Quarterly update: is a potentially disruptive policy response to climate change inevitable?

In the US, we welcomed Senator Elizabeth Warren’s bill, which directs the US Securities and Exchange Commission to issue rules requiring companies to disclose information about their exposure to risks caused by climate change. The proposed legislation, The Climate Risk Disclosure Act, would enable global investors to better assess and manage climate-related risks and opportunities in their portfolios. ‎The PRI’s view is that companies should use the recommendations of the voluntary FSB Task Force on Climate-related Financial Disclosures (TCFD) as a practical framework for identifying and disclosing on financially relevant climate risks and opportunities.

Also in the US, The TCFD published its 2018 Status Report, providing an overview of current disclosure practices and their alignment with the core elements of the TCFD recommendations. Over 500 organisations have expressed their support for the TCFD recommendations, signalling growing momentum for climate-related disclosures.

In Europe, the Council of the European Union recently adopted conclusions on climate change which emphasise the unprecedented urgency which is needed to step up global efforts to avoid the dangerous effects of climate change. Climate change is happening and its effects are being felt all over the world. Environment ministers are sending a strong political signal in these conclusions, which constitute the basis for the EU’s position at the forthcoming COP24 climate conference in Katowice, Poland, in December.

Last week, in South Korea, a report from 91 scientists convened by the UN’s Intergovernmental Panel on Climate Change, shows unprecedented changes are needed across society to limit global warming to 1.5C above pre-industrial levels. It said that the earth had warmed by 1C since pre-industrial times and was likely to heat up by a further 2C by the turn of the century, based on current policies.

The report was commissioned by the Paris parties to help them understand the vastly different implications of 1.5C of warming — the target they agreed to move towards — and the 2C they committed to stay below.

What does this mean for investors?

For investors this report has wide ranging implications as the potential for significant market disruptions become more and more evident. In anticipation of this report the PRI has launched its new research programme —”An Inevitable Policy Response (IPR)”— which states that investors must take additional action on climate change now in order to avoid a hard and potentially disruptive transition in future, with 2025 a likely period for additional measures being put in place by governments through increased regulations.

Our IPR work gives investors a view on what actions would be needed if the world were to limit warming to 1.5C and why a forceful policy response is otherwise inevitable.

The companion technical papers commissioned by the PRI and authored by Energy Transition Advisors and Vivid Economics set out key considerations for investors relating to a hard transition or IPR.

The research shows that investors need to act by reallocating capital to low-carbon investments, decarbonising their portfolios, and increasing their active ownership, including policy advocacy. In particular, investors need to engage with governments on the implications of a hard transition, including the need for policy action around carbon pricing, and more ambition in many countries’ pledges to the NDCs.

Initiatives around climate change must also take the social impact into the equation. A ‘just transition’ for workers and communities as the world’s economy responds to climate change was included as part of the 2015 Paris Agreement. The PRI, in partnership with the Grantham Research Institute on Climate Change and the Environment and the Harvard Kennedy School, and the Centre for Climate Change Economics and Policy recently published Climate change and the just transition: a guide for investor action. We are encouraging Investors to sign a statement of their commitment to support a just transition on climate change.

The ‘how’ of ESG integration

Ensuring that investors integrate ESG into their portfolios is essential if responsible investment is to keep moving forward. Along with the CFA Institute, we were pleased to launch the first of a series of reports looking at how portfolio managers and analysts are increasingly incorporating ESG factors into their investment analyses and processes. However, ESG integration remains in its relative infancy, with investors and analysts calling for more guidance on exactly “how” they can “do ESG” and integrate ESG data into their analysis. With the CFA Institute set out to create a best practice report (Guidance and case studies for ESG integration: equities and fixed income) and three regional reports [one for the Americas (AMER), one for Asia Pacific (APAC), and one for Europe, the Middle East, and Africa (EMEA)] to help investors understand how they can better integrate ESG factors into their equity, corporate bond, and sovereign debt portfolios.

Assessing impact investing opportunities

Impact investing, which has been particularly popular in the US, has shifted, over the last decade, from a disruptive investment concept to a complex and rich investment ecosystem.

According to PRI data, more than 450 investors allocated US$1.3 trillion to impact investments worldwide in 2016 and the increasing demand for impact investing products and services has opened a new commercial avenue for asset managers, fund managers and service providers interested in this growing market.

Impact investments can be made in several ways; through a traditional model aligned with the theory of change, the concept of additionality and purpose-driven companies, to a more mainstream approach that focuses on medium and large businesses that deliver products or services to benefit society and the environment.

With this in mind, the PRI launched the Impact investing market map. Its goal is to bring more clarity to the process of identifying mainstream impact investing companies and thematic investments so that asset owners and fund managers can better assess opportunities in this market.

The map focuses on medium and large impact investing companies (privately-owned or listed equity firms) in the real economy. The PRI used two basic frameworks, the UN Sustainable Development Goals (SDGs) and the PRI Reporting Framework, to identify 10 thematic investments (themes): energy efficiency; green buildings; renewable energy; sustainable agriculture; sustainable forestry; water; affordable housing; education; health; and inclusive finance.

Spotlight on cyber security

With a constant flow of stories in the news about cyber breaches, we thought it was important to better understand company disclosure on cyber security governance and processes. Fifty-three institutional investors representing more than $12 trillion in AUM are collectively engaging with global companies in the healthcare, financial, consumer goods, information technology and communications.

This report and the underlying research findings will support and inform the engagement dialogue. The research evaluated the public disclosure of 100 companies on cyber security, covering 14 indicators on aspects such as policy, governance and flow of communication, access to expertise, training and assessment, and other procedures.

Human rights and the extractives

In the last year, social issues have become an increasing focus for the PRI. We felt it was important to focus on human rights, particularly in industries such as the extractives sector, where strong policies on worker safety are essential. Our report, Digging deeper: human rights in the extractives sector, focuses on these issues.

Companies operating in the extractives sector face a multitude of complex human rights issues. They tend to have a big operational footprint, which can lead to long-term risks. While the local operating context is key to determining risks arising from operations, oil and gas and mining companies face different risks and issues.

Mining operations tend to be more sole operators or have joint ventures with fewer operating arrangements. They typically rely on large quantities of unskilled labour, which may pose various human rights risks such as bonded labour, hazardous working conditions, lack of collective bargaining and freedom of association, and health and safety accidents.

Update on new signatory growth

During this quarter we added 132 new signatories globally, including 10 in France, 13 in DACH and 11 in southern Europe, where interest in ESG is growing steadily. Significant growth was also seen in the UK and Ireland, where we welcomed 25 new signatories. Most notably, in the US, which continues to face a difficult environment for ESG, we added 27 new signatories.

Among asset owners, we were very pleased to welcome National Grid UK Pension Scheme, the Office of the Illinois State Treasury and AGRICA GROUP France.

A quick look ahead

Going into COP24 in Poland, we see a lot of momentum around climate activities worldwide. But we still have to deal with a considerable amount of scepticism. We are counting on our signatories to keep pushing the climate agenda forward, which includes prioritising capital reallocation into low carbon investments and engaging with policymakers to effect stronger regulations.