This week’s statement by investors in support of strong climate policy was a welcome addition to the UN summit in New York.
However, within the statement, and its appearance of a united group of investor signatories, lies a different story of great differences between the genuine leaders, the laggards, and those whose marketing suggests the former but whose actions suggest the latter.
These differences are firstly driven by the different types of signatory; the long term asset owners, such as pension funds, cannot be compared to the fund managers who are incentivised over a far shorter term and are driven by trading opportunities more than long term risk management.
Whilst it is a leap forward for the industry, the statement perhaps ignores the investor’s biggest obligation – which is to manage the risks whether or not governments act immediately, including the risk that governments delay until the last minute or that some other non-US Congress path to the low carbon economy materialises.
The irony here is that the biggest risk of all is that governments actually heed their advice and rapidly move to price carbon.
Whilst long-term asset owners might secretly be prepared to accept some volatility in order to manage the risk over the long term, their Wall St. and London fund managers would in all likelihood cry foul and use every tactic to resist and protect short-term returns.
But if governments were looking to escape blame for the decision to take the painful medicine now before the disease gets too bad, then the investors just handed them the perfect excuse on a plate.
In fact, the longer governments delay, the greater the need for portfolios to be hedged against the uncertainty of an inevitable rapid recovery action at some point in the future.
If governments were to immediately price carbon to match their current 2-degree climate commitments, investor portfolios would be in complete chaos as swathes of 25-40 year assets would immediately have their earnings models compromised and reflected in their asset valuations.
There may be a relatively smoother curve option but some volatility is now inevitable.But what can the asset owners really do without government action and what else should the statement have said? Well perhaps we should consider what a statement written by the beneficiaries might look like? Perhaps something along the lines of:
- “We, as long term asset owners, don’t trust short term markets to accurately price long term risks.”
- “We agree to extend manager commissions to 5-10 years with clawbacks if a climate crisis devastates our portfolios.”
- “We agree to re-price this risk now, in light of the inevitable policy response at some point in the next 15-20 years when many of our high carbon assets are still expected to be producing profit.”
- “We agree to add some degree of uncertainty risk premium to current carbon exposures to reflect the fact that we cannot diversify this risk.”
- “We commit to hedging our portfolios by reducing carbon exposures in obvious areas (e.g. coal, tar sands) and perhaps some thematic extensions of our low carbon investments across all asset classes.”
- “We commit to abandoning indexation, VaR and other historic quant based portfolio risk tools that drive our asset allocation that clearly have no relevance to forward climate risk.”
- “We are going to turn up at high carbon company AGMs this year and file resolutions to abandon new capex or find new board members who understand these risks.”
We clearly have a long way to go – except for the leaders within the list who have demonstrated their actions. The laggards will face increasing pressure from the leaders and other stakeholders such as civil society and their funders, whose financial education is advancing rapidly.
The industry as a whole, however, needs to make up its mind what options are available other than asking governments to do all the hard work.
If the blunt tool of fossil fuel divestment is, understandably, not palatable, then what does a diversified hedging strategy look like?
And if tinkering with portfolio construction challenges their traditions, then what about their claims that company engagement is a valid strategy? This would be believable if we could point to endless examples of resolution filing by large funds to challenge the capex decisions of the high carbon companies who are increasing asset owners’ risks on a daily basis.
Instead, despite growing aggression from the top of the investment chain, the need for analysts and proxy advisors to keep companies on side and not ‘rock the boat’ outweighs the need to take action. Engagement without escalation is no longer an option.
The statement tried very hard to reveal leadership but in the end the caveats stood out more than the positives. The key statement of committing to invest in low carbon opportunities that ‘meet our investment criteria’ and ‘subject to our risk and return objectives’ suggests most will sit with the herd, leaving the leaders to forge the path.
The most likely future is clearly that the capital given in trust by the beneficiaries to the asset owners and in turn to the managers and turned into company assets will make reasonable returns but eventually be stranded – either by events or policy.Then we could be facing a Troubled Asset Relief Program (TARP) 2, bank bailouts and a “sub-clime” crisis that will make the sub-prime crisis look like a … well … tea party.
All this aside, there ARE new positive commitments – a commitment to disclose progress, develop capacity and work with companies to minimise their risk are all bold intentions and some leaders are already there.
The finance NGO’s, who also gathered this week in New York to strategize how better to drive progress, will be laminating the statement, ready to hold investors to account.
With more ethically based foundations and religious funds committing to divestment and with the more fiduciary oriented asset owners planning a more risk oriented action plan for climate risk management, the reality might just be, as one placard at the New York march proclaimed, that ‘The Mend is nigh’.
Julian Poulter is CEO of the Asset Owners Disclosure Project.