Climate lobbying by powerful trade associations is delaying and diluting the impact of net zero policies and running counter to the effort policy makers, companies and investors are making to reduce their emissions, says Clare Richards, senior engagement manager in the investments team at the £4.3 billion Church of England Pensions Board where she has spearheaded CEPB’s push and ambition to limit climate lobbying since 2018. “The CEBP continues to invest resources to try and highlight the issue and shine a light to stamp out negative lobbying.”

Most recently, CEPB, Swedish buffer fund AP7 and BNP Paribas Asset Management have launched the Global Standard on Responsible Climate Lobbying (RCLS). Working with Chronos Sustainability, InfluenceMap, the civil society organization that tracks lobbying activity, and the London School of Economics, the Standard provides a rigorous framework to assess whether a company’s lobbying is governed and delivered in line with attainment of the Paris Agreement’s goals.

Other milestones in raising awareness include the inclusion of climate lobbying engagement within the Climate Action 100+ benchmark to ensure corporate lobbying is consistent with the goals of the Paris Agreement.

Scale of problem

Companies can have “hundreds” of trade association memberships with little sight or governance around how that membership feeds into those association’s influence on policy, says Richards. Moreover, many companies also have legacy memberships that no longer reflect their corporate climate policy. “In the last few years, we’ve seen notable actions from companies reviewing their trade association relationships because they no longer benefit from them. Companies have also decided to pull the plug on their membership because negative lobbying brings reputational risk.”

Rather than negative lobbying, trade associations should increase their responsible lobbying and use their significant influence as a force for good. “Lobbying is a legitimate activity that can help strengthen policy and test its rigour.”

Companies should urge their trade groups to use their resources and breadth and depth of membership to do more to publicise corporate positions on policy and efforts to achieve them. “Companies should interrogate trade organizations and find out what their membership brings. Otherwise, they are silent partners pushing against the type of policies that would enable the transition,” says Richards.

Proxy season

The up-and-coming proxy season will provide another chance to press companies on their relationships with trade organizations lobbying on their behalf.  Its a proven forum for change says Richards, citing the role of investor pressure helping push BHP to evolve its membership with the Minerals Council of Australia. Elsewhere she points to investors successfully pushing  Shell to annually disclose its membership of trade associations. In the past year, over a dozen other companies have published their trade association memberships, she says.

This season car maker VW is in investor’s sights having rejected calls for climate lobbying disclosure. In the next few days together with other investors, CEPB will pre-declare its vote on the discharge of the management and supervisory board at the company on the basis that is is failing to provide adequate oversight of company management on this issue.

VW has fallen behind auto peers Mercedes and BMW which publish their trade association memberships, says Richards. “For more than three years VW has resisted and refused reasonable requests to demonstrate the alignment of their lobbying. The company is spending money on lawyers to resist shareholder requests – it’s a real headscratcher.”

Indirect lobbying

The issue also spans investee companies direct and indirect association with lobbyists. Trade associations direct impact on policy making is clear, but they also carry influence indirectly, particularly via the media. “Media is a vehicle for the message of the lobbyists,” says Richards, adding that negative media coverage can create an environment where climate policy either flourishes or flounders. Its an issue in Australia’s media, recently flagged by the IPCC in its Sixth Assessment Report while in the UK, fracking has come back into the media where it is often reported as a suitable alternative energy source in response the energy crisis. But energy from fracking can be sold to the highest bidder and won’t necessarily solve the UK’s energy crisis, says Richards.  ““There is a growing move in the UK to push against Net Zero targets by vested interests that view them as an impediment to their business agenda,” she concludes.

As private equity returns continue to outpace all other asset classes, so investors have steadily increased their exposure in the hunt for performance. But the way asset owners have traditionally accessed private equity will no longer reap the same return, and higher interest rates and lower growth ahead are set to impact the valuations of many private equity and venture portfolios counting on high multiples and growth expectations, warns Barry Kenneth, CIO of the United Kingdom’s £38 billion Pension Protection Fund (PPF) that has around £1.6 billion invested in private equity across direct and co-investments, and funds.

