Do investors have the ability to tackle climate change? Stephanie Pfeifer from the Institutional Investors Group on Climate Change, Julian Poulter from the Asset Owners’ Disclosure Project and Raj Thamotheram and John Rogers discuss what investors have already done, the challenges facing them in 2016 and how they can flex their fiduciary muscles
Not the finishing line
As delegates gear up to conclude negotiations on a global climate deal at the COP21 summit in Paris, many stakeholders will be focused on the shape and scale of the deal as the key to understanding the future. But while the eventual deal will provide an important signal of intent, it is not going to be the single defining moment which solves climate change at a stroke. And it is not going to make or break the investor response to climate change.
The reason for this is that there is momentum building within the investor community on addressing climate risk. From measuring and reducing portfolio emissions to engaging with companies and policy makers, and investing in low-carbon solutions, investors are identifying risks and acting on opportunities.
An agreement in Paris can help with this momentum but a repeat of the failed Copenhagen talks six years ago will not stop it. This does not mean Paris is unimportant. The underpinning pledges by national governments and the policies they adopt to implement these pledges will impact significantly on low-carbon infrastructure investment.
And investors have been clear about the policies they would like to see from national governments and from the Paris agreement. Some 379 investors from around the world have signed the global investor statement on climate change, launched last year by the Institutional Investors Group on Climate Change (IIGCC) and other investor groups. It is an unambiguous call by mainstream investors for climate policies that support a low-carbon transition.
A big step forward this time around compared with the failed 2009 talks in Copenhagen is that many countries have unveiled emissions reduction plans – Intended Nationally Determined Contributions (INDCs) in the language of climate diplomacy. But the INDCs as they stand will not put the world on a path where the rise in average global temperatures compared with their pre-industrial levels is limited to 2°C. That is why a mechanism which reviews and ratchets up the ambition of these plans, as the US and China are arguing for, is crucial.
Ensuring developing countries get the financing they need to tackle climate change will also be central to a deal in Paris and its successful implementation in the years that follow. The key will be well-designed policy frameworks that incentivise private investment.
And while policy will help drive further action, investors are not waiting for policy to act. From physical impacts to policy responses, investors know climate change poses a real risk to portfolios and long-term asset values, and they are taking steps to respond to climate risk.
Earlier this year, the IIGCC, along with other investor groups, launched the Investor Platform for Climate Actions, which documents initiatives being undertaken in 30 countries by more than 400 investors managing $25trn (€22trn). The platform shows the breadth of action being taken on climate change and is a good resource for investors who are considering how best to respond.
And investors can respond in several ways to understand and then reduce their exposure to greenhouse gas emissions, as set out in the Investment Solutions Guide on Climate Change. For example, some are starting by carbon footprinting their portfolios; some are setting targets to decarbonise portfolios; some are exiting positions with the highest risk exposure and others are using low-carbon indexes to tilt portfolios away from high-carbon assets.
“Investors are not waiting for policy to act. From physical impacts to policy responses, investors know climate change poses a real risk to portfolios and long-term asset values, and they are taking steps to respond to climate risk”
Investors are also engaging with companies, and exerting their influence to ensure companies are managing climate risks and working constructively with policy makers on climate and energy policy. At IIGCC we have been co-ordinating an engagement programme with Europe-based fossil fuel companies, setting out investor expectations on company responses to climate risks.
Alongside this effort, many of our members have also been urging energy intensive and fossil-fuel companies to ensure their lobbying, and the lobbying activities of the trade associations of which they are members, are consistent with a low carbon transition.
An energy transition is under way and investors are in a unique position to access the growth opportunities it presents. As documented in the Low Carbon Investment Registry, institutional investors are investing in the low-carbon future by backing assets such as renewable energy infrastructure, energy efficient buildings, dedicated low-carbon funds and green bonds.
Investors have a critical role to play in helping put the world on a low-carbon footing.
The investment need – which the IMF’s World Economic Outlook estimates at $53trn to keep the world on a warming path of only 2°C – can only be met with the help of the private sector. And the “potentially huge losses” to investors which Bank of England governor Mark Carney recently warned could result from climate change demand the kind of response we are already seeing from some investors.
An ambitious deal in Paris would place policy firmly on the side of investors and enable them to increase their contributions to a low carbon economy more rapidly.
Paris should be seen as an important milestone but it is not the finishing line.
