Op-Ed: Long-term investment and global warming: why ERAFP has joined the IIGCC

The pension fund’s long-term liabilities mean we must act with other investors to change the incentives for greener investment.

Increasingly widespread access to credit and cheap commodities, particularly fossil-fuel based energy, has resulted in rising production and the diffusion of mass consumption. This trend, buoyed by demographic growth, stimulated rates of economic growth that came to be considered as not just normal but a given. Nevertheless, such growth brought its own problems because it is based on a non-sustainable triptych: extract, produce, discard. Is it reasonable to expect unlimited growth in a world with finite resources? The crisis we have been experiencing for more than five years is therefore more than simply a financial crisis: it also marks the end of a cycle. Clearly, it is tempting to rely on technical progress, in the hope that it will provide answers to the problems that we now know must be dealt with, even though we are not really prepared to allocate the resources required to develop the required solutions. And that presents two difficulties. First, technical progress presupposes the use of techniques for which society is more and more reluctant to accept the risks. An increasingly precautious approach is the most obvious manifestation of this mistrust of science. Relying purely on science to find a way out of the crisis is, to say the least, highly optimistic even if we accept that a major technological breakthrough – such as we saw with the development of electrical power – may lie around the corner.
The other limit – if not illusion – to relying on science is that many of the technologies we currently use have a far less favourable overall impact than a quick assessment would show. Digitisation enables the dematerialisation of information flows and thus a reduction in their environmental impact. But, we should be aware that data centres emit significant volumes of greenhouse gases and that the exponential growth of Internet-based exchanges has already had a significant impact on electricity requirements. We have, therefore, an immediate and urgent need: to encourage all efforts to accelerate an ecology-based approach and the transitionto a positive economy based on the “Three Rs” triptych: Reduce, Reuse, Recycle. All entities that have long-term liability commitments and a fiduciary duty to savers or subscribers must therefore ensure that their decisions are properly based – in other words, those entities that have the power to persuade economic players to take account of the cost of external adverse impacts such as greenhouse gas emissions or, more generally, the consumption of irreplaceable resources such as water, biodiversity or minerals. With its 20-20-20 climate and energy package, Europe is demonstrating to the rest of the world its determination to make progress in this area without waiting for an (improbable) international agreement. Despite being widely – and generally unjustly – criticised in this respect, Europe has agreed to a major effort to improve energy efficiency. While the absence of a true European energy policy may be a cause for regret, significant progress has nevertheless been made. To some degree, however, the success of just these efforts has led some to believe that the situation is not as bad as might be thought; the temptation to ease up is all the more natural given that the fight against emissions has been put on the back burner as a result of the economic crisis. Should we defer confirmation of the 20-20-20 principles until some point in the future? No, because beyond a certain level of climate change we run the risk of passing the point of no return, and any delay now will require a greater effort in the period to 2050 if we are to reach the target of limiting global warming to two degrees. In this respect, it is disappointing to see some players retain extremely short-term views at a time when the risks of inaction are becoming increasingly understood. The global warming trend is accompanied by more volatile temperatures. In the same year, a period of extreme cold can be followed by a period of extreme heat. Rainfall patterns are at risk of being disrupted and the resulting major redistribution of agricultural capacity is already on the cards. It should also be noted that the poor are most at risk of being affected.

Nevertheless, those living in the world’s richest nations should not bury their heads in the sand: they are also affected. Hurricane Sandy was a wake-up call for New Yorkers. It caused more than 100 deaths and in excess of $50bn of damage in the eight states affected. As the frequency of extreme climatic events such as Hurricane Sandy is expected to rise, the possibility of continuing certain activities in certain locations should also be reconsidered. Florida is a good example: parts of the state are still habitable thanks only to a mechanism used to subsidise insurance premiums. Without such public interference in the market, it would be prohibitively expensive to insure homes or continue certain activities in the most vulnerable coastal areas. In September 2013, Swiss Re published research into which cities are threatened by natural disasters. Those who wish to take the trouble can now identify the most exposed conurbations and the human and financial costs they may have to bear. The complexity of the decision-making process in modern democracies means that it takes time. Equally, institutional investors are fully aware that a sudden change in the regulatory or tax framework in which they operate risks being proportional to such a delay. The concept of “stranded assets” is now better known. All major long-term investors will need to analyse their portfolios carefully to determine the extent to which they include assets that may lose their value overnight. In addition to recognising this risk, the 2030 climate and energy package must be taken into account at a time when all investors are looking for investment opportunities. As a public service additional pension scheme in France, Établissement de Retraite Additionnelle de la Fonction Publique (ERAFP) has retirement commitments as liabilities that, by their nature, are very long term. It currently manages close to €16bn in assets in compliance with its own SRI charter. In view of the above analysis, it was therefore logical that ERAFP, following a decision by its board of directors, should join the Institutional Investors Group on Climate Change (IIGCC). For ERAFP, the voice of the real business owners must be heard. The IIGCC represents the interests of 85 pension funds, insurancecompanies and asset managers with investments totalling more than €7.5 trillion. The association promotes the concept that if we can determine a carbon price and set a course to reduce emissions, what is felt to be a constraint and, too frequently, presented as a danger by energy pressure groups will become a strong investment incentive. At a time when all governments must reduce their public deficits, they need to reconsider the wisdom of financing occasionally costly subsidies by mechanisms that reduce emissions at prohibitive expense. In Germany, it is estimated that the subsidy – depending on the mechanism involved – ranges from €150 to €200 per tonne whereas that same tonne of carbon trades on the market at around €5. It is somewhat paradoxical to pay expensive subsidies to provide rights that, ultimately, reduce carbon prices… This perverse encouragement to the development of so-called renewable energies contributed to the failure of the carbon market in its first incarnation and had a sharp adverse impact on the value of all major energy producers.
An effective carbon market and realistic but ambitious emission reduction objectives are the best means of reducing emissions at least cost not only to the public finances but also in terms of the economy and employment. It is also a precondition for market forces to unlock the hundreds of billions in investment that are currently stuck in project mode in the absence of a definite timetable and incentives. In a recent report, McKinsey showed for example that improving the energy efficiency of buildings offers the best return on investment since it represents the financing of an activity that, by its nature, is geographically fixed and results in a high level of job creation. The IIGCC Chairman recently made this point in Brussels and also in New York, at the Investor Summit on Climate Risk 2014 organised by the United Nations. In 2015, France will host the 21st Climate Change Conference which is expected to make up for the very mixed outcome of the Copenhagen conference. We trust that the efforts of French institutional investors will show that our country intends to play its full role in promoting a new framework with the 2030 package at its core. ERAFP intends to be part of that.