Investors going into large cap private equity today will struggle to get higher exit multiples than they get entry multiples, he says. “The traditional private equity model where you buy at an entry level multiple, optimize the balance sheet through leverage to improve returns and then sell at higher multiples – I think that game’s over,” says Kenneth.

He argues that private equity investors need to be more selective how they choose their managers. Strategy at the PPF is increasingly focused on finding GPs staffed by teams that can transform companies though operational improvements, adding on different businesses and being more thoughtful about value rather than just playing on structural bias and the multiples game. The PPF is exploring opportunities in Europe where investors can pick up smaller companies, which often struggle to access capital through public markets, at low multiples. “Private equity in the mid European market is doing well.”

Tougher times ahead

Like many CIOs, Kenneth believes private equity’s challenge is part and parcel of a much tougher investment climate ahead. A sweeping inflation and interest rate hedging strategy shelters the PPF’s liabilities but a new macro environment, accelerated by Russia’s invasion of Ukraine stoking inflation, will hasten central bank rate hikes and hit growth assets – currently accounting for around 60 per cent of the PPF’s portfolio and which returned 17.6 per cent last year. “I started in financial services in ’95 and this is the first time I have been in a sustained UK hiking cycle,” he says.

The PPF is not de-risking – but it is on the defensive. Higher interest rates in the long-term will have a negative impact on equities and while some businesses with an inflation linkage will benefit, others will suffer. If the supply chain crisis continues and globalisation trends that have kept inflation low for decades unwind, higher prices will become engrained. Companies with real-time supply chains dependent on imports from China will struggle – while many are still bogged down by Brexit red tape.

Most sectors will struggle with high interest rates and high inflation, but Kenneth urges index investors to look under the bonnet to see which stocks will be most affected. Cyclical companies and growth equity, particularly exposed to high interest rates and low growth are the ones to watch,  he says. “Any asset classes impacted by higher nominal/real yields are worth worrying about, as are sectors like tech that generally have high valuation multiples and are most susceptible to a fall.” Elsewhere, long-term government bonds are now challenged by interest rates going up and the value of the asset falling.

Indicative of a new caution about how best to access certain asset classes, Kenneth favours infrastructure investments that aren’t linked to cashflows. The fund has invested in the United Kingdom’s Thames Link franchise, (a north-south rail corridor across London) yet the return is not based on traffic volumes but on the availability of the asset instead. “We are not doing opportunistic stuff,” he says. Similarly, toll roads where returns are based on traffic volumes are out and forestry, where the PPF now has a £1 billion portfolio that could benefit with the emergence of carbon credit trading backed by real assets, is in.

ESG

It reflects another theme pushing centre stage in today’s challenging environment. The PPF has integrated ESG since Kenneth joined nearly nine years ago, but now a number of key ESG strategies are on the agenda focused on private markets.

The PPF is improving its ESG data. Working with Dutch consultancy ORTEC, it is gathering carbon emissions data across every asset class in the portfolio with a particular emphasis on private markets. The depth of the process is most evident in the PPFs fund of funds allocation in private equity which comprises thousands of different companies.

“We are assigning a temperature score to every company we invest in so we can see how the portfolio aligns to Net Zero and Paris.” Only when the PPF can accurately measure this in a defined process will it set targets, says Kenneth. “Only by doing this groundwork can we figure out how to get to Net Zero without greenwashing,” he says. “There is no standardized process so in a complex portfolio made up of public and private investments where diversification is important this is how we have chosen to do it.”

According to recent data in the annual report, the carbon footprint in the PPF’s listed equities has fallen 16 per cent but it has increased slightly in the fund’s credit holdings, attributed to the inclusion of corporate bonds in the emerging market debt portfolio which tend to have a higher carbon footprint.

