The United Nations Environment Programme recently launched a report on its 2-year inquiry into sustainable finance. Its authors and contributors should be commended for the scope and breadth of the project, which included specific recommendations for actors at every node of the global financial system. Furthermore, as IISD Executive Director Mark Halle pointed out in a recent interview, the Inquiry did a particularly good job of crafting an analysis that benefited from both insider and outsider perspectives, avoiding the pitfalls of both[i]. This is precisely the sort of work we need in order to undertake the task of shifting to a low-carbon economy.
Targeted primarily at governments, the report was not explicitly directed towards investors. That said, it has very helpfully emphasised investors’ fiduciary duty to incorporate material sustainability factors into investment decision-making. It also implores asset owners to align incentives all the way down the investment chain, which is all the more important for investors with a long-term investment horizon. These recommendations – to honour trustees’ fiduciary duty and to align incentives among financial actors – build on earlier work in the same vein. But it is precisely because investors find fundamental culture change so hard to implement that bodies like the Inquiry should be lauded for maintaining the pressure for real change.
As the report alludes to, and as Peter Drucker – arguably one of the truly great management gurus of our times – highlighted many decades ago[ii], long-horizon and diversified investors come as close to aligning with the “public interest” as it is possible for a corporation to do. Perhaps the most important thing they can do today is to play their part in shifting corporate business strategy to keep global warming to less than 2ºC.
With this connection in mind, it is worth considering another recently-released UN report[iii] that notes that the number of shareholder resolutions relating to climate change and the environment has increased six-fold since 2013 – and that, furthermore, over a third of the resolutions filed in 2015 garnered a minimum of 50% support, whereas none of the 2013 resolutions hit that threshold. There is momentum building among shareholders, and a growing willingness to engage on the part of the executives of companies like BHP Billiton, BP, Shell and Statoil.
What are the next steps? As the Inquiry noted, the push for reporting and disclosure of carbon risk is undeniably important, and it, too, has made great strides in the last few years. In itself, however, disclosure will not a low-carbon economy make, any more than disclosure of executive pay has solved that problem. Following the publication of its groundbreaking report, it would be truly inspiring if the Advisory Council were to seize the moment and amplify their message among a very powerful constituency: investors.
What we need is “2ºC transition plans” for all governments and corporations, especially fossil fuel companies, heavy energy users, and key enablers (e.g. finance-sector companies, including insurance companies and banks). This would ensure that, alongside the other sensible measures the Inquiry recommends, the internal decision-making of relevant corporations is influenced. Among other things, the report dealt with policy actions that would change elements of the financial system for the good, such that more capital will flow towards green infrastructure and development; a natural complement to this would be initiatives that reallocate funds within companies, as many capital expenditure decisions are made at that level.
Investors should think of forceful stewardship as the third leg of a stool that is otherwise structurally unsound; the Divest-Invest movement (i.e. divestment combined with green funds, e.g. climate bonds) and Portfolio Carbon Management (e.g. decarbonization, tilting, strategic asset allocation) have played essential roles in beginning to change the investment sector, and more of both are needed. But forceful stewardship is now needed as the critical third leg.
Arguably, it is the most direct way to ensure companies’ business trajectories align with those of governments transitioning towards a low-carbon economy. It must moreover be remembered that many of the larger multinational companies bear more responsibility for GHG emissions than some governments.
Stranded asset risk is significant and typically affects 8% of investors’ portfolios, but an even bigger concern is systemic risk, which affects the other 92%. In a forthcoming study entitled “Unhedgeable Risk” (referenced by the Bank of England in its own paper on climate risk and the insurance sector[iv]), a research team co-ordinated by the Cambridge Institute for Sustainable Leadership has concluded that only half of the expected negative impacts on investment portfolios resulting from policy and market reactions to climate change can be offset by diversification strategies. According to the Bank of England: “. . . [W]hile industries are differentially affected by climate change, the risks are close to systematic rather than idiosyncratic, requiring policy action” – or, we would add, forceful stewardship – “to mitigate”. The authors have also demonstrated that there are plausible scenarios in which investors could experience significant negative financial impacts over the next five years, much sooner than has previously been expected.
Forceful stewardship asks investors to propose and then vote in favour of resolutions instructing boards to present 2ºC transition plans. The key is that companies develop these plans themselves. The target is clear, but the path is flexible and responsive to the unique profiles of the businesses in question. As Harvard Business School professor Michael Porter has shown, environmental regulation with strict targets, yet flexibility in meeting them, tends to result in greater innovation and compliance. Put simply, this is smart policy.
Preventable Surprises has proposed specific “Forceful Stewardship Guidelines” detailing what this means in practice and these are actions that investors can take, whether or not governments act. That said, legislators and regulators could do much to support the work of investors, as per the Inquiry’s report. Specifically, the Inquiry’s Advisory Council could help build resilient alliances among governments and investors by engaging in 5 areas:
- Ask regulators to communicate to investors that there is now an expectation of proactive support in managing serious systemic risks like climate disruption. Regulators can thus create a context in which systemically important investors in particular, but indeed all well-diversified and long-horizon investors, explain how they address this type of stewardship challenge. The Bank of England and the DNR, the Dutch central bank, have already taken important steps. A key regulatory agency for the Advisory Council to focus on is the SEC, which has global reach and which has already acknowledged that it could be doing more[v].
- Ask legislators to reinforce the above. In particular, ask those legislators of countries that have sovereign wealth funds to take action on the “Forceful Stewardship Guidelines”, incorporating them into the Santiago Principles, in line with the Inquiry’s recommendation.
- Invite organisations close to UNEP – e.g. the Principles for Responsible Investment (PRI), the Principles for Sustainable Insurance (PSI), the International Monetary Fund (IMF), the Organisation for Economic Co-operation and Development (OECD), and the World Bank – to report on what they are doing to promote forceful stewardship.
- Alert investors to the importance of taking forceful advocacy positions with respect to critical policy issues such as fossil fuel subsidy reform (for example, supporting the Friends of Fossil Fuel Subsidy Reform[vi], which has high-level government and corporate support, but – as yet – no major investors) and against corporate funding of denialist organisations that are barriers to action on carbon pricing.
- Help investors think through how they can support those governments that have made ‘good’ Intended National Determined Contributions (INDCs) – so that these commitments are actually implemented – and encourage governments that are lagging to catch up. This could be done directly, where investors hold government bonds[vii], and indirectly, by forming alliances with forward-looking corporate business leaders[viii] and respected scientists, economists and civil society experts.
In summary, the Inquiry’s Advisory Council could communicate to powerful investors ways in which they can have more policy impact by demonstrating they are being fully proactive in their own sphere. The risk today is that investors could be seen to be engaged in a cleverly-disguised blame game – telling governments they will act if only legislation were more forceful. The answer is for diversified, long-horizon investors to start to be forceful in their sphere of direct influence, in parallel to their advocacy efforts. The Inquiry’s Advisory Council is ideally placed to communicate this message. Certainly forceful stewardship is a clear way of satisfying the reasonable demands of the Inquiry’s report – and that should be the top priority of the Inquiry’s Advisory Council and all right-thinking investors alike.
Raj Thamotheram, CEO, Preventable Surprises &
Ellen Quigley, Research Associate, Preventable Surprises
[ii] Drucker described The Pension Fund Revolution (1995) as his least-read but most prescient (personal communication, Keith Ambachtsheer, 2011).
[vii] The role of fixed income investors as stewards has only recently been understood: http://www.unpri.org/viewer/?file=wp-content/uploads/PRI-fixed-income-investor-guide-2014.pdf (see pages 29-32)