Rapid changes in the climate for carbon-heavy investments
More often than not it takes a big shock to persuade people to come up with collective solutions to acute global challenges. The difficulty with climate change is that it is literally and metaphorically a slow burn affair in which the threat builds incrementally. Such an insidious accumulation of risk is profoundly worrying.
Yet in the past week institutional investors from around the world have triumphantly demonstrated that something can be done even without the galvanising impetus of a shock. ExxonMobil, the world’s biggest listed oil and gas group, has bowed to investor demands for increased disclosure on climate risks to its business.
This followed a 62 per cent vote against the board at May’s annual meeting on a shareholder proposal calling for a yearly assessment of the long term portfolio impact of climate change policies.
This week the company declared that it intended to spell out how it would be affected by the 2015 Paris agreement, in which nearly 200 countries committed themselves to hold the increase in the global average temperature to well below two degrees Celsius above pre-industrial levels. It also promised to explain its positioning for a lower carbon future.
Since ExxonMobil fought tooth and nail against similar proposals in earlier years, its climbdown was quite something. Separately, 225 global institutional investors controlling assets worth $26.3tn last week launched an initiative to put pressure on 100 of the world’s more carbon intensive companies to step up their actions on climate change.
Climate Action 100+, as it is known, is the biggest shareholder action plan ever launched. The aim, says Anne Simpson, investment director for sustainability at Calpers, the closely involved Californian government employees’ pension fund, is to “put the power of money on the biggest corporate greenhouse gas emitters and hold their boards to account”.
To meet the Paris commitments they will have to cut emissions by 80 per cent. The background is growing interest in sustainable investing and the environmental, social and governance agenda. Institutional investors increasingly regard these so-called ESG issues as part of long term risk management and of their fiduciary duty to beneficiaries.
Many now recognise that climate change poses financial risks to companies, investors and to the financial system as a whole, while the transition to a low carbon world will throw up big investment opportunities.
Many of the large institutions, meanwhile, are mapping out their carbon footprint across every company in the portfolio as they move towards lower carbon investing. Why have institutional investors become so active now, especially those such as BlackRock and Vanguard that had supported the ExxonMobil board over previous climate change resolutions?
On many big governance issues, such as curbing excessive boardroom pay, constraining over-dominant chief executives or policing conflicts of interest, the institutions are serial underperformers.
Part of the answer is that transparent voting puts pressure on fund managers.
The likes of BlackRock point out that they have engaged with ExxonMobil for years and that their patience simply ran out. Their competitors suspect that they were feeling exposed and worried about losing current clients when ESG issues have become mainstream investor concerns. It is impossible to overestimate the importance of the Paris agreement in this.
The two degree temperature target highlighted how the transition to a low-carbon economy would affect corporate cash flows and earnings. It will also create “stranded assets” whose value is impaired because they are rendered obsolete.
Oil, gas and coal could become unburnable without expensive carbon capture technology. An understanding of these risks has been enhanced by Mark Carney, the Bank of England governor, who has dubbed climate change “the tragedy of the horizon”.
That is, the catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors, imposing a cost on future generations that the current generation has no direct incentive to fix. As chairman of the Basel-based Financial Stability Board, he also set up a task force to give investors information to identify companies most at risk and best prepared. The business models of countless companies are not properly positioned for a low-carbon economy.
For want of better information, much capital is being misallocated. And markets are underpricing climate risk, according to Sacha Sadan, director of corporate governance at Legal & General Investment Management. He likens the position to just before the financial crisis of 2008-9, when complex mortgage-backed securities were overvalued and little understood.
“It’s only when it hits you between the eyes that realistic valuations take effect,” he says. Clearly the co-ordinated response to climate change has not been helped by President Donald Trump’s decision to withdraw the US from the Paris agreement.
Yet with the big investment institutions ready, in Ms Simpson’s words, “to breathe down the necks of the worst emitters, while offering the carrot of access to capital for better performers”, something momentous is going on.