for environmental, social, and governance (ESG) thematic and engagement equities to improve. Engagement is often more effective and constructive with smaller companies, where investor knowledge and guidance can be helpful in navigating sustainability objectives and addressing environmental and social outcomes. An ESG thematic focus tends to lead investors into likewise small- and mid-cap companies with revenues tied to impactful sustainable technologies or growing business models. While these two sustainable equity strategies have come under pressure over the past two years, we observe some recovery lately. For example, at the index level, alternative energy thematic equities outperformed their benchmark in September by 2.24 percentage points (4.11% for MSCI Global Alternative Energy vs. 1.87% for MSCI World), although they are still underperforming year-to-date.

Within fixed income, lower interest rates are likely to support pricing for quality bonds, which benefits investors with existing allocations to multilateral development bank (MDB) bonds and investment grade corporate bonds—whether within thematic sustainable fixed income or ESG leader bond strategies. MDB bonds, specifically, have performed in line with US Treasuries historically (in September, 1.25% and 1.26% respectively, at the index level). More broadly, lower interest rates do not favor cash and cash-like holdings, which also happen to not provide any sustainability benefits. This means that sustainability-focused investors, who might have held cash in the past to earn interest income, can now begin to invest in sustainable bonds.

Within alternative investments, lower interest rates are also supportive of infrastructure investments, which have emerged as a way for private market impact investors to address the energy transition, among other key developments.

Within this discussion, it is important to remember that sustainable investing is not an asset class of its own, and the market environment is likely to favor different sustainable investing strategies at different times. Therefore, we advise sustainability-focused investors to maintain a portfolio approach and allocate to a combination of sustainable investments. Our capital market assumptions expect balanced portfolios (45% stocks, 35% bonds, 20% alternatives) to beat cash by around five percentage points each year over the long term.

Investor takeaways:

• Lower interest rates are likely to benefit ESG thematic and engagement equity strategies, and their proliferation within private markets. Coupled with positive secular tailwinds such as government and corporate commitments to the transition to a lowcarbon economy, this is supportive of the opportunities across our blue economy and energy transition(s) longer-term investment themes.
• Within fixed income, we continue to prefer quality bonds, with opportunities across multilateral development bank (MDB) bonds and thematic sustainable fixed income strategies. We advise sustainability-focused investors to re-allocate excess cash and money-market holdings into more durable sustainable bond investments.
• We think that sustainability-focused investors who can diversify and take a longer-term investment horizon have a better chance of navigating volatility in a changing interest rate environment. We continue to favor a (balanced) portfolio approach that combines different sustainable investing strategies across equities, bonds, and alternatives.

The US government and Microsoft recently together seized thousands of domains of Russian hackers accused of targeting US government officials and civil society organizations allegedly intending to disrupt the upcoming US presidential election. Although the details of this case may be unique, they’re clearly part of a trend of increased cyberattacks globally.

Cyber crime is predicted to cost the world USD 9.5 trillion in 2024, according to Cybersecurity Ventures. The pervasive adoption of cloud computing, the increase in remote/hybrid work, the growth of Internet of Things (IoT), and the rise of generative artificial intelligence (AI) have contributed to cyberattacks that are not only increasing in speed and intensity, but are also becoming more sophisticated. AI lowers the barrier for low-skilled hackers, enabling them to launch state-of-the-art attacks with scale. Ransomware attacks, where the attacker demands a ransom payment for the victim’s access to breached data, create a cost for companies that experience a breach. According to IBM, the average cost of a data breach has soared to USD 4.88 million, marking a significant 10% increase.1 This spike is driven by the cost of lost business, operational downtime, and regulatory fines, all of which also add to reputational risk.

The challenge is broadly societal as well. Data from the US Federal Bureau of Investigation show that ransomware attacks are distributed across critical industries, and have a focus on industries which historically do not have advanced security systems in place, with healthcare in the lead (see Fig. 2).

