As negotiators continue to work towards a deal at the United Nations Climate Change Conference in Paris later this year for global and legally binding measures to tackle climate change, the question arises of the potential impact on investors.
It has been a long time coming, but later this year there is a significant regulatory risk moment that is likely to set the tone for investors going forward. From 30 November to 11 December,
the ‘COP21’ will take place in Paris. This will be the 21st yearly session of the so called Conference of the Parties to the 1992 United Nations Framework Convention on Climate Change.
Then, the meeting took place in the wake of a war waged to secure the sovereignty of a major oil exporter (the first Gulf War). This year’s event takes place in the wake of a collapse in oil prices and record sales of electric and hybrid passenger vehicles by both mainstream (Toyota, GM, BMW) and non mainstream (Tesla) manufacturers.
But from an investment perspective there have been significant other changes over time also. At last count there were some 890 asset managers who were signatories to the UN Principles
for Responsible Investment.
Together with other signatories, they now represent some $45trn (€41.6trn) of AUM. And as the PRI Association has noted: “With COP21 in Paris fast approaching, the PRI is encouraging
investors to acknowledge the important role they have to play in financing the transition to a lowcarbon economy.”
And increasingly there is evidence that investors are paying attention to the relevant risks attached to the outcome of this type of event.
Thomas Kuh, head of ESG Indices at MSCI, says that “Investors are beginning to consider the investment risks from climate change, and portfolio decarbonisation is an important first step because it requires conceptualising the problem, measuring it and taking action.”
“The market is at an early stage in this process and – as typically happens in such circumstances – certain asset owners are willing to provide the leadership that paves the way for other to follow. AP4 and FRR are examples of pension funds whose commitments help foster the development of tools for measuring and managing carbon risk, which establish and define best practices for others to follow.
“Initiatives like the Portfolio Decarbonisation Coalition and the Montreal Carbon Pledge provide frameworks for asset owners concerned about these risks.”
For those considering how to respond to the decarbonisation theme, Thomas Kuh notes a number of key developments.
“A growing number of asset owners recognise that climate changes poses risks for their investments. Organisations like the Investor Network on Climate Risk and Institutional Investors
Group on Climate Change have been organising around climate risk for more than a decade, so addressing the risk associated with fossil fuels has been on investors’ agenda for a while.”
“In the past couple of years, activity around climate risk has shifted from a focus on policy to developing investment strategies designed to protect portfolios from risks related to the transition to a low carbon economy. This has been spurred by research from Carbon Tracker Initiative and others. In addition, campaigns initiated by organisations like 350.org have pressed asset owners to divest from fossil fuels, giving prominence to the conversation about climate risk and the appropriate response by investors.”
“Investors have a range of options to choose from. They can implement low carbon strategies, divest from fossil fuels, engage with fossil fuel companies, or invest in alternatives to fossil fuels – or adopt a combination of these approaches.”
Isabelle Cabie (pictured)– global head of Sustainable & Responsible Investments, and Ben Peeters, senior investment specialist SRI at Candriam, say that investors “should definitely consider decarbonisation”.
“If one omits financials, on average 40% of an equity portfolio is invested in sectors that are at the origin of roughly 75% of the world’s CO2 emissions. So, investors have a tremendous role to play in the climate change challenge. They should systematically take into account the climate change impact of their investments, as this is undoubtedly the biggest challenge.”
The mention of sectors is, perhaps, critical to the way in which investors may respond to the theme, in light of the so called carbon profile of companies.
Thomas Kuh notes that “MSCI defines the carbon profile of a company as the combination of its carbon emissions and carbon reserves.”
For Cabie and Peeters the most carbonised sectors are seen as energy, mining, utilities, transportation, automobile and chemical sectors. Looking at weightings in key blue chip indices relied on by European investors such as the FTSE 100 and the EURO STOXX 50 it is clear that these are, indeed, heavily weighted towards these sorts of sectors.
Thus this is not just an issue for active managers, but one that will also affect passive investors – food for thought in light of the fast growth in, for example, ETF assets across Europe, or the tracker funds following these and other key equity indices.
But, as Cabie and Peeters add, this is also a theme that goes into nooks and crannies of all sectors. “The fight against climate change crosses every sector and all sectors should be covered by a specific analysis in terms of the product and services offered, taking into account the CO2 emissions of the entire supply chain and promoting the best practices along the chain.”
“Of course the best solution to mitigate climate change risk is to avoid the unnecessary use of energy. Eco-efficiency should be one of the highest priorities when considering investing in any sector.”
There are, of course, some key practical challenges to overcome. One is in the area of company reporting as identified by the Swedish Investment Fund Association recently.
For funds to report on carbon emissions from their holdings, they in turn have to rely on the companies reporting the data. But there are currently big differences in how companies report, depending on their geographic location and the sector they are in.
But if fund managers have to rely on third parties to make estimates of emissions in order to report themselves, then they become hostage to variations between different third party providers of such data, which would reduce investors’ ability to make comparisons between holdings.
Some 80% of Swedish invested fund capital is managed today according to the UN PRI, the Association adds.
Furthermore, if the assumption is made that the response to decarbonisation comes through a responsible investing approach, then data presented at the recent Association of the Luxembourg Fund Industry Spring Conference by Jane Wilkinson, partner at KPMG in Luxembourg, makes for interesting reading.
She noted how fund managers framing responsible investing in terms of ESG criteria could do so from a number of perspectives including seeking ‘best in class’ assets, conducting norms based screening, applying exclusions, looking for ESG integration, or pursuing engagement and voting. These may all be different ways of working to common objectives, but the point is that investors
have to understand which approach is being followed.
For example, at Candriam the approach used is ‘best in class’, say Cabie and Peeters.