Elsewhere expectations of managers have risen. New managers are scored and must commit to minimum ESG standards enshrined in legal documents. The PPF’s internal team engage with managers on an ongoing basis and Kenneth estimates around a quarter of new managers have signed up with the PRI because of this pressure. “We are involved with moving managers to these platforms,” he says. “In private markets we are more dependent on the managers to push the companies to integrate ESG, but we have significant engagement with these managers to execute our beliefs/strategy here. If a company is listed, it is more likely they will report on ESG related issues, as they are more transparent to a wider investor base.”

The fund delegates stewardship to EOS at Federated Hermes but has the ability to overwrite and apply stronger stewardship if needed. “In our segregated mandates, we have an overwrite process whereby we agree standards on stewardship practices with EOS (at Federated Hermes) but if want to be able to overwrite and be stronger on some aspects, we can,” Kenneth concludes.

The increased adoption of RI principles was clearly visible in this second iteration of the Global Pension Transparency Benchmark. Scores within the RI factor saw the largest year-over-year increase with the average score across all funds increasing by 6.9, so where were these increased scores most evident?

Responsible investing (RI) is increasingly becoming a focus for many large funds across the world. Even funds that previous eschewed RI on the basis that their primary purpose was to deliver returns are coming round to the idea that RI is too important to their stakeholders to ignore.

For pension funds, concerned stakeholders are no longer limited to environmental activists and NGO’s , but also include regulators, plan members and their own employees. Results of early adopters of RI principles mean it is now becoming apparent that you can both focus on RI while still delivering value in the traditional sense – superior investment returns.

As more and more leading funds integrate ESG and RI principles and disclose such endeavors, stakeholders of other funds are asking why their funds don’t. This is forcing those lagging funds to catch-up. Evidence of the increased adoption of RI principles was clearly visible in this second iteration of the Global Pension Transparency Benchmark (GPTB).

Scores within the RI factor saw the largest year-over-year increase with the average score across all funds increasing by 6.9. Where were these increased scores most evident?
• Funds that scored below median in last year’s review saw slightly larger increases than funds in the upper half of last year’s rankings (an increase of 7.1 vs. 6.7).
• Within countries, the lowest scoring funds saw larger increases than average. Across all countries, the lowest scoring funds within countries improved their scores on average by 7.6 points.
• The increase in scores among the lowest scoring funds within countries was even more prevalent in countries that scored in the top half with an average increase of 9.1. Note that these funds didn’t all score poorly. Funds from top scoring countries (eg Denmark, Canada, the Netherlands) were often scored above average, even in last year’s review.

These results suggest that competition, peer pressure and comparisons between funds is driving change. Funds appear much more inclined to increase disclosures when they observe peer funds doing the same.

How are funds improving their disclosures?  Here are two examples that are informative and accessible to all levels of stakeholders.

Example 1: Impact investing case studies

One way funds can increase their transparency around RI, is by using case studies to demonstrate how their impact investing initiative. Eskom PPF from South Africa included a case study on its investment in sustainable housing in its annual report. This shows stakeholders clear examples of responsible investing in action and helps connect a fund’s words to their actions in a relatable manner.

There are similar impact investing disclosures at other funds as well. Many funds are already engaged in impact investing in similar ventures, so it is just one extra step to disclose and report on these sustainable investments.

Example 2: Corporate Stewardship Case Studies

Another way for funds to increase their transparency and reporting on RI is by reporting on their corporate stewardship activities.

For many funds, this involves disclosing an active ownership policy that describes how the fund should engage with portfolio companies. To increase transparency further, some funds also provide reporting on how they engaged with companies throughout the year, including their voting records. This is often done in a summary format, although some funds provide extensive details of their voting records.  These disclosures are useful, but often too technical to be accessible to all users.

Universities Superannuation Scheme (USS) from the UK published their UK voting policy in 2021, as well as a 2021 stewardship report. Its UK voting policy outlines how the fund should exercise its votes on various topics such as director elections, remuneration policies, and auditor elections. The USS stewardship report outlines its engagement activities throughout the year, including case studies on individual companies, as well as a section on significant votes. This allows stakeholders to understand the fund’s stewardship activities on a more tangible level. These two documents were the main factor in the increase in USS’s RI score this year.

