There is now a vigorous debate about fossil fuel divestment as a strategy for addressing climate change. But in this increasingly heated debate about pros and cons, we observe that protagonists on both sides sometimes miss critical questions, fail to consider contradictory factual data and gloss over important connections. We believe that exploring this grey zone will uncover hidden common ground that could become the basis for coordinated action.
In this third article in a series of three, we ask: Is there a “common ground” strategy for concerned mainstream investors and how can other stakeholders support such action?
The earlier analysis on climate change and divestment in our first two articles points to seven priorities that all mainstream investors who take a forward-looking approach to risk adjusted returns should adopt:
1) Formally assess the risks of climate change in their investments, display appropriate awareness of the issues and demonstrate to members that they are acting in their best fiduciary interests and specifically that they are taking proportionate action, and not allowing herding to benchmarks to block such action. As Towers Watson have noted, “… investors focus on returns without paying sufficient regard to the risks that are being taken to achieve these returns. Rarely do funds make their principal focus risk-adjusted return.” (1) The authors were commenting on the flawed risk management approach vis-a-vis basic financial metrics, and the problem is much worse with regards to an issue like climate change. Ensuring that pension funds and other asset stewards recognise that they are being actively watched – and could be at risk of legal challenge on the issue – is, to be realistic, part of the change process.
2) Reduce exposure to the “carbon bubble” at a pace that is defined by a forward-looking understanding of fiduciary duty. Specifically, investors should: divest from companies whose sole business is coal; consider swaps; prepare to divest from companies who sole business is oil sands; and use influence with portfolio companies to stop these companies from new investments in fossil fuel projects which have a particular high risk of becoming “stranded assets” (e.g. oil sands, coal, arctic oil). Instead, these companies should return money to shareholders via higher dividends or share buybacks.3) In parallel to this direct activity, but no less important and indeed intimately connected, investors should ensure that the highly influential investment intermediaries in their own supply chain – namely sell side and credit rating analysts, and investment consultants – are actively taking climate risk and eco-efficiency into account in their day-to-day work. To be clear, this goes well beyond the fossil fuel sector since we need to create a context where all companies in all sectors see that preparing for the eco-resources revolution is a core strategic priority for action today. (2) The experience with the Enhanced Analytics Initiative – i.e. how a system-changing project was mothballed and victory prematurely declared (3)– is evidence of the tendency of ESG investors to be too easily satisfied with superficial/incremental change. The fact that investment consultants have come under so little scrutiny is another indication of a failure to actively manage the investor supply chain.(4) Campaigner pressure was needed to get clothing/footwear and IT companies to really engage with weaknesses in their supply chains and it is appears that the same is needed for investors. That campaigners choose to target otherwise well-run companies like Nike and Apple is noteworthy.
4) Increase their exposure to low carbon assets (e.g. renewable energy and other technologies that lower the environmental footprints of transportation, operations and more).
Two particularly exciting projects in this regard are covered below and it should be noted they are not competitive choices:
- The Climate Bonds Initiative focuses on mobilizing the $80 trillion bond market in support of a rapid transition to a low-carbon and climate resilient economy. Its aim is to grow low-carbon and other climate-relate industries at annual global rates of 30% compounded. Its strategy is: to develop a large and liquid Green and Climate Bonds Market that will help drive down the cost of capital for climate projects in both developed and emerging markets; to grow aggregation mechanisms for fragmented sectors; and to support governments seeking to tap debt capital markets. (5)
- The new Evergreen Coal Transition initiative (“CoalTrans”) being set up by Felix Kramer, Tim MacDonald and others plans to use the new ‘evergreen’ direct investing approach which has been developed with the Capital Institute (6). This proposal argues that the large stewards of capital (i.e. sovereign wealth funds, pension funds and insurance companies), who have an implicit, if not explicit, multi-generational public purpose, should buy up energy companies and manage their orderly decline (or if they are able, their transformation into clean energy companies) in a way that is good for those pension fund members as well as society at large. The initial focus of the “Climate Marshall Plan” is on coal companies. (7)
5) Request that all companies within their portfolios (including media companies) end the practice of spending shareholder funds to undermine government action on clean energy and climate change. Given their strongly anti-social role in the past, those companies who have a track record of being a particular part of the problem should be required to show their commitment to this major culture change by significantly increasing transparency and reporting on all meetings held directly or indirectly with governments, and all political donations related to climate change, whether by the corporation, executives or staff associations. Investor led legal action may be needed to bring about this change of tone from the top but in many cases, assertive engagement will be enough as has happened with Suncor. (8)
6) Help create a new strategic benchmark for investors themselves, which drives continuous improvement in how funds respond to climate change. This is the critical importance of the Asset Owners Disclosure Project (AODP), which has been set up as an independent organisation to compare funds internationally and over time. AODP is a project with big ambitions and potentially a critical role. Of course, it requires funding on a scale commensurate and, in parallel, AODP needs to show it is competent to assess not only technical hedging strategies but also stewardship work focused on companies and public policy, which is arguably the priority now. Additionally, it needs to demonstrate that its governance and leadership will support the broad coalition building that is needed for systemic change.
