What next for investor action over climate change?
At a glance
Institutional investors have decided to take the issue of climate change seriously – not all of them, of course, and not even consistently within individual institutions. But the run-up to and aftermath of the COP21 conference in Paris has shown a ‘stronger for longer’ interest in this issue that goes much deeper than the headline ‘fossil fuel divestment’ numbers and the public statements of proactive chief investment officers.
An ecosystem of interest in the issue is developing steadily across much of the world and throughout the investment value chain that has momentum, breadth and depth. It offers an incentive for IROs in affected companies to mount a proactive response. Asset managers are being gradually squeezed on the issue of climate change from all angles.
On one side, institutional investment clients – notably endowment funds and northern European pension funds – are putting explicit pressure on managers to present investment strategies that incorporate the risks and opportunities that will arise from climate change mitigation and adaptation. On the other side, some of the 78 CEOs who signed a letter to world leaders ‘urging concrete climate action’ are subsequently making it their affair to address their largest investors on the importance to their business of climate change and sustainability. Leading firms recognize they will only be able to effect successful carbon transitions themselves if they bring their investors along with them.
Regulatory pressure is gradually building. The Paris Agreement makes it clear that finance flows should become ‘consistent with a pathway toward low greenhouse gas emissions’ and France has already issued an Energy Transition For Green Growth law that requires institutional investors to disclose how their funds align with national and international climate change strategies.
All of this is happening against mood music constantly played by siren voices (ranging from non-profit body Carbon Tracker to the Bank of England) warning of the size of the ‘carbon bubble’ and the volume of energy assets that will become ‘stranded’. Clients, leading corporates, regulators and research organizations are a combination few asset managers can choose to ignore.
A DIVERSITY OF EVOLVING RESPONSES
Of course, different client requirements, different asset classes and different investment strategies mean each individual asset manager develops a different response to climate change. Frustratingly for IROs, the level of their disclosure in this evolving art is still relatively poor – but there are notable exceptions. For example, UK-based asset manager Schroders provides a particularly clear articulation of its response in a report entitled ‘Responding to climate change risk in portfolio management’.
Most managers, however, make use (to differing degrees) of each of the following climate change response strategies:
• Selection (divestment)
• Selection (active inclusion)
Fossil fuel divestment is the most visible sign of investor activity on climate change. Fossil Free, the divestment campaign launched within US universities, has spread across the Atlantic and the Pacific. Now more than 500 investors representing more than $3.4 tn ‘have made some form of divestment commitment’, according to pressure groups 350.org and Divest-Invest; 120 investors with $10 tn of assets have committed to the Montréal Pledge to measure and publicly disclose the ‘carbon footprint’ of their portfolios; and a range of institutional investors have pledged to reduce the carbon emissions of $100 bn of investments as part of the Portfolio Decarbonization Coalition.
The impact of divestment often goes deeper than these headline numbers, however, because of how it motivates other investment responses. A common pattern is as follows:
• A particular asset manager comes under pressure from its pension and endowment fund clients to consider divestment
• The manager is reluctant to do this because of a perceived long-run impact on the risk-return profile. In recent months, the plummeting oil price has rewarded divestment, and divestment risk may well be less significant than perceived – but the perception remains
• The asset manager, therefore, responds (to the client’s divestment request) by recommending strategies of ‘engagement’ and ‘integration’.
Of course, any divested money has to go somewhere. So companies with significant positive exposure to climate change mitigation, such as those that develop renewable energy or energy-efficiency technologies or those that could be instrumental in the transition to a ‘low-carbon’ economy – telecoms, software, real estate, transport – should be seeing these developments and developments in the ‘green bond’ market as positive opportunities to raise capital from long-term investors at attractive rates.
Some asset managers argue that divestment entails a loss of voice and influence over corporate behavior. They say it is better to stay invested to support companies trying to reposition themselves in light of climate change. This reasoning has led to numerous investor engagement campaigns over the years. More recently a strengthening regulatory backdrop and improved investment arguments around climate change are moving the issue from the SRI space into the corporate governance space, where it resonates with a much wider investment community – most notably in the US.
Prominent examples of this include the fact that more than 98 percent of shareholders in oil majors BP and Shell voted with management in favor of climate change-related AGM resolutions in 2015. Another example is the Boardroom Accountability Project, an initiative of the New York City Public Pension Funds, which explicitly requests improved proxy access at 34 companies on account of their fossil fuel exposure.
As its name suggests, integration involves asset managers taking sustainability or corporate governance information and integrating it into their ‘mainstream’ investment decision-making processes. This strategy is often invisible because it is integrated; but it is also often the most influential investor strategy, because it is embedded within mainstream funds.
SIGNALS FROM THE SELL SIDE
As asset manager disclosure around climate change activity is still generally poor, one way to assess the breadth and depth of asset manager interest is to look at the level of research in the space.
From the sell side we see a growing research focus from bulge-bracket and specialist sell-side companies including BofAML, Barclays Capital, Citi, CLSA, Credit Suisse and many others. In some cases, as at HSBC, research is written by a specialist climate change team; in other cases – as at Exane BNP Paribas, Kepler Cheuvreux, Morgan Stanley, Société Générale and UBS – it is embedded within wider coverage of sustainability and corporate governance issues.
Anecdotally, Citi notes that its research on ‘Energy Darwinism’ is one of its most downloaded research pieces ever. A similar picture emerges from the independent research sector, where many of the top-ranking positions in the recent Independent Research in Responsible Investment survey went to analysts and firms specializing in climate change issues: James Magness from the Carbon Disclosure Project (CDP), James Leaton from Carbon Tracker and Jakob Thomae from the 2° Investing Initiative. Also, the most highly ranked research pieces of the year were CDP’s sector analyses and Carbon Tracker’s work on carbon supply cost curves.
Investors’ recent display of confidence around the issue of climate change masks the fact that, for most, their response to the issue is still at an early stage of development. The investment strategies, research techniques and exposure metrics investors are using are in beta testing: even though they are being given real-world exposure, much remains theoretical and unproven.
One thing is certain, however: investors will develop smarter responses to climate change if they remain in open and active dialogue with the companies that are experiencing carbon transition on the front lines. For IR professionals, therefore, the question is simple: do you want to be a voice in the ear of your investors as this new issue is incorporated into investment strategies? Or do you want the investor to be guided exclusively by the demands of pension funds and the supply from research providers?
The good news for IROs who choose a proactive approach is that it requires only minor adaptations and extensions to well-known IR disciplines.
• Know the nature of your current investors’ interest in climate change
• Identify the influential analysts on the issue and your sector (from the buy side, the sell side and independent agencies)
• Open efficient investor-oriented communications channels
Alice Essam is a researcher and Mike Tyrrell is editor at SRI-CONNECT. Benjamin McCarron is a Singapore-based independent ESG strategist
This article appeared in the Spring 2016 issue of IR Magazine