The improvement in responsible investing reporting is encouraging to see and shows the need for leaders in this space. A pension fund that becomes a leader among its peers in the RI space is not only increasing long-term value for members, but is also driving positive change in the industry, and therefore increasing long-term value for members of pension funds everywhere.

Funds around the world do a good job of disclosing governance frameworks and policies related to financial and investment risks, as revealed in the Global Pension Transparency Benchmark. However, what is best practice for communicating governance around addressing large, one-off events such as the impact of COVID or war? Mike Reid says outlining governance approval frameworks and processes is a step in the right direction.

“Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know.” Donald Rumsfeld

As this article was being written in March 2022, it was more apparent than ever that successfully navigating risks is key to the success of investment management organisations both in the near and long term. For the second time in two years, funds across the globe are facing a major upheaval that has the potential to greatly impact financial markets. Stakeholders are right to be concerned and need to be informed about how funds are navigating through this tricky environment. Are global funds being transparent about how the view and manage risk?

Risk management frameworks need to adequately address both the more predictable risks that funds face continuously in their day-to-day as well as larger scale, less predicable “Black Swan” events. The exhibit below shows the standard deviation of net value added observed among CEM’s clients from 1992 through 2020. A higher standard deviation represents a higher level of idiosyncratic risk, which all else being equal is a drag on long-term returns.

This clearly illustrates that idiosyncratic risk is heightened during large, global events. Peaks are easily observed both for the dot-com bust and the global financial crisis. Idiosyncratic risk in 2020 was also elevated from the levels observed after the financial crisis. In fact, one can even observe an increase in 2013 due to the “taper tantrum”. This demonstrates the value of an effective risk management framework is heightened in times of extreme stress.

First the good news. The vast majority of funds do disclose their views on risk, both financial and other risk, and related risk policies and governance.

The Global Pension Transparency Benchmark, this year’s review of 75 of the world’s largest funds revealed that:
– 96 per cent of funds reviewed disclose their governance framework and policies related to financial and investment risks, and 81 per cent of funds provide at least some quantifiable measures around these risks.
– Although not as universal, disclosures of a fund’s governance framework and policies related to non-financial risks were observed at 81 per cent of the funds reviewed.

However two issues were identified:
– the quality of the disclosures varied considerably among funds; and
– risk disclosures invariably focus on common, easily definable risks of the sort that funds encounter continuously as part of the day-to-day management of the fund.

What is almost entirely lacking are defined plans or processes to deal with “Black Swan” events.

Before addressing the latter point, let’s first look at some of the better examples of risk disclosures that were observed.

South Africa’s Sentinel Retirement Fund provided very comprehensive risk disclosures. Not only was their list of risks exhaustive, including 21 risks, covering most elements of their business, they did so in tabular format with the relevant risk control framework expressed in plain language beside each risk.

Source: Sentinel Retirement Fund 2020 Annual Integrate Report pg. 73-77

In the United Kingdom, pension schemes are required to maintain a risk register. These risk registers are meant to document the full range of risks a pension scheme faces and include a judgement of the relative risk posed by each risk.

Universities Superannuation Scheme (USS) produces an annual Risk Management Supplement which summarises their views on risk. In this document:
– USS outlines its risk taxonomy and the risks it has  identified, by type, in an easy to understand exhibit.

-USS then explains that it translates these risks into 88 individual appetite statements where it outlines its views on the level of risk it is willing to assume for each risk statement using a five category scale which ranges from “averse” to “hungry” which are clearly described. These assessments are summarised graphically using the risk taxonomy.

The exhibits shown above are just two examples, the supplement as a whole provided a 360 degree view of their risk management program, presented in an easily accessible manner. While both examples given above provide valuable information to stakeholders, they focus almost entirely on risks that are encountered in the regular course of business. It is important however for stakeholders to know how a fund would react during a large-scale world or market event.