7) Lobby governments to correct regulatory and market failures: As climate change is fundamentally a regulatory and market failure, what is needed is government action. Today, governments are faced with strong vested interests against meaningful action and weak public support for change. Given their long-horizon and diversified interests, investors should be articulating how the interests of their members would be best protected by proactive government policy and this is starting to happen. The (European focused) Institutional Investors Group on Climate Change (IIGCC), for example, is reported to have recently taken on the services of a professional public affairs consultancy to help it lobby the EU, behind the scenes, on issues related to climate and energy policy (8.1) whilst the (Australian focused) Investor Group on Climate Change has taken the most high profile advocacy role including an innovative public education strategy. (8.2) One investor that is particularly proactive in this manner is NEI which has asked Alberta based companies to be proactively supportive of a price on carbon and also lobbied the Canadian and Albertan governments to this effect.
How is this different from what institutional investors are already doing?
The CEO of a major US pension fund is right when he says that we will still need a lot of conventional oil and gas to fuel the transition to low carbon and that since some of these companies will stay around for some time, we need them to change. And he’s mostly right when he says divesting means: “you are selling your stock and someone else is going to buy it and you are no longer part of the conversation”. (9) But what insiders who advocate integration of eco-efficiency alpha and/or engagement fail to acknowledge is that what ishappening today is light years from what should be.
Mainstream investors do not have a strong track record, nor the right incentives, to be good capital ‘stewards’. Managers are heavily focused on the short-term and gain returns by as much trading as is needed. The stewardship activity that has happened so far is often of a “tummy tickling” variety and undertaken for box ticking (compliance and or PR) reasons. It lacks real organisational weight in part because it is outsourced to a corporate governance or “ESG” (environmental, social and governance) team, and doesn’t reflect the full weight of the investment firm. It is also very vulnerable to changes in executive leadership and business strategy. (10) These points are hard for ESG specialists to acknowledge in public because it would cause significant personal career risk. Similar trends also affect “corporatized NGOs” and ESG rating agencies too, who often provide the basis for stewardship work. (11) For example, while there is now agreement that corporate regulatory capture is a key thing to address on climate change, the rating agencies are still trapped in business strategies that focus on what is easy to measure and “defensible”. To the extent that they are covering political capture, it is being done as a bolt-on activity, much as fossil fuels companies do with green energy.
The good news, however, is that it is possible to enhance what’s being done. There are already early signs that this is happening, in part due to more assertive and effective campaigning: The signs are:
- When investors have been persuaded to deal with issues that are very sensitive and where investors have previously turned a blind eye (e.g. egregious executive pay deals) or that go to the heart of business model (e.g. tiered pricing of drugs by Pharma companies for poor people in low/middle income countries), this has generally been as a response to public pressure. This dynamic is now at work in this debate too and is having knock-on corporate impact: the decision by Exxon to justify why its assets are not stranded. Whilst the corporate position is unexpected, it does intensify the debate. (12)
- Some investors are making a more strategic commitment to ESG stewardship activities, and one good indicator of this is that in a few firms, the head of ESG reports directly to the CIO or CEO. There is also a growing trend to link environmental and social issues with governance issues, the latter having gone mainstream a bit earlier and with less opposition. (13) The recent vote by CalPERS on BHP Billiton’s board elections is indicative of how this could impact on climate risk. (14)
- Some investors are doing work on corporate political influence and climate change. A potentially very important development is the Carbon Disclosure Project’s embracing of the need to get companies to report on this “newer” aspect of their climate footprint. (15) How this programme develops – i.e. whether it is mainstreamed into core CDP methodology and organizational priorities – will be important to monitor. (16)
- Specialist NGOs like ShareAction and Asset Owner Disclosure Project, and large NGOs like WWF and Greenpeace, have significantly stepped up the pressure on investors. There is considerable evidence that such pressure works: it is undoubtedly the case that commitment at two big funds – USS (19) and ABP (20) – received a significant boost after NGO and media campaigns. ShareAction, Boston Common Asset Management and Sarasin have demonstrated that investors can get companies to stop funding corporate lobbying groups, which probably would not have happened had they just divested. (21) A particular challenge for NGOs – and especially the well-funded ones – will be to show they are, as asset owners, leading investor action on climate. Sadly this is not the case today, despite many years of discussion and the same goes even for foundations. (22)
How to make this change happen?
