It is one of the biggest debates in responsible investment today. How should investors respond to climate change and the complex political, economic and social forces that are driving a transition in our energy systems? Should divestment be part of that response or should other strategies, such as engagement, be preferred?
For asset managers that run ethically-screened funds the questions are even more profound. Is continued investment in fossil fuels compatible with the fundamental ethical philosophy of the funds, or, like the traditional ‘sin sectors’ such as tobacco and weapons, should they be screened out?
These were the questions we considered with our Responsible Investment Advisory Council in the run-up to publishing a new, ambitious approach to climate change for our £1.6bn Responsible Funds range, ‘BMO Responsible Funds and the transition to a low-carbon global economy’. Whilst our decision to exclude companies with fossil fuel reserves from our funds was the most publicised part of this, the full policy goes much wider, with five key elements we believe are all essential components of an overall strategy:
• Divestment from companies with fossil fuel reserves
• Case by case assessment of the adequacy of climate change strategies in other key high-emissions sectors including utilities, transportation and industrials
• Investment in solutions, including companies operating in clean energy and resource efficiency, the banks financing these activities and green bonds
• Engagement, where our focus is on encouraging companies to develop transition planning and scenario analysis to ensure they are robust to a range of future energy scenarios, including a 2 degree celcius future
• Transparency, where as well as publishing our policy we will publish carbon footprints for the Responsible Funds range, in line with the recommendations of the Taskforce on Climate-related Financial Disclosures.
Of these, the most challenging decision, and the one that provoked the most discussion and debate, was on divestment, and since making the decision we have spoken with many other investors grappling with the same issues. Three key questions gave us the most pause for thought and shaped our eventual strategic approach.
Question 1: Should we continue to invest in oil, gas and coal mining companies that are supportive of the energy transition?
The shifting economics of the energy market, together with the success of investor engagement, particularly with European companies, has led to significant shifts not just in the rhetoric from the extractives sector but also in their business strategies.The recent Investor Climate Compass report from the CDP and Global Investor Coalition on Climate Change, as well as the work by the Transition Pathway Initiative, show that there is now clear blue water between leaders and laggards, with companies in the oil and gas sector such as Statoil, Shell, Total, ENI and BP, and BHP Billiton and Anglo American in mining, showing Board-level strategic oversight and putting capex into alternatives.
However, in the oil and gas industry, such capex still remains a relatively small part of the overall spend, 1.5% on average across the 10 large oil and gas companies covered in the Investor Climate Compass report.
Ultimately though, our decision was one of principle and was driven by the incompatibility of the extraction of the fossil fuel reserves owned by these companies with the ambition set out in the Paris climate agreement. It is well known that if current reserves are exploited, global temperatures would far exceed the 2 degrees celcius limit agreed in Paris. We concluded that this incompatibility was fundamentally at odds with the philosophy and sustainable focus of our Responsible Funds range.
We were also highly mindful of the preferences of our end-investors, millions of individuals who have chosen these funds because they believe in matching their ethical beliefs to their financial decisions. Surveys, as well as the feedback we have heard from our own clients, now clearly show that many such individuals would rather avoid having such companies in their portfolios. One UK survey of retail investors showed 32% of all adults want a fossil free option for their savings or investments, rising to 46% among under-35s.
Question 2: If we are divesting from extractives companies, how can we carry on investing in companies that are users of fossil fuels?
The highly successful global divestment campaign, which has been instrumental in the $5 trillion in assets now reported as having some form of divestment in place, has focused almost exclusively on the extractives sector. However, with our entire industrial economy built on fossil fuels, the transition to a low-carbon economy of course has impacts across many sectors that we as investors are exposed to and as individuals we all use fossil fuels in some way in our daily lives. Potentially there is an inconsistency here: how can we justify moving away from the companies taking fossil fuels out of the ground, if we still invest in those who are using them?
A simplistic divestment approach cannot work here given the diversity of sectors involved. We therefore looked at the sectors which make the greatest contribution to greenhouse gases: energy utilities, energy-intensive industries, transportation, buildings and agriculture and land use.
In each case, we will analyse the quality of climate strategies, with a particular focus on forward-looking transition planning. We also increasingly seek to invest in companies across these sectors who are not only managing risk, but are providing solutions.
Question 3: Does divestment undermine the ambition of providing access to energy in emerging markets?
As the UN Sustainable Development Goals make clear, as a global community we need to work towards two closely-related goals: Climate Action (SDG 13) and Affordable and Clean Energy (SDG 7). In our Advisory Council we discussed whether divestment as a strategy is premature, given the urgent need to provide access to energy for the 1 billion people still lacking access to electricity, and 3 billion reliant on heavily-polluting fuels such as biomass for cooking and heat.
However, the debate is shifting away from the idea of a simple trade-off between climate change and development, and towards looking at lower-carbon development as a better-quality growth model which is more economically, as well as environmentally, viable in the long term.Particularly when we take into account the significant subsidies supporting the fossil fuels industry (estimated at up to 6.5% of global GDP), the air quality and health impacts of their use (estimated at up to 10% of GDP in China), and, increasingly, the job and growth opportunities offered by the wave of innovation needed to re-tool the global energy industry, the economic benefits of a greener development model start to stack up.
Divestment is not a decision to take lightly, given the continued high weight of the extractives sectors in many key global indices, not least in the UK. But with a thoughtful approach and as part of a more holistic strategy which also focuses on positive investment solutions, we believe it is not only possible, but desirable, to re-orientate investment strategies to avoid fossil fuel reserves whilst also investing in the industries of the future.
Vicki Bakhshi is Director, Governance and Sustainable Investment Team at BMO Global Asset Management (EMEA)