Paris Roundtable: Climate change & “Future Wise” European Investors

This is a note of roundtable held on 28 ^th May 2018 kindly hosted by RMA Asset Management. Organizational affiliations are shown for identification purposes only as participants were speaking in their personal capacity.

Prof Jean Charles Hourcade (Economist) Presentation >>

• Presented preliminary figures on aggregate climate change investment scenarios – see figures in “red” (slide 1).
• Macroeconomic implications: incremental investments per year are key – 1.53% of the GCF in MER and 1.04% in PPP.
• JCH has been arguing for urgent action for nearly 3 decades and has come to realize that theonlyway to obtain these reforms is to engage climate agnostics and accept where they are.
• Under the current business regime, a company makes an early capital allocation/investment mistake, the implications are huge.
• To increase investments in decarbonisation, we have to find a way to cut the capital cost for entrepreneurs and reduce transaction costs (i.e. de-risk de-carbonization).
• This can only occur with state-level commitment, as was done with railways – investors were banking on the real estate near the train lines becoming more valuable and this is a good metaphor for what can happen today.
• Attract savers and investors to channel finance towards currently underinvested infrastructure demand.
• In addition to de-risking, we need innovative financial intermediation to support new business models appropriate for small-scale projects (e.g. households for energy efficiency in buildings, solar in many developing countries, smart transport) with lower transaction costs and higher technical quality.
• Platforms that aggregate these investments would be of interest to institutional investors.

Bob Ward (Policy and Communications Director, Grantham Institute)

• Current Nationally Determined Contributions (NDCs) appear to be collectively insufficient to meet the Paris Agreement’s goals. The Talanoa Dialogue is intended to be non-confrontational but this may result in countries not being adequately challenged to raise their ambitions.
• Revised NDCs are due in 2020 but these may still not be sufficient to meet the Paris goals, and this could call into question the credibility of the Agreement itself.
• Despite President Trump’s announcement in June 2017, the United States won’t be able to complete withdrawal from the Agreement until 4 November 2020, the day after the next Presidential election.
• Other countries, particularly major fossil fuel producers, may be tempted to follow the United States, or at least drag their feet hoping they escape attention while the focus is on the USA. For example, the next G20 Summit (Argentina, Nov-Dec 2018) looks like it may omit climate change from the agenda.
• China’sannualemissionsof carbon dioxide are close to peaking/may already have peaked. The 14^thfive-year plan, details due next year, may include a goal to achieve a reduction in emissions.
• Increasing focus on subnational action, particularly in the USA – it will be the focus of the Global Climate Action Summit (San Francisco, September 2018).
• Power sector:
  • Mostemissionsreduction progress is happening in this sector.
  • It is possible to phase out of coalfor electricity generationwithout damaging growth, as the UK has demonstrated – the ‘Powering Past Coal’ alliance now includes 27 countries that have pledged to phase out the use of coal for electricity generation.
  • Some renewables in some parts of the world are already at, or approaching, the point of no longer needing subsidies – however, in the UK investors in new onshore windfarms areseeking the guarantee of long-term subsidy-free contracts.
• The Taskforce on Climate-related Financial Disclosures (TCFD) has advanced climate action but the (2°C) scenarios currently being developed are not likely to be compliant with the Paris goal of limiting global warming to «well below 2°C degrees».
• A major challenge for energy utilities and governments is how to re-structure power markets to account for increasing amounts of renewable electricity (low operating costs) compared with fossil fuels (high operating costs).
  • How to help finance renewables such that the capital costs do not need to be recovered through the price of electricity?