Uncomfortable as it may be for ESG investment professionals and their employers, the bottom line that emerges from this analysis is that much more campaigning pressure is needed before investors do the tough work to find the meaningful common ground between the pro- and anti-divestment camps. To be clear, this is not all about challenge coming in one direction: campaigners will need to listen and learn from sympathetic insiders; and containing egos will be critical. We also need system infrastructure. The good news is significant pieces are now in place like the Carbon Tracker Initiative and potentially the AODP. However, much more work needs to be done on where investment assets could be redirected. This requires funding for projects like the Climate Bonds Initiative and the Climate Marshall Plan to ensure their proposals are fully credible. Whilst we are waiting for these mega projects to deliver, campaigners need to gain more expertise to evaluate investors on the stewardship front. This needs resources (to appoint suitable staff) and for campaigners to be willing to be more nuanced (e.g. reward good funds and penalise bad ones).What could really help is a specialist “engagement overlay provider” (EOP), that focussed on climate. It could become the benchmark for other stewardship activity as well as the coordinator of such activity with companies that are resistant to change. This could be an existing EOP that sees the business rationale for adapting to fill this niche, or it could be a new organisation, analogous to CDP but focused solely on engagement. Foundation support would be needed given the lack of client willingness to pay for engagement services. Campaign pressure for action (including transparency) and AODP-led ranking will result in others being attracted to the debate: the media delight in benchmarks which show leaders and laggards; academics can research why funds are and aren’t acting and how it affects performance/risk and lawyers could help those funds who want to move and to sue the laggards.
Get governments involved
Of course, we also need government action to make this kind of investment behaviour the norm. This has begun to happen in the UK on the issue of long-termism where the government, pushed by an unusual alliance of outspoken insiders, campaigners, think-tanks and the media, commissioned a review by a leading expert, Professor John Kay, of the role of UK equity markets in the financial crisis. This led to a Law Commission review of the legal long-term fiduciary duties of investors, since the law is often used as an excuse for inaction. That this is happening in the UK, where the finance sector has outsized influence, is good news, (23) as is the “extra-territorial impact” it is having in the EU and globally. What is needed today is for a government to do the same for investment and climate risk. Sadly it seems the UK Government will not be up to this challenge. (24) Perhaps it might be Norway, given the cross party understanding of how disruptive climate change will be and because its prosperity is heavily related to its huge oil reserves. (25) Or Singapore, which also has a particularly good understanding of climate related risks as well as a respected sovereign wealth fund that is committed to the long-term. (26)
Raj Thamotheram is an independent strategic adviser, CEO of Preventable Surprises and a visiting fellow at the Smith School, Oxford University. Antoine Thalmann provided research support for this article.
Tomorrow we will be issuing a survey to get your feedback on the fossil fuel divestment debate
The Network for Sustainable Markets is supporting an active, positive dialogue on responses to the divestment campaign: to join this dialogue, feel free to contact: Cary Krosinsky
Footnotes for this article can be found on the next page
1. Towers Watson
5. Climate Bonds
7. Climate Marshall Plan
9. Jack Ehnes
10. RI Article
11. For example, CERES which is highly regarded for its work, and rightly so, recently astonished many of its supporters by asserting that US investors now understood climate risk, a claim which sits uncomfortably with the fact that one third of companies not responding to CDP are American. And in its landmark 2013 report, the issue of corporate political influence got very little attention. CDP, which has played such an important role in carbon reporting, has embarked on new work to document political influence and this is very encouraging, but it is far from being at the core of the project’s operational priorities. Equivalent examples could be given for all the other ESG rating agencies and investor climate change groups – the challenge is systemic.
16. This workstream has, as of 20/04/14, not been profiled on the main CDP site: https://www.cdp.net/
22. Raj Thamotheram
24. UK government
26. GIC Singapore