Minimum Standards: A Flexible Investing Framework from the Decarbonization Advisory Panel
In the third of a series of four articles, Joy Williams and Alicia Seiger of the New York State Common Retirement Fund’s Decarbonization Advisory Panel take a deeper look at the work of the expert panel. Click here for the first and second articles.
The final consensus report from the Decarbonization Advisory Panel (DAP) for the New York State Common Retirement Fund (the Fund) was released last month. The report outlines our six-member panel’s foundational beliefs and ambitious recommendations. Previous articles covered our key beliefs and our primary ambitions for the fund.
Minimum Standards require investors to have a point of view on climate change and to invest in ways that are consistent with that point of view.
Investors often cite uncertainty as to when, and how fast, the low-carbon transition will take place as a key challenge to accounting for climate risk. We believe that the transition is akin to other investment decisions made under uncertainty. Investors are no strangers to taking calculated risks, nor to using tools to manage uncertainty. Climate change should be no different. It has however, historically been considered an ‘environmental’ issue. Investors may be reluctant to integrate climate change into investment decisions because of a lack of familiarity with the subject matter.
Our recommendation to create Minimum Standards seeks to help funds build more robust decision-making processes that better capture and apply climate-related information. Minimum Standards require investors to have a point of view on climate change and to invest in ways that are consistent with that point of view.
To build that point of view, multiple expert bodies, such as the IPCC and IEA, have produced models of warming scenarios (e.g., 1.5, 2, or 2+ degrees warming) and transition pathways (e.g., smooth or abrupt). Different models assume different technological and policy pathways. Investors need to choose which models they believe are credible and how they might affect their portfolios. As a decision-making framework, Minimum Standards are designed to be responsive to new information as actual scenarios and pathways unfold.
Minimum Standards have two component parts: criteria and consequences. Criteria refer to specific expectations for assets to qualify as “buy”, “hold’ or “sell”. These criteria could have to do with governance structures, targets and metrics, carbon intensity, or protections for supply chains. Consequences might include selling securities or assets that fail to meet minimum standards over time, or excluding managers and funds from new allocations. Criteria for minimum standards can increase in ambition over time. Consequences should ratchet over time as well.
We did not define minimum standards beyond a conceptual level, as they should be tailored to an investor’s point of view on warming scenarios and tied to a larger fund strategy that accounts for resources and priorities. Instead, we included a number of examples of criteria in our report’s Exhibit A and suggest that the Fund take advantage of existing methodologies like the Climate Action 100+ initiative, of which they are member.
There are several other efforts defining climate-wise criteria that will allow the Fund to avoid ‘reinventing the wheel’.
Minimum Standards can be applied to different areas of investing. That is, they can be designed for and applied to specific securities or assets, or to managers and consultants. The criteria may be qualitative or quantitative. Their flexibility allows the use of Minimum Standards to go beyond risk mitigation and address other embedded challenges to building climate resilience in large, global portfolios.
First, our recommendation to pursue 100% sustainable assets requires tools and products from the broader market. Communicating these needs and expectations transparently through Minimum Standards, and carrying through with consequences, will help to build this support.
Second, Minimum Standards can be rolled out incrementally. While there are increasingly sophisticated models of the pathways to a low-carbon economy, there is no crystal ball. That uncertainty should not delay action. Funds can start with priority sectors, such as energy, transportation and real estate, before moving on to establishing minimum standards for other sectors or asset classes.
Third and finally, Minimum Standards are dynamic and allow for learning and adaptation. As investors gain more insight into transition opportunities and the mounting physical risks of climate change, criteria and consequences can be adjusted.
Many have noted that we didn’t make a specific recommendation on divestment. Our framework and ambition do not preclude divestment. Indeed, currently held securities may be sold or downgraded under this process. However, under our recommendations, assets that don’t make the cut will be ‘sold’ as a result of a scalable and sustainable decision-making process rather than ‘divested’ as the result of a mandate. Our recommendations require the Fund to use all the tools at its disposal and its informed judgement as part of a larger strategy to make buy, hold and sell investment decisions. We discuss some of these in the last article in the series.
Joy-Therése Williams is Senior Advisor, Mantle314 and Decarbonization Advisory Board Chair. Alicia Seiger is Managing Director, Stanford University Sustainable Finance Initiative and a Decarbonization Advisory Panel Member.
Williams is moderating the following panel at the RI Europe 2019 conference on June 11/12 in London:
Sustainable Infrastructure: New Policy Foundations and Investment Plans
Why is sustainable infra an opportunity? How are governments and cities stepping up on long-term, green infrastructure? How are infrastructure specialists evolving their funds to meet the transition and demand?
Other panellists include:
• Heidi Finskas, Vice President, Corporate Responsibility and Corporate Governance, KLP Kapitalforvaltning
• Harold D-Hauteville, Head of Infrastructure Equity, Europe, DWS
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