GLOBE-Net (October 16, 2009) What is the role of investors in creating a more sustainable economy? A survey of fund managers just published by the UK’s Fair Pensions campaign provides challenging reading for anyone who believes that a green future will emerge simply through market forces operating in the investment community.

 

The market purist argument is that the system should regulate itself; because if climate change really is a material risk for businesses, it should be built into the way companies are valued. Companies whose factories or plantations could be destroyed by climate change-induced floods or droughts should be less attractive investments than ones making wind turbines or hybrid car engines.

 

Of course, this approach doesn’t work because it depends on investors taking an unrealistically long-term view. Right now, the impacts of climate change seem distant and uncertain - and coal or gas are much more reliable sources of value and dividends than unsubsidized renewables. This is one reason why Lord Stern proclaimed climate change "the greatest and widest ranging market failure ever seen". And it’s why governments are stepping in to redraw the boundaries of the market and direct it to more sustainable ends - what Tomorrow’s Company calls creating ’frameworks’.

 

One of the solutions to the financial market failure is to create a carbon market, capping the total volume of emissions. This has happened in the EU and should happen under the Waxman-Markey proposals in the US. The idea is that capping emissions and forcing high polluters to buy allowances from better performers incentivises energy efficiency and green investments. Theory and practice diverge here too though. As a result of generous caps, the recession and falling oil prices, the EU carbon price is now languishing around €14 when a much higher cost is needed to drive serious change. Alongside trading are simpler measures - mandates such as the UK’s Renewables Obligation; regulations such as Canada’s tailpipe emissions standards; and direct public stimuli such as President Obama’s green jobs package.

 

All this gives investors more calculations to do - not only covering physical risks but regulatory ones. And the latter are growing. The approaching Copenhagen climate summit may trigger a process in which such measures come thick and fast - or not - depending on the level of political willpower. Recent years have seen increasing efforts to evaluate companies’ carbon exposure - physical and regulatory - notably the Carbon Disclosure Carbon Disclosure Project through which over 2,000 organizations disclose climate change related data at the behest of 475 institutional investors.

 

Investors and their fund managers of course cover a huge range, from small shareholders to giant pension funds; from those with burning concerns for the environment to those whose choices are purely based on algorithms. However, within the vast investor universe, the ’responsible investment’ sector is expanding. Signatories to the UN-backed Principles for Responsible Investment initiative have soared in three years from 50 to 500 and now represent over $18 trillion of assets under management. Of course this doesn’t mean they are all selling oil and piling into wave power. There are limits to what fund managers can do, especially when many of their investor clients owe a fiduciary duty to millions whose pensions depend on their decisions.

 

Given such constraints, some investors are remarkably active in encouraging companies to chart a sustainable course. Penny Shepherd, Chief Executive of the UK Sustainable Investment and Finance Association, said: "Investors exert an influence in various ways. They can integrate environmental factors into their overall valuations. They can engage directly with companies. And they can seek to influence policy. Public policy engagement is now seen as an integral part of responsible investment."

 

Some have taken radical action to put pressure on companies. The Co-operative Financial Services (CFS), for example, has joined with the environmental campaign group WWF-UK to demand legislation requiring oil, gas and power companies to disclose future carbon liabilities. CFS is also funding the Beaver Lake Cree Nation’s legal challenge to oil sand production in Alberta. Others - such as the UK’s Environment Agency in a report compiled with Innovest - have sought to change the investment culture by highlighting evidence that good environmental governance helps deliver better financial performance.

 

However what the Fair Pensions survey makes clear is that there are still big obstacles to putting climate change at the heart of investment choices. Fewer than half the fund managers asked to participate did so. Of those who replied, two thirds said the low carbon price was the biggest barrier to building climate risks into their analysis and over half pointed to lack of demand from investor clients for more attention to be paid to global warming.

 

Both of these issues can be addressed by stepping up the scale and pace of political action, which is why many responsible investors are now focusing advocacy on politicians. The approach reached unprecedented proportions this year in a co-ordinated call for action by 181 investors managing more than $13 trillion, convened in New York by groups including the US Investor Network on Climate Risk and the European Institutional Investors Group on Climate Change. The investors are demanding what has become widely seen as the necessary package of measures to avert dangerous climate change - a cut of 50-85% in global emissions by 2050; a cut of 25-40% in developed country emissions by 2020; and the policies and mechanisms needed to make these cuts happen.

 

The Fair Pensions report highlights the limitations on what investors can do, but the New York statement shows the power of what they can say - especially en masse. The ball is now very much in ministers’ court. The strength of the frameworks they construct at Copenhagen and beyond will be the real determinant of whether the capital markets finally start to believe that green is good.

 

David Vigar authored Tomorrow’s Company’s report on global warming and business, Tomorrow’s Climate: Tomorrow’s Climate: Beyond Peak Carbon. It is available at forceforgood.com here. To find out more about Tomorrow’s Company please visit their corporate site, http://www.tomorrowscompany.com/, or their interactive web platform, http://www.forceforgood.com/. David can be reached at 077 3410 2708 david@davidvigar.co.uk