Part of the FTSE Russell COP26 Blog Series. Informing investor action in the countdown to COP26.
With the critical COP26 climate talks fast approaching, an effective response by investors to climate risk will depend on comprehensive economy-wide action alongside coordination by governments, according to leading asset owners.
With exactly 200 days until COP26 begins in Glasgow, Scotland, investors, companies and civil society groups are looking for clearer near-term policy signals from governments that will put economies on a pathway to meeting mid-century net-zero emissions targets. Countries representing around three-quarters of global GDP have made such commitments.
For institutional investors speaking at a recent webinar hosted by London Stock Exchange Group (LSEG) and the Principles for Responsible Investment (PRI), a “whole economy” approach is fundamental to addressing the climate risks they face.
“If the world fails to meet the goals of the Paris Agreement, the impacts on our fund of those systemic risks could be catastrophic,” said Liz Gordon, Executive Director of Corporate Governance at the $240 billion New York State Common Retirement Fund. “We need the entire economy to decarbonise in order to protect our funds ... A fully decarbonised fund in a highly carbonised world wouldn't protect our investments from the systemic risks posed by climate change.”
The fund has committed to become net-zero emissions by 2040, a decision that Gordon said was driven by an objective to reduce risk – thus demonstrating its consistency with the fund’s fiduciary obligations. “That was the big hurdle we had to get over.”
A challenge for investors are the uneven incentives – whether carbon prices, subsidies, or taxes – between different markets towards decarbonising economic activity, noted Bob Litterman, founding partner of Kepos Capital and chairman of the US Commodity Futures Trading Commission's Climate-Related Market Risk Subcommittee.
“Countries that have strong incentives to reduce emissions also have made rapid progress in reducing carbon intensity,” he said. “Risk management considerations require that the world quickly harmonise around globally appropriate strong incentives to reduce emissions.”
There are signs that such harmonisation is underway. Mark Fulton, advisor to the PRI and lead of its Inevitable Policy Response initiative, explained how his team has been analysing an anticipated ratcheting up of climate policy and its economic and investment implications.
When the initiative was launched in 2019, “I’m not sure people believed in the inevitability”, he said, but since then “we’ve seen continued cost deflation in renewables, leadership from EU policymakers, leading investors pushing, increased regulatory pressure [and] shifts in corporations’ strategies which are becoming like policy themselves.”
The most important thing, he added, is the re-engagement of the US in climate action following the election of President Biden.
Given the scale of the low-carbon transition, it is important for institutional investors to properly ground their response in their overall investment approach, argued Kirsty Jenkinson, Investment Director at CalSTRS, the second largest US pension fund, with $287 billion in assets. In January 2020, it added a ninth “investment belief” that stated that “investment risks associated with climate change and the related economic transition … materially impact the value of CalSTRS’ investment portfolio.”
“It’s important to be really clear why you’re investing in the low-carbon transition, why you’re engaging companies, why you're looking at physical and transition risk across asset classes … [It’s] because we believe that this is part of our duty to understand risk and identify opportunity,” she said.
That investment belief then filters down into how CalSTRS is managing risk in its existing holdings and identifying opportunities in the climate solutions providers of the future. Jenkinson talked about “escalating activity” on corporate governance where company boards have failed to set out a sufficiently strong decarbonisation plan. This might involve engagement evolving from voting against directors to suggesting an alternative slate. “More and more investors are thinking about how we can encourage companies going forward” on climate strategy, she said.
A big focus of engagement is ensuring that companies avoid greenwashing, said Nathalie Lhayani, Head of Sustainability at French state-owned financial institution Caisse des Dépôts, one of the founder members of the UN-Convened Net-Zero Asset Owner Alliance.
“We see some companies, especially in the energy sector, making commitments towards net-zero that don’t cover Scope 3 emissions [in their supply chains]” and which rely on carbon offsetting, she said. “That’s not efficient.”
Caisse des Dépôts also pursues an escalating engagement strategy, initially focusing on dialogue and often in cooperation with other investors: “Sometimes as a shareholder, you can be much more effective in a coalition,” she said. But the firm reserves the right to walk away. “If they’re not answering our questions, then we might get up and we might exclude”, she said.
The Net-Zero Asset Owner Alliance is one of a number of collaborative investor initiatives created to help investors respond to the climate issue; these initiatives are summarised in a recently published guide from the PRI and LSEG.
Speaking on the webinar, Sagarika Chatterjee, Director of Climate Change at the PRI and COP26 High-Level Champions Finance Lead, noted that, although COP26 is a governmental negotiation, finance in general and asset owners in particular have a key role in accelerating the low-carbon transition.
In the run-up to the COP, she said, asset owners should consider asking themselves three questions regarding climate change. They should ask: whether they are ready to adopt a net-zero target; what the portfolio implications are of so doing; and what their peers are doing, and whether the investor can work with them to overcome barriers to moving to net zero.
“Asset owners can’t do this on their own,” she added, “but they have significance influence within the investment chain to spur the innovation that’s needed.”
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