Investing for sustainability impact is relevant for all investors and they should consider doing so where it can help meet their financial objectives, said David Rouch, partner at law firm Freshfields, Bruckhaus Deringer and lead author of ‘A Legal Framework for Impact’, the so-called Freshfields Report.

Published last year, it explores to what extent can and should institutional investors use their power and influence to generate a positive sustainability impact, exploring the role of the law in supporting this process.

Speaking at Sustainability in Practice at Cambridge University, Rouch told delegates to continue seeking to influence companies for impact as an effective way to achieve their financial goals.

“Continue doing what you are doing,” he said.

The report, launched by PRI, UNEP FI and The Generation Foundation, lays the foundation for the financial policy reforms needed to reorient investors, markets and economies towards net zero and inclusive, sustainable economic growth.

It follows on from the first Freshfields report of 2005 which concluded that investors are permitted, and arguably required, to integrate ESG factors into their analysis, and the subsequent UNEP FI, PRI and Generation Foundation program: Fiduciary Duty in the 21st Century, which determined that ESG factors must be considered for investors to meet their fiduciary duties. All these legal developments amount to building blocs to the infrastructure supporting sustainability and impact investment.

legal pinch points

The latest report found that across 11 jurisdictions, investors are able to pursue sustainable impacts (via, for example, stewardship, policy engagement or divestment strategies) if they are an effective way of achieving financial goals. Rouch said investors can pursue impact to achieve their financial goals that are put at risk if those impact are ignored. In this way, investors are instrumentally seeking sustainability goals to achieve broader financial goals.

The study has revealed various legal pinch points however. For example, how will pension funds assess if they are having any influence on the third party?

It flagged potential issues around a pension fund’s ability to divest and the importance of investors and asset managers remaining unbiased, continuing to represent all their investor or beneficiary cohort who might care about different impacts.

“Investors have to be impartial,” he said.

Pension funds will also have to factor in cost, balancing the cost of engaging with the impact on the fund. It makes collective action an important decision, he said.

Evidence is a crucial element of the legal process. If investors are ever challenged in court, they may have to provide evidence that the benefit outweighed the cost. He said in such a circumstance, the court will always look at the process behind the decision making; charting how investors take responsible decisions based on evidence and properly consider the risk of sustainability and what the fund can realistically do about it.

“A court will be influenced by good industry practice – but it is virgin territory.”

Collective action

Rouch also noted how successful sustainability and impact investment requires collective action, however this can come with legal challenges.

For instance, one of the challenges with collective action is that the results are enjoyed collectively – and success depends on collective action. It could leave investors struggling to define what contribution they have made to the collective outcome – or what benefit they derived from the collective action.

He said that if by pursuing sustainable impact investors can protect the value of their fund, then logically they should be doing it.

He concluded that one of the biggest challenges is getting people to understand the legal arguments, noting that US investors are particularly anxious around these issues. He said the investment community needed to embed this into their practice outside the legal and consultancy world which is more familiar and comfortable with these concepts.

The €268 billion Dutch pension provider PGGM is leading its global peers when it comes to shaping 3D portfolios based around risk, return and impact.

Speaking at Sustainability in Practice, Piet Klop, head of responsible investment at PGGM, charted the investor’s journey from building an actively managed €2.5 billion impact equities portfolio five years ago to targeting nearly 20 per cent of the entire portfolio contributing to the SDGs today.

Klop said steering capital to positive impact requires measuring real-world impacts wrought by investment decisions, and he said investors also need a clear mandate to invest for impact. PFZW, the pension fund for Dutch healthcare workers, which is PGGM’s biggest client, specifically aims for climate and healthcare solutions at market-rate return expectations.

“Our board of trustees wants more than alignment with the SDGs, they want to make a difference,” Klop said.

He added that reputations matter, and trustees are increasingly aware that also means the avoidance of negative impacts.

real world impact

Klop said that capturing real world impacts requires investors look at what companies are actually doing to meet the SDGs – and not just their conduct.

“What problem are they solving?” he asked.

Investors must understand how companies make their money, from what solutions, and how these translate into real world outcomes .

“Few companies report their real-world impact, how much water is saved; how much carbon is avoided, or healthcare provided thanks to their products and services.”