Mark Lewis (Research Director, Carbon Trust) Presentation >>

• A major energy transition has affected the European utility sector and far from finished.
• What’s been missing is a public policy framework but even when this was created (Germany) major incumbents and their investors missed it!
• ML’s experience of working with a CEO of a major player was that X didn’t have a strategy for renewables and considered that “it wouldn’t be a safe way to invest shareholder money as there was no proven long term political support for renewables” plus the grid might not “have the capacity to take in renewable generation levels”.
• All assumptions have proven to be wrong but this was widespread view and the change in German utilities happened much quicker than expected. Have the leaders of these companies learnt and adapted?
• Now they have been burnt, investors are coming in as a new “driver” to demand more clarity from utilities regarding their capex plans and strategic positioning regarding their stranded asset risk and their low carbon plans.
• RES costs in Europe are falling so quickly that they are about to break through fossil fuels’ operating costs – a true revolution.
• Fossil fuel reserves won’t be burnt not because of climate per se but simply because it’s will be uneconomic. This dynamic is changing quickly now.
• Average RES LCOE around the world is becoming consistently lower than fossil fuel power average LCOEs
• Most of energy demand growth is happening and will keep happening in the Emerging Markets, where population growth will be the most important.
• The question is then, are EM going to follow the large-scale classical European utility model for generation and distribution? See slide 10.

Philippe Desfossés (CEO, ERAFP)

• Institutional investors and asset owners are still too little involved in investment de-carbonization and still mostly stick to index-tracking and usual mutual fund investing diversification models – a backward-looking way to look at the economy!
• It makes little sense to allocate capital to technology which are almost done: relates to ML’s Levelized Cost of Energy (LCOE) comment.
• But how to address the existing stock of fossil fuel assets remains a complex issue.
• Also developing electricity access without questioning the long-term adequacy of the energy mix is pointless.
• Therefore, institutional investors must join forces in engaging with power utilities – money shouldn’t be invested in utility companies that refuse to address climate change.
• Asset owners must engage with fund managers given how important managers are (refer to PS’s slide about AUM vs GDP).
• Utilities is the good point to start with because they are at the centre of the dysfunctional “system” we must fix before it is too late.
• Engagement could find a new lever with bonds because if “stocks do not mature, bonds do”. Corporates should not take for granted their current bondholders will necessarily refinance their maturing bonds

Raj Thamotheram (Chair, Preventable Surprises) Presentation >>

• Climate change: an urgent threat to human well-being (best case) or a threat to human civilization (worst case). Jeremy Grantham : “we should not unnecessarily ruin a pleasant and currently very serviceable planet just to maximise the short-term profits of energy companies and others”.

• Investors and society facing a radically uncertain future with risks weighted to downside.
• But climate change could also be a blessing: spur to innovation and full employment.
• Energy utilities are major emitters (25%+), the pre-requisite for other sectors decarbonizing (e.g. EVs) and everything is in place there for it to happen. Despite some achieved progress, Europe has some big utility laggards (according to CDP the laggards are RWE, CEZ, Endesa and EnBW).
• Univ of Zurich academics have concluded that active ownership, thematic funds & impact investing have the biggest societal impact.
• Exclusion, best in class and ESG integration/portfolio decarbonisation have different strengths (political signal sending, delivering good financial returns whilst aligning with non-financial values, smart beta) but they don’t cause firm level capital re-allocation at the pace that’s needed to bend the curve of GHGs by 2020.
• Muscular engagement and voting (“forceful stewardship”) is the only strategy that can plausibly put pressure on corporate management to act at the pace needed across multiple sectors – which is why Trump Administration wants to block it.
• Scenario analysis disclosure was a good idea 1-2 decades ago but it’s not fit for purpose now (it encourages “one way” thinking i.e. how climate affects company, not how company affects climate). Shell have been doing it for 30 years with what impact? What’s needed now are transition plans. Whole sectors need to be pushed to do this, not just a few big brand companies.
• Annual General Meeting (AGM) voting puts pressure on free rider/fence sitting investors to take a stance: private engagement allows laggard investors to hide and this applies to most of the biggest fund managers in the world. No investor has the resources to do detailed engagement for all the companies that are major GHG emitters: industrial scale AGM resolutions are the only viable option.