How can a fund best communicate to stakeholders on its governance for large one-off events when these events, by definition, are unpredictable? One way to address this issue is by clearly outlining governance approval frameworks and processes. How quickly can a fund respond to external events? Who has authority to make decisions, and what are the relevant thresholds? Is there an emergency framework in place?

If a fund must convene its investment committee for approval, approvals may come too late. Most funds will have some sort of operational business continuity plan, stakeholders would benefit from knowing how investment decision making will occur during emergency times.

One example of how this could be addressed was observed in the disclosures of Swiss fund BVK, the manager of funds underlying pension for employees in the canton of Zurich. This exhibit, from BVK’s investment policy presents the approval processes for many major investment functions. Additionally, it shows how these processes vary based on certain investment limits when applicable. This information can allow stakeholders to assess how the fund’s governance structure would allow the fund to respond in times of market stress.

Source: BVK Zurich Investment Policy pg. 21-22

Unfortunately disclosures such as this were extremely rare.

We would like to see more funds disclose this information. An added bonus would be if they discussed how the process may change in times of stress, perhaps building on real world experiences from both the global financial crisis and the market crash at the beginning of the pandemic.

The transparency of pension fund disclosures has improved in the past year across the 15 countries and 75 pension funds measured in the Global Pension Transparency Benchmark, a collaboration between Top1000funds.com and CEM Benchmarking.

The GPTB, now in its second year, examines the transparency of disclosures across four drivers of value, namely cost, governance, performance and responsible investing.

In this second year, governance disclosures showed the biggest improvement with the average score of 65 out of 100 marking an improvement of seven from last year’s average score of 58. Governance was the best overall average score of the four factors.

The Canadian funds continue to excel in this category which CEM Benchmarking’s Michael Reid says is consistent with their reputation for excellent governance.
In last year’s review CEM noted that governance scores were most closely correlated with the overall score: good governance produces positive results and creates greater incentive (or perhaps less disincentive) to be transparent with stakeholders.

This year responsible investing disclosures showed an equal correlation with governance. Good governance allows funds to move beyond simply managing assets and towards addressing wider environmental and social issues.

The overall average performance score was 62, a slight decline from 64 last year and the second highest scoring factor after governance. The performance factor was the only factor to have a decline in the score this year. Average country scores ranged from 43 to 84.

The average country cost factor score was 48, unchanged from last year’s review, with individual scores ranging from 10 to 77.

The average country score for responsible investing was 49 out of 100 up from 42 in last year’s review, marking the biggest relative improvement among any of the four factors. These improvements mean that responsible investing is no longer the lowest scoring factor overall, having surpassed the average score for the cost factor. Improvements to disclosures were evident across all components and most countries. RI did continue to have the greatest dispersion of scores reflecting that countries are at different stages of implementing responsible investing within their investing framework. Average country scores ranged from 11 to 77, a slightly smaller range than last year.

“It was apparent from the reviews that many funds are actively taking steps to improve communications on responsible investing to stakeholders. In particular, many funds are expanding their disclosures to include quantifiable measures and progress towards climate related targets,” Reid says.

The GPTB ranks countries on their disclosures and found the following countries to be the outstanding performers in each category:
• Canada for governance
• The Netherlands for cost
• The Netherlands for responsible investing
• The United States for performance.

The Netherlands continued to lead the way in cost disclosure with the highest country score of 77. Scores were tightly banded from 71 to 89 and the top four cost factor scores were held by Dutch funds.

The Netherlands also ranked number one in the responsible investing factor, usurping last year’s winner of Sweden, with a score of 77. Both countries had improved disclosures over the past year. The Nordic countries – Sweden, Denmark, Finland, and Norway – continued to do very well on RI as a region, with all countries receiving scores well in excess of the overall average.

In the performance factor, the components with the highest scores continued to include asset mix and portfolio composition and risk policy and measures. Similarly the lowest scores were seen for asset class returns and value added and benchmark disclosures.