He noted that some companies score well in a traditional ESG rankings (the ‘how’) but when investors look at  products and services through the problem-solving lens (the ‘what’) the scores change. Companies like Unilever and BAT may have sector-leading ESG scores, but what SDGs do their products solve?

semantics: impact v outcomes

Measuring impact is hard work; data constraints remain a challenge because of limited company reporting on SDGs and climate impacts.

It also requires conviction: Klop said that clearly pursuing real-world impact incurs extra effort even though the difference on the SDGs will be marginal . He also cautions that, technically, the word ‘impact’ requires knowing the context in which solutions are put to work. Better perhaps then to talk about ‘outcomes’.

He suggested investors engage companies to improve on outcomes that they may have approximated using revenue-to-outcome models first.

Klop explained that investing with impact (outcomes) requires quantifying impact in a way beneficiaries readily understand.

He said that although beneficiaries rarely dig down to the finer detail of impact strategies, it is easy to overclaim impact and therefore lose trust.

“If you overclaim, it will only be a matter of time until you get caught out  ” he said.

He also noted the importance of trying to find impact investments close to home in beneficiaries’ own countries.

“Even so, beneficiaries take comfort from the knowledge that  their pension savings are delivering  a global benefit.”

 

 

 

Net zero objectives are not enough, and the world needs to do much more to create a manageable future, said Professor Sir David King, founder and chair, Centre for Climate Repair at Cambridge University and UK government chief scientific advisor from 2000 to 2007.

King said ongoing extreme weather throughout the northern hemisphere is no coincidence, and warned that the world’s chances of staying below 1.5 degrees of warming “don’t look very good.”

Temperature rises reveal that the Arctic is heating up at a faster rate than the rest of the planet, creating a tipping point whereby the temperature rise causes the ice covering the Artic to melt during the polar summer. As the Artic soaks up sunshine and warms, so the air above it warms the surrounding land masses, including Greenland’s permafrost.

Jet stream impact

King said this in turn impacts the jet steam, causing it to meander lower. The jet stream keeps cold air in the North Pole and warm air out. However, the cold region of the planet is no longer centred around the North Pole, which is now above zero for the summer months as warm air supplants the cold air, pushing the jet stream into distortion.

“Warm air is sucked up as cold air is pushed down, causing dramatic changes in the global weather system.”

He said that if Greenland’s ice melts it will cause profound rises in sea level. As permafrost melts it will release methane, a much more toxic greenhouse gas than carbon dioxide.

“This is potentially a disaster,” he said, outlining traumatic temperature rises. “I am not going to say if, and when, this will happen, but it’s not a risk you want to take.”

He noted evidence of explosive releases of methane already happening in Russia where it is bubbling up from under the permafrost. Rising sea levels would impact low lying sea level countries like Vietnam with devastating impacts on global food production. At current levels of warming, he said 90 per cent of Vietnam’s land mass will be under water by 2050 at points in the year.

Borrowing from the future

King said deep and rapid emission reduction needs to be fair and orderly. He said continuing to use fossil fuels equates to borrowing from the future, and noted the growing distrust between the developing and developed world because promises made by the developed world have not been enough.

“The country that has to take a lot of the blame is the US,” he said.

He said decision making and progress in the US is blocked by the fossil fuel lobby.

“They have the Senate and Congress in their pocket.”

He noted how the lobbying system went against democratic elections and said that China has done much more to switch from fossil fuels than other countries, developing nuclear and wind power at a rapid rate.

Technology’s role in resolving the crisis

King suggested that technology could help resolve the crisis. Technologies focused on removing excess greenhouse gases in the atmosphere are developing. Elsewhere, he cited progress around marine biomass regeneration by recreating whale poo on the surface of the ocean around which green matter or phytoplankton blooms forms. It involves learning what the faeces contain; artificially lying it on the ocean and using it to capture tonnes of greenhouse gas as well as feed billions of fish.

Aping natural processes is at the heart of another approach. He also told delegates how scientists are exploring how to refreeze the Arctic in a process the imitates natural processes to brighten marine clouds. Using high-pressure sprays mounted on boats, droplets of salt water would be fired straight into the air. When these evaporate, the salt crystals left behind would rise on natural convection currents and help to form clouds overhead, reflecting sunlight away from the ice and allowing it to form a thicker layer of protection for the summer months.