Discussion
How do we get asset owners to create demand for forceful stewardship?

• Asset owner mandates are the most important driver.
• Change depends on a strong business case (already present in the EU, is it true in the USA?) PLUS public pressure on asset owners, as well as investment managers. Just a good business case or just pressure on fund managers won’t be enough.
• What does the low vote in favour of the Shell resolution tell us? Different interpretations but at a minimum, that collaboration between campaigners and investors is weak and compares unfavorably with the collaboration that happened over anti retrovirals for HIV/AIDS.
• Could France help set a global benchmark for collaboration between campaigners and investors?
• Climate aware philanthropists could be doing much more as stewards – why are they holding back? It’s their money so none of the usual fiduciary excuses apply

How to get governments to push investors to do more?
– The OECD is a good example of the challenge: it’s taken about 20 years for the OECD to “acknowledge” climate as a core issue but still the importance paid to it by the finance-oriented people of the OECD is very variable, for example, depending on the priorities of country hosting the G20 or G7 Summit.
– Decision-makers at the OECD still tend to relate to climate as a “specialist issue” and not inherently part of long-term investing or the infrastructure financing challenge (which seeks to solve the funding gap that exists).
– Institutional investors contribute to this problem by not raising climate change as forcefully as they might with OECD policymakers i.e. with financial regulators. Is there as joined up thinking between the corporate governance advocates in the investment community (who deal with pay, nominations, etc) and environmental advocates? Is the International Corporate Governance Network (ICGN) as active on climate change as it needs to be given that climate is a systemic risk?
– Many different lobbies exist about energy / utilities / climate change and there is a lack of comprehensive framework and language to discuss climate change. The result can be wasted effort eg ETS.
– A comprehensive policy framework is needed for the capital re-allocation that can enable large-scale decarbonization, that needs to address how individuals can save money to encourage that. Policy is needed beyond just electricity generation.
– France is a good a position to show leadership on this nexus of issues because of the views of the government and major institutional investors (if Amundi, AXA and BNP Paribas can speak with one voice, this would be very powerful). [could mention also to liaise with env community – could be even more powerful alliance to bring change in policy]

How to get faster action on energy utilities?
– We need a narrative about how the changes in the electricity sector will ripple down to other practical areas such as consumption, transportation, etc. Electricity touches people and we need to show how transformation in the sector could benefit individuals.
– Could fixed income tip the balance? PIMCO is one of the few very big US managers in ClimateAction100. What would it take for bondholders to decline to refinance maturing bonds?
– Convincing credit rating agencies to integrate climate change in their frameworks has been very difficult (timing and materiality). But with energy utilities, this should be possible given that most European utilities have lost so much value. Thus utilities and their investors/analysts can’t hide behind old ways of functioning. The first battle has been won.
– Investment analysts/portfolio managers don’t focus on climate change until their CEOs/CIOs tell them to do so. Quantitative easing means too little interest/capacity to focus on things like climate change.
– The shift from active to passive management in fixed income is another challenge unless we can get passive investors to be good stewards.

Next steps
This section, which builds on a specific proposal from one of the participants, is based on the presentations and discussion and has been drafted by Preventable Surprises.

1. Develop a “stewardship initiative” such that all major French institutional investors put real pressure on EU utilities and so trigger similar action by other European investors and also global investors with a particular focus on the USA and Asia.
2. Build a bridge between climate campaigners who are focusing on finance AND investors working on climate change. This needs to be an informal, private platform that can help align strategies and enhance effectiveness.
3. Develop a strategy that moves the biggest financial sector players (fund managers but also investment consultants and research agencies) on stewardship. The strategy will need to take into account that most of the biggest players are headquartered in the USA. The strategy will need to combine ‘carrot’ ie public acclaim and business rewards for leaders. Policy makers can help ensure asset owners give appropriate mandates but since this likely to be a slow process with weak mandates at the start, there will also need to be a ‘stick’ component, ie public exposure of laggards.