One of the most hotly debated themes was the extent to which awareness of climate change is becoming a mainstream issue for investors – and how effectively companies are responding.
In the past two years, some 120 investors with $10 trillion in assets have committed to the PRI’s Montreal Pledge which requires signatories to measure and report their carbon emissions. The signatories include many big-name investors such as HSBC, Axa and Universities Superannuation Scheme. Furthermore, 25 investors have committed to significantly reducing the carbon emissions associated with $600bn assets under the Portfolio Decarbonization Coalition.
Looking more broadly at incorporating environmental, social and governance (ESG) issues into investment decisions, in the US, assets worth $6.57 trillion are invested subject to ESG considerations, according to data from US SIF. In Europe, €7.5 trillion are invested under ESG principles, according to Eurosif. Among the leading responsible investors is the UK’s Environment Agency Pension Fund, which revealed that it currently invests 28% of its assets in clean and sustainable companies.
The coal divestment movement, which started in the US as a small student campaign to change the investment polices of University endowment schemes, now has the support of 538 institutional investors with asset worth $3.4 trillion, according data held by 350.org for the Fossil Free divestment campaign. Notable divestment commitments have been made by the Norwegian Sovereign Wealth Fund – the largest investor in the world – as well as the Rockefeller Brothers Fund, the World Council of Churches and the British Medical Association.
This is driving demand for tools that investors can use to analyse the carbon risks in their equity investments. These include checking the ‘two-degree alignment’ of companies in a portfolio with the carbon reduction pathway implied by the Paris climate change agreement’s goal of limiting global warming to two degrees Celsius, analysis of the relative proportion of ‘green’ versus ‘brown’ energy used by companies in a portfolio, and assessment of the risks associated with unburnable fossil fuel reserves and carbon-intensive stranded assets in a portfolio.
Concern was expressed at the events about the slow-pace at which some companies are taking action over the risks of climate change. Investors have shown that they will force the issue to the top of the agenda. In May last year, almost 99% of shareholders at Shell’s annual general meeting supported a resolution demanding the company compare its business to international goals to limit climate change. This April, US energy company Peabody filed for bankruptcy due to the shrinking market for coal driven by the transition to lower carbon fuels and coal divestment.
Investors are starting to look beyond carbon towards the risks of other environmental impacts, in particular water use. Sectors such as agriculture, mining, utilities, and oil and gas are intensive users of water – for instance, in agriculture to irrigate crops and feed livestock, or in energy utilities to cool power stations. They are therefore exposed to operational risks from water scarcity in areas of the world affected by drought due to climate change.
Many other sectors are also at risk from water scarcity because they are dependent on agricultural commodities, energy and transport fuels through their supply chains. These include manufacturers and retailers in the apparel, consumer goods, and food and beverage sectors. Companies in these sectors face higher costs and lower revenues which may reduce returns to investors.
Some companies are responding by assessing the threat of water scarcity at sites in different countries using tools such as the Water Risk Monetizer from Ecolab and Trucost. It enables a company to calculate the “risk premium” it might have to pay for water, which it can use to make decisions over where to invest in water efficiency and where to expand its business.
Awareness of the risks of climate change, air pollution and water scarcity is increasing among banks in Brazil, China and India as a result of the environmental damage caused by rapid economic growth and industrialization in these countries. For example, a report commissioned by the Industrial and Commercial Bank of China (ICBC) shows that China’s banks are exposed to costs of RMB 11 trillion as a result of the environmental damage caused by industries they finance. The report provides a new tool for financial institutions to analyse the environmental risks to loan repayments and investment returns at a sector level.
From risk to opportunity
Another notable trend debated at the events has been the recognition among investors of the opportunities that are emerging from the shift to a low-carbon, green economy. This is driving demand from companies for tools to communicate the net benefits of products that reduce carbon emissions and other environmental impacts to investors. Companies hope these products will boost revenues by giving them a competitive advantage.
A good example is Dell’s use of closed loop recycled plastic for use in its desktop computers. Research commissioned from Trucost shows that closed loop recycled plastic has a 44% greater environmental benefit than virgin plastic, equivalent to an annual saving to society of $1.3m in avoided environmental costs. If all of Dell’s plastic was supplied by closed loop recycling, the environmental benefits would increase to $50m per year, and if the whole computer industry used it the environmental benefit would be $700m per year.
Another opportunity is the chance to invest in green bonds issued by companies that want to raise finance for projects with environmental benefits such as installing renewable energy, improving water efficiency, and reducing waste through recycling. Green bonds offer investors competitive returns with the added benefit of demonstrating their commitment to tackling climate change by investing in more sustainable business.
Overcoming barriers to change
The event also discussed barriers to incorporating climate change into investment decision making. One long standing issue is fiduciary duty – the requirement that institutional investors such as pension funds should act in the interests of their clients, the fund members.
While several delegates said that it had been clear ever since the influential 2005 Freshfields report that investors should consider whether climate change could affect the value of pension funds, some said that there was evidence that investors did not understand this. For example, some thought that climate change was an ethical issue that did not need to be considered, or that the duty fell on investment managers rather than pension fund trustees.
The event also debated the psychological barriers to awareness of climate change. Investors suffer from “irrational apathy” over climate change in which they recognize the risks but feel powerless to do anything. Investors change their attitudes and behaviour to suit the values of workplace to avoid cognitive dissonance – the unpleasant feeling of holding conflicting ideas. Investors also suffer from confirmation bias in which they tend to seek out information that fits their beliefs while ignoring contrary advice. There is survey evidence that investors lack accurate information on which to base their judgements such as the benefits of renewable energy. The issue underlines the need for a leader from within the financial community to use their influence to change attitudes.
A barrier for companies is the difficulty of communicating the business relevance of environmental issues to investors. On 13 July, the Natural Capital Coalition will publish a protocol to help companies identify their relevant environmental impacts and use monetary valuation to understand and communicate their significance in business terms. The protocol is being supported by guidance for the apparel and food and beverage sector developed by Trucost. The results could be published in integrated profit and loss accounts (IP&L), so that shareholders can see the potential risk of pollution and unsustainable resource use to revenues.