Climate transition – moving to the core of board investment governance

The ever-steepening climate scenarios of the last five years have pushed many responsible investments and ESG heads into areas where their experience and competencies are increasingly being tested.

Assisting investment committees and boards navigate the unfolding climate transition is now a permanent career challenge. The new IPCC AR6 report has stripped away any remnants of comfort for policy makers that mainstreaming of emissions reduction and hence sustainability in global finance and investment can be undertaken at the current pace.

Keeping abreast or one or two steps ahead is an already difficult existence for sustainability specialists. Large corporates with heavyweight consultancies at their side may be used to unfolding strategic and structural challenges but not every asset owner.

Few have yet fully developed the in-depth knowledge models on all levels of the investment chain, up from individual companies and industry sectors to asset management to the asset owner level, but this is what the climate transition now demands.

Speaking in July to an audience of Australian pension funds, UN climate envoy Mark Carney advised climate risk would become a core competency for investment managers. Not just in in terms of understanding their exposure to carbon across their entire portfolio, but also understanding what plans individual companies have in place to reduce emissions, and how those plans look against global, science-based targets and the best-in-class in that sector.

Climate transition at board level

If analysing individual company futures is difficult enough for asset managers, portfolio teams and sustainability specialists then some sympathy is due for asset owner boards themselves.

An issue for boards is strategy lockup - the number of asset owners currently mid climate strategy review is significant. The danger is that they are re-strategizing a moving feast. Speed and decisiveness are key, funds used to a steady decision-making process over two to three year cycles before a full review may find themselves at risk of underperforming.

Benchmark policy is another area under stress, as many doubt the ability of the broad market to navigate the transition well, particularly if the upside opportunities are emerging in other asset classes.

Brett Himbury, ex CEO of infrastructure giant IFM Investors, sees the systemic shifts impacting businesses and investors representing a once in one-hundred-year challenge and most particularly, a significant opportunity.

His list of challenges includes all time historically low interest rates, investors seeking to respect the role of boards, yet have a greater influence in ensuring superior long term shareholder value is achieved, monetary policy locally and globally largely exhausted, unprecedented fiscal stimulus from governments and extreme levels of geopolitical risk.

More than a one-in-a-hundred-year challenge as some of the issues outlined by Himbury are, climate change is a permanent challenge out to 2100, with flashing way points in 2030 and 2050.

For boards, the complexity and materiality of the transition is compounded by pressure to make public, portfolio emission commitments, with investment leader groups like the Climate Action 100+ and Net Zero Asset Owners Alliance (both of which can trace their genesis back to the PRI convened Montreal Carbon Pledge of 2014) generally being ahead of government and regulator policy settings.

The role of IPR

Connecting those investor commitments to the realities and uncertainties of future climate policy development in the investment landscape is the raison d’être of the IPR and its Forecast Policy Scenario (FPS).

The 2019 IPR thesis of a policy acceleration has been borne out by events in two short years. Our view is that there is more acceleration to come in the first half of this decade, driven in part by the looming 2023 Paris Stocktake and 2025 Ratchet and the real time, lived (and viewed) experience of extreme weather events on tens of millions, adding momentum to civil society pressures on politicians.

The embedding of climate and carbon pricing issues deeper into global trade and economic agendas via WTO, G7 and G20 is another indicator to a new stage in the acceleration.

What should asset owner boards do?

Determination from the board to embrace this transition as an organisational change project is a central option. As is avoiding the understandable temptation to try to be ‘in the middle.’ It’s likely to have moved. 2030, the first of those flashing way points is already exerting an influence.

Trust in staff is also central. That ESG and sustainability specialists are keeping pace, CIOs and investment teams are building and using their insights to help pick the right managers or investments.

But if IPR is right in one of its longer-term assessments then net zero is not the end of this transition. It is increasingly possible that the world in coming decades ends up trying to claw back an emissions overshoot.

In this future, boards and their now fully integrated ESG and sustainable investment teams will find themselves with new career challenges in the form of negative emissions assets and a likely set of investment beliefs having to adapt to the investment opportunities arising from that.

 

 

 

This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.If you have any questions, please contact us at [email protected].