One of the striking features of the global climate agenda over the past five years is the scaling up of institutional investor commitments, signalled by the recent formation of the Global Investor Coalition, bringing together four regional groups in Australia, Asia, Europe and the US. This has taken place against a backdrop of policy uncertainty post-Copenhagen and severe volatility in key clean tech markets.
This tough reality is now changing, with the prospect of accelerated action in two pivotal nations: China and the US. In addition, the first volume of the Intergovernmental Panel on Climate Change’s fifth assessment review will be published in September, refocusing attention on the fundamental science of global warming.
The key is to peak and then reduce global emissions in line with the available carbon budget. Although some European nations such as France, Germany and the UK have structurally peaked, we are still a long way from a peak at the global level. According to the International Energy Agency, global emissions need to peak before 2020 to have a 50:50 chance of holding warming below 2°C (see Chart).
As governments, businesses and campaigners increasingly focus on the transformational steps that are needed to avoid dangerous climate disruption, we believe that there are five themes that could help shape the capital markets’ response through 2020 and beyond: capital stewardship for high-carbon sectors; energy efficiency across asset classes; focusing financial incentives; climate-proofing financial regulation; and setting course for climate targets.
1. Capital stewardship in high-carbon sectors: Our work on the risks of stranded assets in coal, oil and gas sectors has highlighted the critical role that investors can play in stress-testing capital expenditure plans in these and other high carbon sectors to ensure that they can deliver attractive returns in a 2°C scenario; this also links powerfully with the post-financial crisis emphasis on stewardship more broadly.
2. Energy efficiency across asset classes: Asset owners are becoming increasingly comfortable with renewable energy as a portfolio theme, particularly within infrastructure allocations. Efforts to improve the energy efficiency of portfolio holdings are generally less developed, with the exception of direct real estate investments and collaborative initiatives such as the CDP’s Carbon Action programme. This has helped to stimulate energy efficiency measures with an average payback of three years. Scaling up these efforts across all assets is now an urgent priority as efficiency is the quickest and cheapest way of postponing lock-in to a high carbon pathway.
3. Focusing financial incentives: Global pensions and investments receive considerable fiscal support to encourage long-term savings. To date, some countries have directed small sums for environmental investing. But none have yet introduced links between this support and the responsible management of environmental, social and governance (ESG) factors, such as climate change.
In other policy areas, cross- compliance is becoming well-established. For example, as part of agricultural reform in the EU, environmental and other conditions are applied to farmers who claim payments. Discussion is now beginning on how fiscal support for savings can be aligned with sustainability objectives. For example, in the UK, the Green Alliance has suggested ways in which annual support of cGBP40bn could be linked to responsible investment and long-term stewardship.
4. Climate proofing financial regulation: The design of post-crisis financial regulation has revealed that ESG drivers of financial risk and market stability are still largely absent. Many low-carbon options – such as renewables and energy efficiency – are capital intensive and therefore sensitive to financial regulation.
A recent White Paper from Bloomberg New Energy Finance highlighted concerns with Basel III rules for banks and EU Solvency II regulations for insurers, suggesting that financial regulation may be ‘biased against clean energy and green infrastructure’. Over the next decade, it will be important for climate and wider ESG factors to be integrated into financial policy to remove unintended barriers to the low-carbon transition.
5. Setting course for climate targets: Experience at the country and corporate level shows that well- designed climate targets are an important driver of performance. Ultimately, asset owners hold responsibility for financial and ESG performance – and looking ahead to 2020, we see the introduction of climate targets by institutional investors as a useful way of guiding their investment decisions, ownership actions and policy dialogue.
Universal investors such as pension funds invest across the economy, deriving returns from overall macro-economic performance. If global carbon emissions need to peak before 2020, one could argue that emissions from universal investors should also peak at that time.
Taken together, we believe that these five themes could be part of a 2°C strategy for investors – helping to co-create the conditions in which they can deliver the climate future they need to sustain returns on a resilient basis.