“If we can demonstrate feasibility, money will flow,” he concluded.

 

 

 

The giant Canadian investor, CPP Investments, has drawn up a proposal for projecting the capacity of companies to abate greenhouse gas emissions. The framework offers a standardised template to measure the extent to which organisations can remove or abate their GHG emissions that is applicable across industries and geographies, with common assumptions.

The data from the template will help corporate boards and executives better understand the least and most polluting elements of their business, and steer investor capital to industries with lower emissions, said Richard Manley, managing director, head of sustainable investing at CPP.

“If you want to build a business case, reframe the debate,” said Manley. “We need to allocate capital to companies that can support the transition.”

He said the paper was born from the fact many companies have set ambitious 2050 decarbonisation plans that are not grounded in reality.

“Companies are not providing any insight into how they are going to achieve net zero,” he said, echoing a theme of the conference.

assessment Steps

The first step proposes companies create a clear, standardised assessment of their emissions across Scopes 1, 2 and 3. Next they conduct an Abatement Capacity Assessment (ACA) to project their capacity to abate them, and finally report their Projected Abatement Capacity (PAC).

When companies assess their current emissions, they can develop an estimate of what portion they can abate using currently available, proven technologies; efficiencies or through greening their power consumption. For example, a cement plant may be able to eliminate all its emissions associated with its electricity consumption by using renewables, but only 10 per cent of emissions from its kilns based on technologies that are economic today.

However, the framework suggests companies don’t factor in cheaper technology costs and new regulation in the future. They should only adjust future projections of abatement capacity in accordance with two standardised carbon price assumptions that exceed current levels.

“We have assumed there is no change in regulation and have not baked in consumer behaviour or dramatic reduction in costs because of technology,” he said.

If companies can’t effectively abate emissions in parts of their business the framework suggests they close or cease the business activity; further technological development or acknowledge that the emissions will likely require offsets.

Investor guide

The framework will lead to new capital allocations: a company with high abatement capacity relative to its industry, will likely have access to more and cheaper capital. Or, if the information provided by these projections reveals that multiple industries are confronting similar regulatory or technical hurdles to lower a specific source of emissions, this framework can help guide policy decisions and prioritise investment in innovation.

Manley noted that the framework isn’t something new, but said effective abatement plans were crucial to test companies net zero commitments. These commitments are changing security prices, but if they prove empty it will lead to the possibility of fraud and market abuse.

“Regulators need to be aware and prepared for false climate claims,” he said. “Issuers need to corroborate their long term guidance with projected abatement capacity.”

Board strength

Away from the framework, Manley highlighted the importance of strong corporate boards.

“We need boards to ensure executives have identified all climate risk and opportunities and integrated this into their reporting,” he said. He added that CPP is prepared to withhold support for re-appointed directors if their climate strategy lacks. It is a process that has spurred some companies to commit to TCFD filing processes lest they lose the investor’s support for their directors, he said.

He said that companies with a boardroom culture to proactively mitigate and capture the business risks and opportunity from climate change will outperform. He also noted that investors have more control in private markets. In public markets, investors count on boards to provide effective oversight and counsel executives to integrate sustainability.

Manley concluded that meeting net zero commitments poses a number of challenges for CPP Investments, and for many investors. The fund is growing fast making reducing emissions more difficult in general. At a macro level, several of the world’s largest economies are not planning to be net zero by 2050 so deploying capital in those economies
will result in portfolio emissions beyond this date unless those economies accelerate their NDC’s

 

A new paper outlines how investors can align their portfolio to science-based carbon budgets consistent with 1.5 degree of warming. Speaking at Sustainability in Practice at Cambridge University, Frederic Samama, head of strategic development, S&P Global Sustainable1 and co-author of Net Zero Carbon Portfolio Alignment, argued that the methodology has an 83 per cent probability and only a negligible tracking error in an approach that works for both active and passive investment.

Samama wrote the paper with Imperial College’s Marcin Kacperczyk and Columbia University’s Patrick Bolton. The methodology also establishes an exit roadmap for carbon-intensive corporates, generating a form of competition to decarbonise within each sector, he argued.

Samama said the research paper was born from the realisation that trillions of dollars is now seeking to align with net zero commitments – around $130 trillion, of which a growing proportion is now backed by legally binding commitments from investors in Europe, Japan and Canada. If a sufficient mass of investors aligned their portfolios to a net-zero target, then companies will be more incentivised to follow suit, he said.

