Institutional Investors Must Take a Leadership Role in Financing Climate Mitigation and Adaptation

At the recent Conference of the Parties “COP21” in Paris, 195 countries adopted the first-ever “universal, legally binding global climate deal”, committing to limit global warming to below 2°C above pre-industrial levels. The science is now clear: under our current approach to emissions, the onset of 4℃ warming could occur within 44 years, with the consequence that the majority of the global land surface will be subjected to unprecedented heat extremes, water and food scarcity, and irreversible loss in biodiversity. The International Energy Agency estimates that the world must invest at least an additional US$1 trillion per year into clean energy by 2050 if there is any hope of limiting global warming.

Carbon dioxide is the greenhouse gas (GHG) to be most concerned about, as it has far longer lifetime in the atmosphere than other human-released GHG, running from centuries to hundreds of millennia. There is need to drastically reduce the most serious generator of such emissions - fossil fuels. Yet, in 2015, the top 200 fossil fuel companies allocated US$674 billion to develop more reserves, and governments continue fossil-fuel subsidies of US$548 billion annually, revealing a disconnection between global aspirational discussions and economic reality.

Institutional investors have an important role to play in charting a new course in corporate approaches to climate change, aimed at long-term sustainability. Institutional investors such as pension funds are by their nature “patient capital” because of their size in the market and the illiquidity of their shares; they can have a significant influence on corporate decision makers in tackling climate change.  Aside from our collective public interest in a sustainable world, there is a business case to be made.  Howard Covington and Raj Thamotheram suggest that a plausible case for value at risk due to climate change in just 15 years is a permanent reduction of 5% to 20% in portfolio value. The Intergovernmental Panel on Climate Change estimates that global annual economic losses for additional temperature increases of 2°C are between 0.2% and 2.0% of world GDP, without accounting for catastrophic changes and tipping points.  At risk is a significant portion of the value of diversified investment portfolios. Hence, there are compelling reasons for capital markets participants to aggressively press for immediate and comprehensive action. Indeed, arguably, institutional investors have a fiduciary duty to act to prevent risk to their portfolios from anthropogenic climate change. The strategies need to be multifold: decarbonisation of electricity, a massive move to clean energy or lower carbon fuels, less waste in all sectors, and improved carbon sinks in forests, vegetation and soil.

There is a nascent but growing type of institutional shareholder activism, “forceful stewardship”, where investors are demanding a recasting of fiduciary obligation away from short-term shareholder returns towards ethical obligations and reduction of long-term environmental risks. Forceful stewardship involves helping directors and officers of all types of businesses understand that it is a breach of their fiduciary duties to ignore long-term environmental risks such as climate change.  This activism by our most powerful advocates in the market needs to be seriously and quickly ramped up if we are to change the current course of climate change.

An example is the Swedish pension fund AP4, which is committed to decarbonising its entire US$20 billion listed equities portfolio in less than 5 years.  It has a multifaceted strategy that includes opting out of companies with the greatest and most negative impact on the environment in terms of carbon dioxide emissions; providing funding for more green projects by being active in the primary market of the new issue of green bonds, as that is the only time the actual funding of green projects takes place, in that capital is transferred directly to the issuer for green projects; and participating in the trading on the secondary market of green bonds to help the asset class become more liquid and more attractive. AP4 is a member of the Portfolio Decarbonisation Coalition, a coalition of 25 investors committed to the decarbonisation of US$600 billion in assets under management.

Preventable Surprises, a “think-do” tank that seeks to assist institutional investors to align their activities with the long-term needs of their members, has suggested how investors might play a bigger role in the solution to climate risk. Investors can declare their intentions to vote in favour of shareholder resolutions that will help reduce systemic climate risk while growing shareholder value in the long-term; they can vote in favour of resolutions that call for listed companies to publish robust analyses of their assessments of the physical and economic impacts to their businesses of carbon budgets; and they can press for a halt to the hundreds of millions of dollars spent on lobbying campaigns by the fossil-fuel industry to mislead the public regarding climate science and to delay adoption of cost-effective policies.  

Institutional investors need to be innovative in how they encourage a shift away from short-termism. One approach is to seek amendment of corporate charters to specify that the company is to be managed in keeping with the objectives of the Paris Agreement, specifically, to hold the increase in the global average temperature to well below 2°C above pre-industrial levels. Enshrining such objectives in the constating documents would give directors and officers an express mandate to make business judgments with that corporate purpose in mind. The time for investor leadership is now.

Janis Sarra is a professor at the University of British Columbia, where she was recently appointed UBC Presidential Distinguished Professor.