Frankfurt Roundtable (18th June 2018) Frankfurt Roundtable Report PDF
If you have time for nothing else, make sure you see Professor Rahmstorf’s Prezi – click here.
Organizational affiliations are shown for identification purposes only as participants were speaking in their personal capacity.
Prof. Stefan Rahmstorf (Potsdam University) Stefan Rahmstorf Frankfurt PDF
Conclusion – The finance sector has a crucial role to play (Slide 19):
Global warming isn’t news! The first publication that used global warming in the title was in 1975. There has been a 40% increase in CO2 and humans have caused this (slide 2).
During the Holocene, temperature has been in a narrow band that humans are well suited to. Now 5000 years of gradual cooling is being dramatically reversed by human activity – hence some suggest we are now in a new period, the “Anthropocene” (slide 4).
The way this is changing the earth is already very significant (e.g. 3/4 of the Artic sea ice volume has been lost; significant and unprecedented sea level rise during the 20th century)
Weather is now showing clear signs of change – important to take range of evidence together (slides 5-11):
Tipping elements in the climate system are critical but not a major focus for the IPCC (slide 13):
Some disruption is now certain – therefore it is critical we minimize this so we aren’t overwhelmed and can adapt. But focus on adaptation without mitigation is foolish: both are needed.
Big assumptions being made about carbon capture and storage (CCS) and disappointment is almost certain (slide 16).
To meet the Paris agreement, we can emit a further ~600 gigatonnes. If emissions continue at current level, this is about 15 years. The more we emit now, the earlier we have to hit zero i.e. the more abrupt the change will have to be if we want to keep to 2°C (slide 15).
Major challenge is that national contributions promised in Paris were not enough to actually match the Paris agreement, and many countries are not even meeting these promises (slide 17).
Intergovernmental organisations are challenged. IEA has been repeatedly wrong on renewables but doesn’t seem to learn (slide 18). Renewable energy has developed much faster than even optimists expected.
Karsten Löffler (Frankfurt School – UNEP Collaborating Centre for Climate & Sustainable Energy Finance)
Karsten is on holiday and hasn’t been able to check this, so it’s what I took away from his presentation. If there are significant changes, I will let you know.
Policy is critical for climate change and investors.
Policy makers have not yet been bold enough – climate regulation has had limited real world effects. Several industrial sectors need to make major change
The good news is that Europe acknowledges climate related systematic risk and there is a big push on sustainable finance and long-term focus on the financial industry. A lot of the debate is focusing on questions of materiality, how to integrate ESG factors into investment decision making. But what impact is this having on climate change?
Insurance companies are seen as most vulnerable. The big challenges lies on the asset side, not on the liabilities side, since liabilities can be adjusted yearly underwriting changes. Yet the asset side has had less attention.
One big question is what is the social role of the financial sector? Should it contribute to a policy/political goal? In Germany, the agreement is that there should be a ‘hands-off’ approach: politicians shouldn’t tell finance what to focus on and finance shouldn’t tell politicians what they should do. But is this what actually happens in reality on other issues?
In other countries (e.g. France and UK) the finance sector is being seen as a key player in the climate debate. How far is this actually happening i.e. is there a ‘walk the talk’ challenge? If so, might Germany and other countries be, in practice, quite similar?
FS UNEP is one of about 20 centres globally working together on finance and sustainability. Much interest in China.
Germany risks falling behind if the urgency is neglected and there’s insufficient innovation.
German utilities were very reluctant to invest in renewable energy, ignored the fact that fossils would be reduced, e.g. though legislation and generally hesitated for too long to transform the business model
Marc Lewis (Carbon Tracker Initiative) Mark Lewis Frankfurt PDF
What happened to the utility industry [slide 5] has useful lessons for: other sectors that are reluctant to make climate related changes, for the utility sector itself (it still faces major changes) and for investors (who need to choose to either enable forward looking leadership or cement in BAU).
European utilities are being squeezed from two sides: i.e. volume impact (due to renewable production) and value impact (wholesale power prices has been pushed down by renewables). The financial impact of climate change (and consequent action) is already very significant for this sector (EU utilities have written down $150bn of assets since 2010). And building new renewables is now cheaper than building new fossil but still more expensive than existing fossil – however, this will change over the next few years. [Slide 4].
Carbon Trackers calculate that half the coal plants in Europe are loss-making at an operating level today and almost all will be by 2030. [Slides 6-7].
A positive policy/cost/consumer cycle for renewables has started in many countries – lower costs emboldens regulators to make the polluters pay. But as economic and technological obstacles to transformation have reduced, so political obstacles have grown in some countries e.g. US, Poland. [Slide 8].
Emerging markets have a clear choice – either stick with model that worked in the West or leapfrog this to a much more direct and much less disintermediated system (with a lot less waste and pollution). [Slide 9-10].
Who are the leaders? ENEL & Iberdrola. The market is rewarding companies that have shifted business strategy. Who are the laggards? RWE but even they are moving (significantly increased exposure to renewables as a result of the deal with E.ON). There have been big changes during the last 12 months.
What did senior execs/boards get wrong? They wrote off the development of renewables and over-estimated their political influence re nuclear.
Nicolas Moreau (DWS)
How can investors help finance the transition to a low carbon economy? Infrastructure, private equity and venture capital are likely to be offering the best kind of partnerships (e.g. DWS new private equity fund focused on Chinese clean tech companies or the new infrastructure fund focused on solar assets to help decarbonize company’s supply chains). There is a need for capital and there is a demand from clients and large investors can play a useful intermediary role.