Global regulators started their cyber policy response in earnest following COVID 19, where cybersecurity rapidly rose on the list of security issues at the national level. The US set up the Cyber Safety Review Board (CSRB) by executive order in 2021, tasking the group with reviewing cyber incidents and making recommendations to public and private entities. The European Union is rapidly strengthening its cybersecurity legal framework, with the EU Cyber Resilience Act proposed in February 2024, following its first introduction in 2022. In 2023, Australia launched its 2023-2030 cyber strategy, and Japan launched an updated cybersecurity strategy.

Given the rapid development of AI, however, regulatory, enforcement, and corporate frameworks for response will have to continue to adjust.

Cybersecurity and sustainability

Data privacy and security, always part of ESG frameworks but often sidelined by mainstream investors, now take center stage. Data security and protection have historically been part of sustainability frameworks as a matter for social concern, but the market is only now starting to fully understand the financial implications of this issue Traditionally categorized under the social aspect of ESG, data privacy is now poised to influence governance and environmental reporting as well. This shift is driven by the enactment of more stringent privacy laws.

In an example of cyber risks imposing higher costs, the CSRB earlier this year published a strongly worded report on Microsoft’s handing of a cyber threat in 2023, finding that the company made “avoidable errors that allowed this intrusion to succeed."2 In response, Microsoft last month initiated regular reporting on its security initiatives; it said 34,000 equivalent full-time engineers were dedicated to addressing its largest cybersecurity project ever.

Investor takeaways:

• The rise of AI is likely to increase cybersecurity risks as barriers of entry for malicious actors are lowered.
• Technology companies have to focus engineering efforts on cyber protection technology, which should benefit the Security and safety Longer Term Investment (LTI) theme.
• ESG leaders with high people scores may manage data privacy and security issues better than their peers. Given the rapid changes in the space, however, engagement on these topics will be critical moving forward.

According to a Reuters report, the US will support a global target to reduce plastic pollution in a binding United Nations treaty which will be finally negotiated in November in South Korea.3 The US is home to the largest plastics manufacturers globally, making this shift in position meaningful. Yet, its stance does not guarantee that the UN treaty will include meaningful targets, given the reported opposition from China and Saudi Arabia, among other countries.

Setting up global targets to accelerate plastics production is critical not only to environmental objectives, but also to global health objectives. As we discussed in the May edition of the Sustainable Investing Perspectives report, traces of microplastics have been found in placentas and brains of newborns, and lately have been linked to declining male fertility as well as other health risks.

Sectors likely most impacted by the UN treaty would be those where policies around tailored collection, washing, sorting, replenishing, transportation, and redistribution systems can be implemented. For example, the University of Portsmouth has identified six sectors where reuse systems can be rolled out: venues, events and onsite dining; bottled beverages; food and drink on the go; ecommerce; household and personal care; and businessto- business (B2B). A focus on product design to enable better recycling will likely affect a broad range of sectors, like electronics, transportation, industrial machinery, and building and construction.

A limitation on plastics production could have an impact on companies in the petrochemical sector that produce monomers and polymers for plastics production. If the production ban was extended to single-use plastics, there could be a greater impact on these industries.

Yet, as we have discussed earlier, near-term challenges abound and will likely impact the likelihood of any treaty being approved and realized. Despite global efforts to mitigate plastic consumption, demand continues to rise, fueled by economic growth, especially in emerging markets. The OECD's Global Plastics 2060 Outlook predicts a 60% increase in plastic usage by 2060, driven by GDP growth and without significant policy or technological interventions. Thus, any objectives to lower the use of virgin plastics will have to address both the supply of alternatives and the demand for the material.

Investor takeaways:

• We see opportunities in advanced recycling such as waste management and collection, and recommend that investors consider exposure through our longer-term investment themes of The circular economy and The blue economy.
• Companies that are relative leaders in managing their pollution and waste, in particular those related to the use of plastic packaging, might benefit as strong regulatory attention is being paid to the use of materials.