Stephanie Pfeifer is chief executive of the Institutional Investors Group on Climate Change
No ghosts of 2009 as governments tell investors: ‘Now you’re on your own’
In 2009, at about the time of the last significant climate summit in Copenhagen, investors produced a series of statements on climate change that read like a to-do list for governments. They rolled out one expectation after another, emphasising their concerns, but failing to mention the small matter of how they were going to manage their own risk.
While most large investors simply react to policy initiatives, the 2009 Copenhagen disaster changed perceptions among some long-term asset owners. They came to look at climate policy as a risk they might have to mitigate themselves, rather than bank on legislation.
There have been several initiatives since the Copenhagen summit: the divestment movement, Papal intervention, Bank of England warnings, a US president going it alone and China methodically going about decarbonisation. Such external assistance has buoyed leading investors and slowly but surely the language among this group has begun to change. With so little political action, but with seemingly so much to lose, some investors have started asking themselves what measures they can take and at what risk.
Many of these leading investors have also realised that they need to embrace calls for industry change. Change is required everywhere – in culture, processes, agents, incentives, models and their manager contracts. Pity those asset owners for a minute for being asked to support a degree of change that no other industry, including information technology, has been asked to bear.
But much as the leaders have wanted to act, everything has seemed uncertain, so the question of how to proceed is still delicately poised. After all, here is a risk with probably only one outcome, a nasty one at that, the only issue being when, not if.
“Much as the leaders have wanted to act, everything has seemed uncertain, so the question of how to proceed is still delicately poised. After all, here is a risk with probably only one outcome, a nasty one at that, the only issue being when, not if”
The key question now is what will become of investors after the COP21 summit in Paris. COP21 itself will end up being fairly simple in terms of emissions agreement. It is an easy calculation and a poorly guarded secret that the individual government commitments to emissions reduction (Intended Nationally Determined Contributions – INDCs), suggest that average global temperatures will increase by about 3°C above pre-industrial levels. So on this basis it looks like high-carbon investing for the mainstream investor is set to continue unabated for a while.
But perhaps not. There are signs that investors may need to recrunch the numbers. Many analysts argue that coal use is in structural decline, Tesla electric vehicles have made a mockery of the International Energy Agency’s numbers for a clean transition and some analysts are hinting that the Saudis’ oil price strategy might be in part because of climate concerns.
Investors might initially feel after the summit that they have returned to a climate vacuum. But there is evidence that momentum is growing. In addition, recent commodity price falls are impeccably timed to take advantage of the opportunity to invest in a new economy.
To see what will fill that vacuum after COP21 it is necessary to identify leadership and momentum. The leadership shown by the companies in the We Mean Business coalition is admirable and crucial, but few of those commitments will affect core businesses or threaten share prices. In the carbon investment game, risk-return balance defines core businesses and on a risk that is present in over half of a portfolio they must get it right.
Supporters of change such as CalPERS, the New York Common Retirement Fund, PGGM, the UK’s Environment Agency Pension Fund and Local Government Super in Australia, have shown exceptional leadership. Much of their original investment book has been replaced by a new belief system that challenges many received wisdoms.
The new climate leaders are already underweight carbon and overweight clean investments. All of them have gone in search of marginal clean investments and dropped them the other side of the marginal divide, not because a global carbon price exists but because they know that a risk premium is required for their high-carbon alternatives.
The leaders, brave though they have already been, will need to take a deep breath in 2016. They will need to collaborate to create funding economies of scale to create massive diversified funds and shift the economics. These leaders will need to abandon the polite form of engagement with high-carbon companies practised particularly by the European funds – there simply is not time to gently persuade those companies to agree to their own death. They can and must force them to diversify.
The challenge facing leaders is to move this pricing of uncertainty further, faster and deeper into their peer community. In an industry known for its politeness and herd mentality, it is necessary to create new levels of pressure on those laggard funds that are not prepared to join them. Such funds, currently a majority, are adding to everyone’s financial risk and not even taking the easy options for action. For their comfort they will have a community of non-governmental organisations eager to help.
The run-up to the Paris summit has shown the necessary moves can be taken. Slow-moving funds and the high-carbon lobby would do well to realise that the situation looks different than in 2009.
Julian Poulter is CEO of the Asset Owners’ Disclosure Project
A defining moment for institutional investors
High-carbon companies and fossil fuel countries have fought hard to ensure the COP21 summit in Paris does not result in disruptive change any time soon. They have not had everything their way but on the key question of binding targets to keep warming below 2°C, they have won.