Carbon budgets

The methodology assigns portfolio managers an annual carbon budget compliant with a 1.5 degree objective. From this they can reshuffle their portfolio within these constraints.

“The sum of the carbon budget mirrors the one prevailing at a planet level,” he said. “What is true for the planet, should be true for all forms of financing.”

Portfolio managers’ carbon budgets will be adjusted annually, and he said the carbon budget would be expressed on a level with emissions rather than intensity.

forward looking assessment

He said the process would enable investors to see what their portfolio will look like years hence – and to see which companies they will have to exit in the future.

“They can build a world map of carbon intensive sectors,” he said.

This knowledge will incentivise companies to accelerate reducing their carbon footprint. In effect, it will put companies  in a competitive race to decarbonize to maintain their place in the portfolio.

“It will create a form of competition to accelerate the transition.”

He said if corporates fall out of portfolios, they can come back in once they get back on track towards net zero and envisages investors shaping a process of active engagement that creates competition in the sector. Samama also suggested central banks use the carbon budget approach for their own collateral management. It would be a way for them to reduce their climate risks and at the same time spread net-zero commitments within the financial sector.

Still, Samama flagged challenges in the proposal. Carbon budgets will shrink (particularly if warming speeds up) and change over time.

Some delegates raised concerns that the methodology would encourage investors to drop high emitters regardless of these companies’ emission pathway. Others said it would help investors own portfolio targets, but not help reduce wider emissions.

 

 

Aligning investment with the UN’s SDGs brings challenges, said investors gathered at Sustainability in Practice at Cambridge University. For instance, it is easier to align pension funds fiduciary duty to climate goals rather than some of the targets of the 17 SDGs. Elsewhere, because SDGs often overlap with ESG integration it makes it hard to see the difference between the two frameworks.

Investors explained how it is difficult to score managers on SDG alignment, raising the risk of SDG washing; data is more readily available in listed equity markets, yet investors could have a more genuine impact in private and credit markets. In another challenge, investing for impact and meeting the SDGs requires more capital flowing to the global south and frontier markets, but most of the capital going into the SDGs flows into listed companies in the global north.

Despite the challenges, many investors seek to align their investment with the SDGs. The SDGs provide the most compelling blueprint for those seeking to achieve real world sustainable outcomes; they are truly global and all encompassing, said Jan Anton van Zanten, SDG strategist at asset manager Robeco which began developing a bespoke SDG framework in 2017. The framework quantifies and scores the impact of the products and services of the companies in its portfolio. “With these scores we can invest in those companies that invest in solutions and avoid those that score negatively,” he said.

Netherlands-based asset manager APG has also forged ahead, creating tools to support SDG investment. Together with PGGM it has developed a sustainable development investment (SDI) Asset Owner Investor Platform  driven by AI technology. It sifts through reams of structured and unstructured data to gauge the extent to which companies’ products and activities meet the SDGs. “The goal was to set a standard with like-minded parties to drive capital to the SDGs,” said panellist Claudia Kruse, managing director global responsible investment and governance, APG. “Existing data sources didn’t enable this; we needed a dedicated data source.”

Kruse said the platform has a growing subscriber base and is evolving to encompass data detailing companies positive and negative contributions to the SDGs as well as incorporating a forward perspective. She said the tool is a way of engaging with companies. Importantly, it also analyses companies in the public and private markets, enabling investors to steer capital into SDG outcomes in private markets which is more difficult. APG has recently invested $750 million in an SDG-focused private credit fund. “It’s very important we can steer capital into this space,” she said. She also noted the platform allows a nuanced approach – by focusing on the core business, product or service of a company rather than its conduct.

A point expanded upon by van Zanten, who explained that Robeco’s data is structured around some 200 KPIs based on publicly available data and revenue streams reported by companies. Reflecting on the difference between SDG and ESG scores, he noted that SDG scores are better at integrating impact. Research shows that some companies with poor SDG scores can secure good ESG scores. ESG ratings can also struggle to reflect positive impacts: ESG scores reflect a company’s financial risk from ESG issues while SDG scores incorporate impact in a double materiality. “We look at this double materiality,” he said.