How can investors integrate climate risk into the investment decision-making and price it well? Engagement is key. But also have to adapt basic models e.g. DCF which assume historical distributions of risk (e.g. catastrophic events) which aren’t like to happen going forward. And then develop appropriate execution strategies. The 2011 floods in Asia had a very big impact on the tech supply chain, so DWS is creating an index which exclude companies that have a supply-chain in areas that are at risk of flooding. Similarly, investors need to take climate risk into account when buying sovereign bonds.
How can investors best do engagement? Today, engagement is primarily for better disclosure. Many insurance companies have signed the Montreal pledge and are disclosing the CO2 footprint of their investment portfolio. ‘What gets measured, gets addressed.’
Q – It used to be the asset owners who pushed the agenda. Has this now changed?
A – Yes and no. More and more asset owners are requesting ESG. But whether there is client demand or not, IMs still need to take into account all material risks, e.g. climate change, in the way how they monitor securities. Also asset owners, particularly in France and especially those with union connections, are putting billions into impact investing projects that designed to tackle some of the most pressing social and environmental issues.
Q – Should we have more/better climate finance regulation?
A – French institutional investors, including asset owners, are quite active due to the implementation of article 173 which has a comply or explain aspect.
Current regulation has provoked greater interest in carbon footprint of investment portfolios and this has been a good thing.
Q – DWS has voted at US AGMs in favour of climate risk disclosure. Many large fund managers did not do this. Why has DWS been able to act consistently?
A – DWS follows Ceres principles and other fund managers are moving in this direction too.
Raj Thamotheram (Preventable Surprises)
Generalising – there is too much easy optimism (“green tech will solve climate change”) and it feeds incrementalism/complacency amongst even climate aware investors.
There is radical uncertainty as Stefan explained and this is exacerbated by policy uncertainty as Karsten described and together this means investors should be being much more active than they are.
Energy utility sector is 24% of CO2 emissions and everything is in place to make the major changes needed. Plus the sector’s current BAU has been a major cause of financial loss. McKinsey’s recent report shows the sector’s business model is fundamentally broken.
Unless we deal with this easy to change “low hanging fruit” sector now, we will not have the time to deal with the more difficult sectors e.g. aviation, shipping, cement etc.
Governance aspect: forward looking analysts and insiders had seen the problem for many years but the sector decision-makers ignored these warnings and the investors went along with the incumbency.
Academics at Zurich University have concluded that different investment strategies have different strengths – e.g. political signal sending, risk management, value alignment but that stewardship along with impact and thematic investing are most likely to create real world change.
Just as there are corporate leaders and laggards, so too in investor stewardship. One leader is ETHOS in Switzerland which is engaging, on behalf of Swiss pension funds, with 8 utility companies. Many of the biggest stewardship laggards are in the USA. And it’s not just pension funds and investment managers – the USA is the HQ for most of really big investment consultants, sell side analysts, credit rating firms, auditors.
EU players need to push a systemic risk management agenda to make sure the global investment industry plays the part that it should.
Q – Should the financial sector be asking for more regulation?
Participant A: We have asked for more regulation for 15 years! Why does the industry keep asking for data? How much more information is needed to make the correct decision in this context? There are just some investments out there that should not be in the investment. Data scientists will change the investment industry, showing patterns which then can be acted upon. Reporting of (many) companies is far ahead of the financial industry which must use the data that is out there before asking for more.
Participant B: Depends what investors are asking regulators to do. In the UK ‘Know your clients’ has focused on bribery & corruption but it could also focus on e.g. (climate related) systemic risk. Regulators could require all IMs to as their AO clients “do you want us to manage climate related systemic risk?” This regulatory nudge would apparent lack of demand into a clear signal for action. And we need to be careful about the unintended consequences of regulatory asks. For example, the French regulation has pushed investors towards managing their portfolio carbon scores. What we need is regulation which pushes investors to be active owners and ideally forceful stewards.
Q – What to do about the USA?
Participant C: The EU follows regulation, China follows the political path – the government just takes action to green the economy. Regulation in the USA doesn’t work due to its specific context. Companies and cities/states, will need to take the lead. DWS, using Ceres principles, has a near 100% record of voting in favour of climate resolutions, whilst BlackRock is at 6% but this will change. By 2025 75% of the work force will be millennials. Studies show that millennial invest in line with their values and beliefs and they belief that climate change is happening. If fund managers don’t adapt to this, they won’t succeed with customers. But will this be fast enough?
Q – Are investors using AGMs as much as they could to push this agenda?
Participant D: We do not see many ESG resolutions on European AGM agendas, in contrast to the US. Remuneration is always on the agenda. And digitalization is a hot topic with many German boards about experts on this. But there are no ESG experts on the boards of energy utility companies. Why?
Participant E: There does not need to be an expert on the board. Once it is mainstream the people on the board should know about it. Companies have known about this for a long-time.
Post roundtable reflections – some personal comments
In the two short hours of this event we covered a lot. To try to come to consensus wasn’t the aim. What this fascinating roundtable, building on an equally excellent event in Paris, has highlighted for me is as follows:
In the meantime, GHGs rise year on year and we look on track for 4-5°C average warming by 2100.
What then can be done to move things forward?
An outsiders’ perspective can be both useful. Climate change is a global phenomenon, no market is doing things well enough and learning from other markets is especially relevant to a sector like finance where German fund managers increasingly depend on non-German clients. But outside perspectives can be limited or unrealistic. Ultimately, it’s how the outsider/insider interaction dynamic is made use of. In this context, let me share some ideas for German investment insiders to consider in the decisions that only you can take.
Dr Raj Thamotheram, Founder & Chair, Preventable Surprises
 https://www.esma.europa.eu/sites/default/files/library/2015/11/2014-677.pdf -see 4.1 (d) (ix)