Cracks show in investors’ voices on climate change

Investors around the globe are increasingly incorporating climate change into their risk analysis, however there are huge regional discrepancies with investors in Europe streaks ahead of their counterparts in the US and Australia.

The Global Investor Survey on Climate Change –the first global survey of investment practices co-ordinated by the three investor networks on climate change – the IIGCC, based in Europe, INCR based in North America, and the Australia/New Zealand IIGCC – found that three quarters of asset owners monitor the extent to which existing funds managers integrate climate change into their investment process.

The survey is conducted by Mercer on behalf of IIGCC, which represents European investors with a voice on climate change,and its sister networks in the US but (INCR) and in Australia/New Zealand (IGCC). This year’s survey is the third of its sort but it has been expanded from its previous European focus to a global one.

The report, based on survey responses from 44 asset owners and 46 asset managers with collective assets totalling more than $12 trillion, found public equity and real estate are the asset classes with the most integration, and private equity and infrastructure are catching up.

Some asset classes such as hedge funds still present challenges mostly because of the short-investment horizon.

As a result of stronger climate policy in the EU, there is greater integration of climate change across the portfolio from European investors.

These policy interventions have put a price on carbon via the EU Emissions Trading Scheme (ETS) and provided government support for low-carbon technologies, which has facilitated quantifying and integrating climate change considerations into investment analysis for European investors.

While Australian investors are increasingly focused on policy advocacy and addressing the physical impacts of climate change, they face policy challenges including the lack of a carbon pricing system and an uncertain regulatory environment. US investors, which are also faced with a lack of a coherent climate policy, are focused on engaging with companies, particularly with regard to improving disclosure.

The report said without strong climate change policy that provides transparency, longevity and clarity for investors, the revolution that is called for in transforming our energy systems is not possible.

Ole Sorensen, chair of the IIGCC and head of research and strategy at the Danish ATP, said investors almost unanimously point to policy as a key variant in the field.

“This is very much in line with what we’ve been saying through the three networks. Private finance plays a crucial role, but if you skip the concerns of climate and go to the business side, then the necessary policy frameworks are not in place,” he said.

“What investors need is sustainable, stable and credible policy frameworks to support the drive for low carbon investment that’s desperately needed.”

“We can point to the benefits of collaborating on this, and demonstrate the role and necessity for sustainable, credible framework to support the investment that’s desperately needed.”

He said the study confirmed that investors realise climate change is a serious risk, especially in the long term, and that they realise that they need to address those risks.

However while Sorensen said it was a welcome result that the study revealed an increasing awareness of climate change and the need to encompass it into investment risk management, he said it also revealed that fiduciary investors often struggle to quantify what they can and should do with respect to climate change.

“What does it really mean to integrate in practice on a day to day basis? As the report shows, many investors are struggling to develop methods and approaches and as many other things in life, this is work in progress” he said.

The research found that investors still struggle with how to translate currently available climate change related data and research into investment practices and decisions.

Some challenges identified include lack of data availability, uncertainties around climate change policy and the price of carbon, lack of confidence in the materiality of climate change among portfolio managers – partly due to the longer term nature of some climate change-related issues – but also a lack of experience in interpreting and analysing data on climate change impacts.

The survey also indicated a lot of time and money was spent on climate change but there was less action, with two thirds of asset manager and half of asset owners commissioning and supporting climate change research in 2010, and yet there is little implementation,

There are of course some exceptions, with a number of the collaborators on the recent Mercer “Climate Change Scenarios: Implications for strategic asset allocation” report, planning to use the research in different ways.

CalPERS, for example, will use the research to educate staff on the potential climate change impacts across the portfolio, and integrate the research within its investment processes in developing its strategic ESG-integration plan. Similarly the BT Pension Scheme will use the research to monitor the direction of climate policies and pricing of carbon models as well as quantify potential absolute loss scenarios. The analysis will feed into the scheme’s ESG risk factors which are integrated into their wider risk reporting.

And AustralianSuper intends to draw on the research to review its current asset allocation mix. Initially it will review and analyse the risks associated with changes to policy and physical impacts on their current assets.

According to the report Australian investors were most instructive in asking advisers to incorporate climate change in their advice. European investors appear to use consultants to a lesser extent when short listing managers, preferring to use proprietary information and systems. North American asset owners primarily use consultants for advice on peer comparison.

However across the board the study revealed there is little evidence that asset owners actively perform gap analysis or competency benchmarking between investment managers on climate change.

The report identified a number of areas for improvement in investor practices on integrating climate change into the investment process

  • Better depth and breadth of research on climate change impacts across all sectors and asset classes
  • Extended awareness and training across investment teams regarding the potential risks and opportunities arising from climate change
  • A clearer direction from asset owners for their asset managers and consultants to make climate-related risks and opportunities an integral part of their investment strategies and practices across all asset classes
  • Further development of tools such as gap analysis or competency benchmarking by asset owners to assess external investment managers on climate change integration
  • Extended analysis of climate change issues for investments in hedge funds, government bonds and commodities
  • Improved transparency and reporting around climate change activities in private equity investments
  • Greater level of consideration of climate change risks and opportunities at the strategic level, including specific, detailed analytical processes to identify deal-specific opportunities across asset classes.