Long-Term Matters: Followers will make the money flow
“Investment is the most often repeated word in IMF meetings, UN meetings, [the] G20 meeting, IIF meetings,” Angel Gurria, secretary general of the OECD said at the organisation’s recent long-term investing conference in Paris. There is an “enormous responsibility on your shoulders,” he added. “Everyone is asking, why the Dickens don’t you deliver the money?”
Gurria may be an unusually jocular international diplomat but investors are certainly at the centre of a pincer movement. On one flank are governments and intergovernmental bodies. On the other are academics, think tanks, pressure groups, litigators and billionaires. Investors should not ignore where these strange bedfellows are heading.
In the aftermath of the financial crisis, the G20 focused on the banks. Now, investors are in the regulatory cross-hairs. In 2013 the G20 endorsed its high-level principles on long-term investing by institutional investors and asked the OECD to focus on investor transparency. The G20 also recommended that the Financial Stability Board (FSB) produce a report on climate risk, which helped trigger the comments by the governor of the Bank of England, Mark Carney, on climate action, in his position as FSB chair.
There is now widespread awareness that infrastructure and other long-term investment is critical for a successful transition to a low-carbon economy. The Framework Convention on Climate Change has asked the OECD to review how fiduciary duty is interpreted. China has made clear it wants to make long-term finance the issue of its presidency of the OECD in 2016. And in the US, the Department of Labor has reversed earlier guidance and says trustees “should” take ESG into account.
If these governmental and inter-governmental actions were not challenging enough, an unusually wide range of other stakeholders are pushing for action in broadly the same direction. Thought leaders like John Kay argue persuasively against an overly intermediated financial system with a much greater focus on real assets.
The Nobel economist Michael Spence speaks about the clogged pipeline between the “large pools of savings in sovereign wealth funds, pension funds, and insurance companies” and the “emerging economies’ huge financing needs for infrastructure and urbanisation”. The United Nations Environment Programme Financial Inquiry has been actively building global support for action by governments, which would push investors to be more long-term and sustainability focused. And Bill Gates has set a new benchmark by agreeing to invest 2% of his wealth in a new green energy R&D fund. If the world’s 50 biggest institutional investors followed suit, the fund would be about €770bn.Some institutional investors may find this new context unsettling.
But might it be exactly what they need to re-discover their own social purpose? Investors also have their own good reasons to be upbeat about infrastructure. At a time when, as Guerra says “all four cylinders of the growth engine are at half speed”, and there are fewer good places to invest, infrastructure offers the potential of better yield than Treasury bonds.
So what is getting in the way of faster progress? For investors, the challenges are scale, governance and competence. For governments, the challenge is policy confusion and uncertainty.
Size really does matter in infrastructure investing. It defines fees, the competence needed to monitor investments and the ability to co-invest. The good news is that movement by the biggest funds would have a snowball effect. According to the OECD, the top seven EU pension funds account for $3.5trn (€3.3trn) while the next 160 only account for $2.7trn. Arguably, these smaller funds are wise not to get into infrastructure until the big funds have restructured the marketplace and made it more customer centric.
Governance and twenty-first century definitions of fiduciary duty are major issues and have been much talked about. The only thing that needs to be said is “just do it”.
Less mentioned is the challenge of technical know-how. Stewardship is at the heart of long-term investing but investors are not naturally competent at this. CFA polls show that only 33% investment professionals in Canada – leaders in long-term and infrastructure investing – understand climate risk. The solution is for asset owners to select better suited investment managers and monitor them better, so they deliver better. This is a major culture change project requiring reforms in how investment staff are paid, who they use as sub-advisers, and many other things.
For their part, rather than just jawbone investors to try to push money uphill, governments must deliver greater policy authenticity and certainty. Why, for example, are so few regulators talking about climate-related systemic risk in the way that Mark Carney has?
At the eleventh hour, the oil & gas industry has started to make proposals for how to stay within 2°C but these remain overly conservative, as demonstrated by The Heat Is On initiative. If a consulting firm with close links with the extractive industries can challenge its clients, could not regulators push harder too? Most practically, a key issue defining whether we decarbonise rapidly enough is what kind of infrastructure we build now. Investors are anxious about non-listed infrastructure for two reasons, according to Prof Amin Rajan, a specialist in asset allocation trends in institutional investing.
First, unlisted infrastructure often involves governments as partners and they are known to move the goalposts, often to the detriment of other investors. Second, institutional investors also worry that if they are turned into forced sellers, who would buy these illiquid assets? “The 2008 crisis was a defining moment: lack of liquidity saw prices going into freefall in many cases,” Prof Rajan says. So it cannot be forgotten that today’s regulation of institutional investors makes it harder for them to do the right thing on climate. This is another incentive for getting insurance and pension fund regulation right.
Policy makers can do at least three things to attract investors. First, they must give cast-iron guarantees that they will not rewrite the rules retrospectively to suit their own agenda. Second, unlisted infrastructure project finance should be tranched by time horizons, so that not all investors are locked in for long periods. Third, more new projects are needed, as the existing ones are overvalued, like all other asset classes. Diplomats may be hoping that if they can seduce enough capital to begin to change the global energy infrastructure and reduce technology costs, then it will become a self-fulfilling process.
But bubbles created with good intent (such as sub-prime housing) can also burst. Investors appear to be a ‘lever’ that works when other levers (such as hard policy decisions) seem stuck. The big question is whether investors will actually change their asset allocation enough until there are clear incentives in place.
For their part, investors can moan about policy uncertainty or roll up their sleeves and help get it sorted. For example, investors could support the Friends of Fossil Fuel Subsidy Reform agenda. And by requiring companies to disclose their political donations, diversified investors could help sunlight shine in ways that improve policy-making and reduce portfolio-level systemic risk. InfluenceMap now gives investors the ammunition they need to have these forceful discussions with companies.
Institutional investors and governments are in a tango. Governments are in the lead but as all good dancers know, it is the follower who really makes the show. The money will flow if we get the dance right.
Raj Thamotheram is CEO of Preventable Surprises and a visiting fellow at the Smith School, Oxford University. Edward Waitzer is director of the Hennick Centre for Business and Law, Osgoode Hall Law School and Schulich School of Business, and a senior partner at Stikeman Elliott