Last week in Istanbul, I heard the International Energy Authority’s chief economist say the world’s on track for six degrees warming by 2100. This “catastrophe for all of us” is the mother of all preventable surprises.
Institutions are not completely ignoring this crisis. But do investors really believe they can discharge their risk management obligations, let alone be ‘responsible’, by simply looking for ‘climate alpha’? As John Kay says, it’s the beta - the win-win option - that pays the pensions and what sustains the inter-generational contract.
Investors could be a bigger part of the solution by: discouraging inappropriate corporate political lobbying; pushing for a level playing field in energy subsidies; and ensuring that their own research supply chain takes into full account climate-related risks.
Why these three? As in medicine, making the right diagnosis is the key to regaining health. The primary failure today is that while the vast majority of experts accept the science, the public has been confused and politicians bought off by an unholy alliance of vested interests (especially oil and gas companies and oil-extracting countries), ideological free-market fundamentalists (who would rather put off mitigation than accept that climate change is the biggest market failure to date) and ‘common or garden’ short-termists (who now dominate finance).
A secondary failure has been to deal with ESG issues in silos and so marginalise the discussion to specialist teams and even specialists events.
The practical implications of what needs to happen are both easy and challenging - easy, because the foundations have been laid, and challenging, because investors have lost sight of the changed outcomes they need to see and have learnt to be satisfied with box-ticking.
Take the ESG reporting and rating agencies. They have done well to put carbon risk on the agenda. But none have yet found a way to analyse what companies are doing to encourage/block policy change. Clearly, this often has a bigger impact on the climate than many operational issues. Highlighting how News Corporation (the parent company of Fox News) went “carbon neutral” and was rated AAA by MSCI ESG, an article in the Harvard Business Review suggests that “sustainability ratings risk seriously misleading consumers and shareholders” and “enable greenwashing by allowing corporations to game the system”. This must change.
Investors could also help create a level playing field for energy subsidies. IEA’s chief economist describes the current situation - pushing green while subsiding brown energy - as “grotesque”. Investors have many reasons to support corrective action. Heavily subsidised sectors are inherently vulnerable to substantive and sudden revaluations - think carbon bubbles. With government budgets heavily squeezed, there’s no justification for subsidies to boost already huge wealth transfers to countries and companies, many of whom have awful records on ESG matters; even less justification to subsidise the weekend breaks of the 1%. For sure, fuel poverty requires targeted government action and there will need to be a period of 10 years, for example, when subsidies are either phased out or balanced in a planned way. But the key is to get this ball rolling and investors who are exposed to all energy sectors could usefully disclose what they believe the different subsidies add up to. Last, investors could ensure their own suppliers - sell side and credit rating agencies - take ESG performance, including climate-related risks, fully into account. This means integration into core research notes, not just ESG reports. And it also means analysis of sovereign debt.
Güler Sabanci, the respected chairman of Sabanci Holding, framed the discussion well when she said humanity has been slow to respond to climate change and this generation “has an important responsibility to address this global challenge”. That’s the leadership we urgently need from institutional investors.
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and president of the Network for Sustainable Financial Markets