But a binding inter-governmental agreement has consequences that investors cannot ignore. The likely limited success of COP21 means that investors will be expected to ratchet up the Paris agreements. And high-carbon companies might find global pension funds and insurance companies much harder to manipulate than a handful of key governments.
The governor of the Bank of England has given a foretaste. Mark Carney’s recent speech on stranded assets was aimed at UK insurers but was studied globally. He proposed a voluntary disclosure standard but, crucially, he advocated “companies disclose not only what they are emitting today, but how they plan their transition to the net-zero world of the future”.
After years of frustration in trying to engage with high-carbon companies and energy extractors, many investors have come to realise their current risk management paradigm – that is, diversification, hedging and constructive engagement with companies – is unfit for this particular purpose. What they do not yet know is that the only viable solution for managing big climate risk to their own portfolios is to make a rapid transition to a low-carbon economy, which means shrinking brown energy as well as growing green energy. And what they certainly do not realise is that such a transition can be done in a way that is cost neutral for diversified investors.
Part of the problem is a low awareness of the issues. The CFA Institute, the global association of investment professionals, highlights that in some key countries (such as Canada, India and US), awareness of climate issues is particularly weak. But it is 53 years since Rachel Carson published ‘Silent Spring’, which marked the beginning of the modern environmental movement. Now we find ourselves at another dangerous crossroads. The earth’s average temperature is likely to rise in the near term by over 2°C, and scientists agree that the burning of fossil fuels is a substantial contributor to this problem.
The good news is it does not have to be this way. We have all the technology and talent we need to change tack, to ride the turbulent period that is coming and thrive in a low-carbon world.
That is why so many stakeholders are focusing on finance. Institutional investors have grown enormously in the past few decades in both numbers and size. The top 1,000 retirement funds control over $9trn (€8trn) – enough to buy all of Europe’s listed companies. These investors, which we call ‘super fiduciaries’, have the muscle to effect change in the companies whose shares and debt they own. They have long time horizons, and their beneficiaries will stretch across future generations. There is no excuse, and every incentive and duty, for institutional investors to pitch in and mitigate the dangerous path we are on.
“There is no excuse, and every incentive and duty, for institutional investors to pitch in and mitigate the dangerous path we are on”
We call this approach fiduciary capitalism and it enables a fundamentally different risk management strategy to address systemic risks like climate change. Once fiduciary capitalists take their duty of care and loyalty seriously, and place the needs of their beneficiaries above all other considerations.
It would be wrong to say that investors are doing nothing. On the contrary, there is much happening with ‘divest/invest’ and portfolio decarbonisation. But imagine a stool with two legs. Our proposal – to be launched post-COP21 when attention focuses on how to bridge the gap – is about stabilising the wobbly stool by growing a third leg, building on the success of the ‘Aiming for A’ shareholder resolutions at BP, Shell and Statoil that saw companies pressured to disclose their resilience to climate scenarios modelled by the International Energy Agency and publish details of any low-carbon R&D work. Forceful stewardship, using governance rather than investment levers.
Forceful stewardship means investors acting together to guide the decisions company directors make about corporate purpose and strategy via shareholders’ resolutions at annual general meetings. What is a weakness of the investment system (that is dispersed ownership) and what is often considered irrelevant (that is voting rights) combine into a powerful system-change strategy. Forceful stewardship also means investors influencing legislators and regulators (for example, to abolish energy subsidies). Crucially, this advocacy is done on the back of acting in investors’ own sphere of control first, so neutralising the criticism that investors are simply engaging in blame games.
Will it work? Society has retired powerful economic interests that no longer fit with society’s needs before: the abolition of slavery, for example. And, more recently, an issue which was once totally divisive in the US – gay marriage rights – has morphed into something that does not warrant debate.
Investors who bristle at having to show they have a social purpose which is fit for this global emergency should be grateful. Forceful stewardship is a cost-efficient strategy that allows fund managers to continue investing as they want. If investors resist, the alternative is certain to be more intrusive as the divestment movement has already shown and as lawyers are getting ready to test in court.
Raj Thamotheram is CEO of Preventable Surprises and a visiting fellow at the Smith School, Oxford University. John Rogers is former president and CEO, CFA Institute, and global president and CEO, Invesco Institutional Division