The US funds continued to lead the way, with an average country score of 84 for the performance factor. The US funds typically had extensive and good quality reporting across all performance components.

To examine the results for 2022 across factors, countries and the underlying funds click here.

Climate Action 100+, the $68 trillion investor-engagement initiative on climate change, is advising its 700 signatories to step up engagement with companies ahead of the US and European proxy season to pressure top emitters to do more to cut their carbon emissions.

Following on from a record number of majority votes on climate proposals last year that included a dramatic board shake up at ExxonMobil, the coming months will be a critical time for investors to support key climate shareholder resolutions at companies including Berkshire Hathaway and energy groups Phillips 66 and Valero Energy.

Recent analysis of climate progress at 166 companies revealed in the investor pressure group’s  Net Zero Company Benchmark gave the lowest scores to eight companies including China’s largest vehicle maker SAIC Motor and Berkshire Hathaway, which owns companies in sectors heavily exposed to climate change risk such as insurance and rail groups.

“We will continue to use the power of collaborative engagements and proxy voting to drive action at our portfolio companies to align their climate ambitions with their long-term strategies and capital allocation decisions,” says Simiso Nzima, a member of the Climate Action 100+ global steering committee and managing investment director of CalPERS global equity allocation – around 49.3 per cent of the giant $478.1 billion portfolio.

“As a long-term investor, we want our portfolio companies to execute sustainable business models and thrive in a low carbon economy.”

CalPERS is a long-term owner of Berkshire Hathaway shares and together with a group of other investors including Brunel Pension Partnership, Caisse de Dépôt et Placement du Québec and State of New Jersey Common Pension Fund is behind shareholder proposals for change at the conglomerate flagged for this proxy season.

“We know that the current climate trajectory presents a systemic risk to investment portfolios and long-term returns to funds’ beneficiaries,” adds Andrew Gray, director, ESG and stewardship at AustralianSuper, also a member of the Climate Action 100+ the global steering committee. “This demands intensified engagement from investors, calling for near-term action from the companies they are invested in. Long-term engagement works, and accountability is key.”

High level progress

Positively, the Net Zero Company Benchmark found some corporate climate progress against key climate indicators and year-on-year improvements on cutting greenhouse gas emissions, improving climate governance, and strengthening climate-related financial disclosures. For example, 69 per cent of focus companies (the world’s largest corporate greenhouse gas emitters) have now committed to achieve net zero emissions by 2050 or sooner across all or some of their emissions footprint, a 17 per cent year-on-year increase.

Elsewhere, encouraging signs of change include 90 per cent of focus companies having some level of board oversight of climate change and 89 per cent of focus companies having aligned with TCFD recommendations either by supporting the TCFD principles or by employing climate-scenario planning.

Challenges

However, the research also reveals more action is urgently needed from companies to support global efforts to limit temperature rise to 1.5°C. One of the most alarming findings reveals the vast majority of companies have not set medium-term emissions reduction targets aligned with 1.5°C or fully aligned their future capital expenditures and the future investment meeting the goals of the Paris Agreement requires, despite the increase in net zero commitments.

According to the assessments only 17 per cent of focus companies have set medium term targets that are aligned with the IEA’s 1.5°C scenario and only 5 per cent of focus companies explicitly align their capital expenditure plans with their long-term greenhouse gas reduction targets.

Elsewhere the survey found a continued failure to integrate climate risk into accounting and audit practices. “Climate accounting and audit appears to be a topic that many companies and their auditors have yet to fully consider when preparing their reports,” state the Benchmark findings. “Climate Action 100+ investor signatories should therefore engage focus companies on this topic to better understand the financial impact that climate-related matters can have on company financial statements and audit work, and the financial implications of company climate targets and decarbonisation strategies.”

Launched in 2017, Climate Action 100+ is now in its fifth and final year of its first phase. The pressure group will move onto a second phase in 2023 set to bring more ambition, urgency and accountability for both companies and signatories.