On 14 September, in the New York offices of investment bank JP Morgan, around 200 institutional investors, financial analysts and government officials gathered to hear the results of the third Carbon Disclosure Project (CDP) questionnaire.
Speaking were luminaries including Margaret Beckett, the UK’s secretary of state for the environment; Jim Rogers, the CEO of major US utility Cinergy; and New York State Comptroller Alan Hevesi.
Launched at the end of 2000, the CDP is an unprecedented collaborative initiative by investors concerned about the possible impacts of climate change on the planet – and on their portfolios.
It involves sending the chairmen of the world’s 500 largest companies (the components of the Financial Times Global 500 index) a short questionnaire.
This contains nine ‘investment relevant’ questions, put on behalf of the signatories, covering the degree to which climate change poses risks or presents opportunities to the company in question, and how its management is addressing the issue.
The rising importance of climate change as a concern for investors is evidenced by the dramatic growth in the number of investment companies that are signatories to the CDP questionnaire, and the size of the assets they collectively manage. The first questionnaire was backed by 35 investors, controlling assets of around $450bn (€368bn). CDP3 was signed by 155 investment companies, managing a staggering $21trn in assets.
The risks, these investors believe, are real. These can be broken down into two categories: those arising from changes to the global climate, affecting companies’ markets, supply chains and, with increasingly severe extreme weather events, companies’ very infrastructure; and those from government actions to reduce greenhouse gas emissions, such as carbon taxes and emissions trading schemes.
Conversely, while destroying value in some sectors, the climate change issue will create value in others. Alternative energy stocks are expected to soar, as the world moves to less-polluting power sources. Patterns of agriculture will change, as the environment costs of air transport make ‘food miles’ increasingly expensive. And financial institutions are eyeing carbon allowance markets as offering potentially lucrative new lines of business.
In terms of the growing number of corporate responses that the CDP is generating, it seems that the managers of the world’s largest companies are waking up to the issue. Only 47% of the companies contacted for CDP1 responded with complete answers, although 78% made some response, such as directing the CDP to environmental reports, or to their websites.
For CDP3, these figures had jumped to 71% and 89%, respectively.
So far, so good. Innovest Strategic Value Advisors, a New York-based investment research firm, has analysed each series of responses, and has produced in-depth reports that tease out indicators and trends from the wealth of information disclosed.
Innovest notes, with approval, the dramatic rise in signatories putting their names to CDP3, and the steadily climbing response rate among companies.
But it also observes that disclosure is no substitute for action – and finds that corporate action on climate change is not taking place fast enough. For example, while more than 90% of respondents acknowledged that climate change presented risks and/or opportunities, only 51% of those same companies have implemented programmes to reduce their greenhouse gas emissions, and only 45% have set themselves reduction targets.
Moreover, there is as yet little evidence that corporations are rising to the challenge of reducing their emissions of greenhouse gases. Innovest found that only 13% of the 500 firms reported a reduction in emissions in the period between the second questionnaire, sent out in 2003, and their responses to CDP3, while 17% reported an increase.
Such limited progress is not particularly surprising. While many governments are increasingly stressing the importance of tackling climate change, policy responses have, to date, been limited and halting. The very public split between the Bush administration and the EU over the efficacy of the Kyoto Protocol on climate change has given pause to companies considering radical action – as has continuing bluster from climate change sceptics in the scientific community, despite their growing isolation.
But, as climate science becomes ever more compelling, such foot-dragging is putting considerable shareholder value at risk. It is likely to take several decades to begin to put the global economy on a low-carbon path. Given the long lifetime of many investments – particularly in infrastructure – companies that fail to act soon risk seeing considerable amounts of capital locked up in stranded assets.
This is where the investment community comes in. Many in the socially responsible investment world have long argued that so-called ‘mainstream’ institutional investors are matching, or even exceeding, the management of the companies in which they invest, in terms of their inaction on this key issue.
It is particularly incumbent upon pension funds and insurance companies, as long-term investors, to begin shifting capital away from the heavily emitting industrial sectors of the past, and towards those of the future, they say.
This is, of course, easier said than done. Refusing to invest in airlines, say, or the oil and gas sector, because of their impacts on the climate, would put investors at risk of seriously under-performing their benchmarks, in the short-term at least. Conversely, there is simply not a sufficient number of solar power companies, or makers of hydrogen-powered fuel cells, to absorb a sudden shift in the allocation of capital – certainly not without a dangerous investment bubble forming.
Investors have often tied these arguments to their fiduciary duties to their beneficiaries, arguing that to take account of climate change issues could undermine the returns they generate, rather than protect them. Many in the SRI community have also accorded a great deal of blame here to the investment consultants, arguing that these ‘gatekeepers’ have persisted with a conservative view of the issue that has retarded action by their trustee clients.
In August, however, one of the leading firms in this area, Mercer Investment Consultants, authored a report for the Carbon Trust, a UK-government funded company dedicated to promoting a low-carbon economy.
That report, ‘A Climate for Change’, crucially makes the case that it is, in fact, the fiduciary duty of the trustee to address the climate change issue.
“The materiality of climate change as outlined in this document clearly shows that climate change risk could have the potential to impact a fund’s investments over the long term,” it finds.
“In addition, we suspect climate change risk is neither fully known nor understood and that it is not yet properly managed by the various groups involved in the ongoing management of pension scheme assets. In line with these definitions of fiduciary responsibility, we suggest that it is consistent with fiduciary responsibility to address climate change risk.”
The report then sets out a ‘toolkit’ for trustees to employ. This covers such uncontroversial suggestions as assessing their portfolios to evaluate the extent of climate risks they contain, and ensuring that external fund managers are cognisant of the issue.
It also suggests that investors should “behave as active owners” and engage with the companies in which they invest to encourage them to improve their performance. Importantly, it suggests that investors should participate in the public policy debate. This is crucial.
Companies, typically, lobby in the often narrow interests of their particular shareholders. As institutional investors tend to be ‘universal investors’, with financial exposure to entire economies, they are in a position to take the wider view that will be necessary to address climate change.
But it also suggests that investors might consider placing a portion of their assets in “strategies that specifically incorporate elements of climate change analysis in their investment philosophies (and which would benefit from the shift to a lower-carbon economy)”. These might include specialist funds, energy-efficient property, alternative investments such as ‘carbon funds’, or in ‘clean technology’ private equity firms.
The increasing buy-in of the investment community into initiatives such as the Carbon Disclosure Project is to be applauded. But in the same way that the disclosure of corporate emissions levels is no substitute for actually reducing them, collecting information is no substitute for acting on it. Tackling climate change has the potential to generate one of the most profound shifts in capital that the global economy has ever seen. It is vital that the owners and managers of that capital are at the vanguard.
Mark Nicholls is editor of Environmental Finance magazine in London