Last week we attended a discussion on how to align the financial sector with a low carbon world – a timely and necessary discussion given our current trajectory towards a dangerously warmer future. The workshop, held by Fossil Free SA, aimed to build awareness of climate change and carbon risk for South African investors, consider tools for tracking decarbonisation, and catalyse the creation of new low-carbon and divested funds (of which there are far too few available).
With representatives from the asset management industry, NGO’s, and academia, it was encouraging to see that there was more to agree on than debate about. The common sticking point in the divestment debate is whether it’s the most effective tool to support the low carbon transition (see both arguments below). Yet both would-be-divestors and those in favour of more nuanced strategies stood firmly behind the following: that climate change threatens not only the stability of society but also financial stability, that more needs to be done to integrate sustainability into financial decision making, and that while there are legitimate barriers to “future-proofing” the financial system, there’s common ground on how to overcome these.
But first – a quick recap on both sides of the divestment argument:
The case for divestment
Simply, (in the absence of more “out there” strategies like geoengineering) there’s a trade-off between financial returns from the fossil fuel industry and a safe and stable global climate. This has both moral and economic/financial implications.
If the continued investment in fossil fuels leads to an average global temperature increase of 4°C, a future which “is incompatible with an organised global community”1 the knowledge that one’s short-term returns came at the expense of societal and economic chaos seems indefensible (a moral problem). More so given the ample evidence that low-carbon or fossil free funds perform just as well or better than their high carbon peers.
Conversely, to successfully keep Earth’s climate system human-friendly, we need to leave around two-thirds of current known fossil fuels reserves in the ground. But because fossil fuel companies are valued based on the assumption that all their reserves will be burnt, this would mean these companies are currently overvalued. Since we should be betting that the world will successfully decarbonize, the argument goes, continued invest in overvalued fossil fuel assets is risky (a financial problem). What’s more is that the systemic and unpredictable risks associated with unmitigated climate change will be global – they cannot be avoided by any country, sector, company, or investor – and therefore it would be in the best interest of all financial players to avoid this scenario.
The case against divestment
But there are also good arguments against divestment. Firstly, when investors with social and environmental awareness drop their fossil fuel shares, these shares will immediately have a willing buyer. This will be true as long as there is an economic rationale for fossil fuel companies to exist – that is, as long as there is a demand for fossil fuels. These new owners of fossil fuel stocks will almost certainly care less about climate change or corporate sustainability than divestors. As a result, fossil fuel companies will face less and less pressure to disclose critical climate-related data, plan for different future scenarios, implement long-term adaptation strategies, and ultimately miss the opportunity to transform themselves into the integrated energy companies of the future.
Following this line of thought, climate-conscious investors could have more impact by keeping their shares in the carbon economy and engaging with companies on these issues. Of course, this option requires that large investors use their influence responsibly, and not all are doing this. For example, three of the world’s largest mutual funds – BlackRock, Vanguard, and Fidelity (who have assets under management equivalent to the GDPs of Japan, UK, and Russia respectively), have never voted in favour of shareholder resolutions on climate change. BlackRock and Vanguard, for example, own 11% of Exxon Mobil but voted against a shareholder resolution asking Exxon to disclose how its business model would fare in a low carbon scenario. Despite this, 38% of investors voted for Exxon to stress test its business model, a record number for resolutions of this sort. There may just be hope for the engaged investor argument.
For proponents of both divestment and engaged investment, a number of issues in the financial industry are of shared concern and can benefit from shared solutions:
1) Investors need to engage with policy that affects our energy future.
How many financial institutions commented on South Africa’s draft Integrated Resource Plan (IRP 2016)? The plan will dictate South Africa’s energy future, and therefore associated investments and markets, until 2050, and the draft was up for comment from November 2016- March 2017. At the workshop, there was broad agreement that a clear, low carbon energy policy would open up new investment opportunities that may not exist without this policy certainty. Yet there was also broad speculation that not many financial institutions are speaking up on what they expect from a policy.
2) Fund managers feel the short-term pressure, and this pressure comes from their clients.
It’s difficult for fund managers to integrate long-term considerations when they live under the threat of being sacked for underperforming one quarterly benchmark. If we want our fund managers to invest for the long term (whether through divestment or engagement), we need to give them the mandates to do this. This puts the responsibility for shifting the financial industry firmly on all of us.
3) There is a lack of supply of fossil free funds/low carbon funds/funds that integrate engagement on climate change. But there is also a lack of demand.
At least part of the reason for a lack of low carbon funds is that the asset management industry is unaware of investor preferences for such funds. What types of funds are people or institutions looking for? Are they willing to commit to long-term mandates? Are they looking to just avoid fossil fuel stocks or actively invest in the green economy? Again, this puts the responsibility for shifting the financial industry firmly on all of us.
4) We need better data on all Environmental, Social, and Governance related performance, including climate change.
For investors to create climate-resilient investment funds, we need reliable climate data from companies. But instead of pointing fingers at corporates, investors need to a) demand this data and b) signal to companies that it will actually be used to guide decision making.
In short: divestment and engagement are complementary strategies that may have more in common than we think. They both have a long way to go to achieve the type of scale and impact that would align us with what the science is telling us. They both need informed investors, innovative investment products, long-term horizons, reliable non-financial data, and low-carbon policy security. Let’s focus on getting those right.
Author: Lise Pretorius – Head of GCX Strategy
1 Kevin Anderson, Deputy Director of the Tyndall Centre for Climate Change Research, University of Manchester