2020 is a critical year for global climate change mitigation – and the finance sector is the lifeblood of these efforts, writes Harry Ashman of the Church Commissioners for England.
In advance of COP26, governments across the world are required to submit enhanced Nationally Determined Contributions (NDCs – the national carbon reduction targets and plans that articulate each country’s contribution to achieving the goals of the Paris Agreement). In parallel, non-state actors are being heavily encouraged to play a supporting role, specifically by setting targets for net zero emissions by 2050 at the latest. But why net zero, and what does this mean for investors?
Scientific consensus is that we must reach net zero global emissions by 2050 to have a reasonable chance of limiting the average global temperature rise to 1.5˚C above pre-industrial levels by the end of the century. As a result, greenhouse gas emissions must roughly halve by 2030, as their warming impact continues for years after emission, before reaching net zero by 2050. The foundations for this transition must be put in place now, meaning government and corporate ambitions must align with climate science and set net zero targets for 2050 or before, and as soon as possible.
Our industry has a vital role to play in driving this radical global transition, indeed its importance is highlighted in the original text of the Paris Agreement, with Article 2c calling for signatories to“[make] finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”.1
Unless we redirect businesses and capital from ‘sunset’ carbon-intensive activities, we risk maintaining the status quo and locking the global economy into highly emitting infrastructure and business models for decades. Ultimately, all investors will benefit from actions seeking to minimise the immense financial damage that climate change and associated socioeconomic disruption will wreak. Likewise, an orderly low-carbon transition driven by voluntary action and considered policy is clearly preferable to a disorderly one characterised by the sudden imposition of restrictive regulation and even greater social and client pressure.
Driving a transition
The Church Commissioners for England have long taken a very active approach to responsible investment, and in January we announced we would be joining the UN-convened Net Zero Asset Owner Alliance (AOA). This group of institutional investors represents over US$4.6 trillion (€4.2 trillion) in assets under management (AuM), all of whom have committed to transition their portfolios to net zero emissions by 2050.
We believe setting this goal is the best way to signal support for the actions required to drive the transition required from the global economy, and is the logical next step to focus our minds and money on what is required to remain a responsible investor in a way that is firmly in line with our fiduciary duty.
Net zero finance is about driving a transition, not just cherry-picking portfolios. In theory, a fund could achieve net zero emissions through selected divestment of carbon-intensive industries and investment in offset certificates, green bonds, or assets like forestry.
Yet this would largely miss the point; assets do not exist within a vacuum, and whilst some value would be protected from carbon taxes and other policy measures, the wider impacts of climate change would still harm overall performance, not to mention the moral imperative to act upon a problem that disproportionately affects those least responsible for it.
Rather, as an AOA member, we believe that to enable investors to meet their fiduciary duty to manage risks and achieve target returns, our net zero commitment must emphasise emissions reductions in the real economy to truly achieve the target’s intended purpose and make a meaningful contribution towards the Paris goals. The AOA is seeking to have this real economic impact by working with hard-to-abate sectors to remove barriers to progress and supporting existing engagement initiatives, like Climate Action 100+, to directly push companies to align with the Paris Agreement. Members are also pressing governments to increase the ambition of their NDCs and engaging regulatory bodies to improve disclosure standards.
These efforts are underpinned by the development of methodologies to assess the carbon footprint of members’ portfolios, and short-term emissions targets are being developed to maintain momentum and map a path to net zero.
Living up to the rhetoric
As asset owners are again increasing their ambition, it is time for asset managers to step up in order to supply the services required and be a greater part of the solution. The industry has made progress, with more major US managers like BlackRock and JP Morgan Asset Management making statements of intent and joining Climate Action 100+. However, the industry has frequently been accused of being slow to act. Managers must go further by setting their own net zero targets and taking a more active approach to engagement, not just to protect their returns and remain in line with an increasing number of clients, but to use their position in the global economy for real impact.
When it comes to being heard by companies, asset managers have two advantages: they tend to have closer relationships with the companies and a far larger stake than individual asset owners. These two factors should be leveraged more for climate engagement, with managers calling for laggards to develop Paris-aligned emissions reduction targets and low-carbon transition strategies, alongside supporting companies that have already done so.
This focus must be reflected in voting activities.; Many managers’ voting histories have failed to live up to their rhetoric. Asset managers’ support for relevant climate-related resolutions is vital, but so is voting against the re-election of board members who oppose transition, ensuring those who run investee companies are aware of what is required for their long-term success, and capable of delivering it.
Reliable reporting
In addition, we would like to see more asset managers pushing for improved reporting from companies, as BlackRock and State Street have done with their support for the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD). Reliable, decision-useful financial information is vital for investors to price climate risks and opportunities efficiently; encouraging financial flows away from riskier high carbon companies towards those making the transition effectively, enabling asset managers to both improve returns and meet the needs of increasingly climate-conscious clients.
This includes requesting companies use accounting principles consistent with the Paris Agreement. Companies should publish the potential impact climate and transition risks will have on asset values, whether this requires depreciating potentially stranded assets and posting impairment charges, as Repsol did earlier this year2, using fossil-fuel price assumptions consistent with Paris-aligned scenarios, or setting aside capital for future fines or liabilities.
Make your position known
Greater asset manager support for climate-friendly policy is also needed. Large managers were conspicuously absent from the list of 631 global investors who signed the 2019 Global Investor Statement on Climate Change3, calling for government to take the actions required to meet the goals of the Paris Agreement. With COP26 on the horizon and sustainable finance set to play a large role, asset manager support for improved NDCs and accompanying climate policies would embolden policymakers’ decision-making.
Finally, asset managers should ensure that investee companies insist that influential trade associations do not act to undermine the creation of a climate-friendly policy and regulatory environment. We have seen positive steps from companies reviewing industry organisations’ alignment with their own corporate positions on the Paris Agreement. However, many associations continue to take unconstructive positions. Asset managers should push their holdings to take a step further and proactively lobby for climate-friendly policies, alongside managers themselves.
In short, 2020 must be the year that net zero targets gather pace, and asset managers can and should be a central part of this movement. A push for net zero portfolios from those at the front line of investment capital allocation decisions will go a long way towards ensuring finance flows are indeed “consistent with a pathway towards low greenhouse gas emissions”.
Through taking a holistic approach to net zero, managers who move early will demonstrate leadership, standing out as being best-placed to service the needs of increasingly climate-conscious asset owners. Being at the forefront of low-carbon transformation will reduce transition risks and help them seize the opportunities that arise.
Finance is the lifeblood of the low carbon transition, but without setting net zero portfolio targets, the asset management industry risks falling short of what is needed.
1 – https://unfccc.int/files/meetings/paris_nov_2015/application/pdf/paris_agreement_english_.pdf
2 – https://www.ft.com/content/90f49a98-1528-11ea-8d73-6303645ac406
3 – https://www.iigcc.org/media/2019/12/191201-GISGCC-FINAL-for-COP25-007.pdf
Harry Ashman is an engagement analyst in the responsible investment team at the Church Commissioners for England
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