The case for asset owner action on climate change

Globally, pressure is mounting.

The IPCC’s 5th Synthesis report from November 2014 cited 1000 Gt of remaining carbon budget before we reach likely tipping points. The IEA’s incoming Executive Director Dr. Fatih Birol most recently spoke to this global carbon budget expiring in 2040. The Carbon Tracker Initiative’s carbon budget analysis finds similar and PwC recently estimated that we have approximately 20 years left of annual carbon emissions at present rates before this budget is completely spent. It will be harder to stay within the global carbon budget the longer we do not take action. (See Appendix A for more on climate science).

Leading economists have proposed a ten-point global action plan for a low-carbon economy. Senior religious figures, such as Pope Francis, are now asking followers to take up this cause. Such calls are expected to accelerate in future.

For carbon reductions to occur at the level required, corporate strategy, public policy, and investment strategy need to work in concert, each informing the other’s needs.

Companies such as BP and Unilever are speaking publicly about a need for action on climate change and a growing number are calling for stronger carbon pricing, including most recently six major European energy companies. Over 90 companies have committed to one or more business leadership initiatives on climate change ahead of COP21 and an increasing number of companies including Unilever, Nestle, AXA Group, Allianz and Honda, have committed to adopting a GHG emissions reduction target.

Policy is needed to support investor strategy, for example by levelling the playing field on energy through subsidies as per the IEA’s 4 steps to keep us within 2 degrees. Policy is also needed to help support corporate strategy, such as long-term fixed incentives to inspire renewable energy investment. Companies have been frustrated where incentives such as feed-in tariffs are established and then removed too soon.

Governments are working towards COP21 in Paris in December through bilateral agreements, high-level discussions and other lead-up gatherings. The Climate Change Convention - effectively a planetary risk management treaty - aims to manage climate change within acceptable limits. Parties to the Convention agreed in Cancun in 2010 to 2°C as the upper limit of acceptable warming. Governments will make a significant contribution by calling for a minimum 60% reduction in global emissions by 2050 from 2010 levels (consistent with the IPCC range of a 40%-70% reduction).

However, even if governments fail to reach an agreement at COP21 in Paris in December, the potential impacts of climate change on the economy and the global carbon budget mean that asset owners will still need to consider their carbon risk exposure and the full range of possible actions to reduce emissions. Their portfolios are inevitably exposed in some way to costs from climate change.

Large, institutional owners typically have diversified and long-term portfolios broadly representative of the overall capital markets. They can play a positive role in influencing companies and policy makers to minimise their exposure to these costs.

“As a passive investor and universal owner we have a unique perspective in that we invest in a small share of the whole global economy, rather than specific companies or industries. As we are not an active investor, we do not distinguish between companies or industries being winners or losers in terms of climate risks. Our perspective is that the whole economy needs to lower its climate risks, because our interests and challenges are essentially the same as society’s as a whole.”

Charlotta Dawidowski Sydstrand, Sustainability Strategist, AP7

Asset owners are already taking concrete actions. Examples include the Aiming for A Coalition shareholder resolutions on climate change as well as the growth in green bonds, whereby proceeds are earmarked for projects with environmental and/or climate benefits. A new investor platform, investorsonclimatechange.org indicates a range of possible actions in measurement, engagement and reallocation to low carbon investments.

“Catholic Super believes it is essential to reduce global carbon emissions in order to reduce the effect CO2 may have on our climate and to improve the quality of life. This is one of the core reasons why Catholic Super supports the PRI’s climate change project and is active in collaborative investor groups, and also why we engage with companies and strive for integration of risks of this kind into investment processes of our underlying fund managers.”

Garrie Lette, CIO, Catholic Super

Whilst climate change poses risk to the environment, opportunities for investment in new energy sources and new technologies also exist for investors.

Fiduciary duty

Fiduciary duty has long been a fluid concept, and there is little reason to expect the interpretations and definitions of prudence and loyalty to not continue to evolve. The UK Law Commission has been looking at the relationship between ESG and fiduciary duty, and other jurisdictions are paying close heed to such developments in fiduciary duty laws and interpretations.

Asset owners such as CalPERS have developed investment beliefs that include recognition that fiduciary duty is multi-generational. The University of California has undertaken similar work and other asset owners including The Pensions Trust and the BT Pension Scheme have established belief sets or equivalent investment policies. Increasing across the globe there is an understanding that part of an investors fiduciary duty is to manage risks, that include long term risk such as environmental, social and governance risks.

“As investment fiduciaries it is our responsibility to meet our stakeholder’s long-term financial objectives and understand a broad range of risks that affect the long-term returns of the investment portfolio. Climate change is both a risk and an opportunity that cannot be ignored, and understanding the impact to our portfolios, the companies we invest in, and the economy as a whole is our responsibility as investors.”

Jagdeep Bachher, Chief Investment Officer, University of California

A group of over 50 companies and investors, including Unilever, Lenovo, CalSTRs and Aviva Investors, are supporting The Climate Disclosure Standards Board (CDSB)’s statement on fiduciary duty and climate change.

There may be a time where trustees and others in charge of pools of investable assets will need to be seen as positively addressing climate change or risk being found in breach of their own fiduciary duty. Sarah Barker, of Australian law firm Minton Ellison, identifies three trends; a proactive stance on governance on climate change is consistent with financial wealth interests; boards must actively engage with the issue of climate change impacts on their operations, risk and strategy; and a passive approach to climate change governance may be inadequate to satisfy directors’ duties of due care and diligence.

“Most trustees are tasked with balancing risk and return across generations in an impartial manner that reflects evolving standards of care. Those who proactively integrate consideration of the material, longterm effects of environmental, social and governance factors into their investment and risk management process will be in the best position to demonstrate future compliance with fiduciary obligations.”

Keith Johnson, The Cambridge Handbook of Institutional Investment and Fiduciary Duty17

The PRI is examining how considering ESG risks is consistent with fiduciary duty through its project Complying with your Fiduciary Duty: a Global Roadmap for ESG Integration16, which will be published September 2015.