SEC chair Gary Gensler is in favour of the regulator stepping in to bring greater clarity and consistency to corporate climate disclosure. Speaking at a PRI webinar he said the current level of disclosure doesn’t allow investors to compare corporate climate preparedness, and that much of the data is inconsistent. 

Above all investors want consistent climate disclosure, said SEC chair Gary Gensler speaking during a recent PRI webinar.

Moreover, feedback so far on the SEC’s call for input reveals an overwhelming demand for mandatory climate disclosure – with 75 per cent of submissions in favour. (See Investors urge SEC to mandate climate reporting.)

This is a demand that chimes with PRI members said chief executive Fiona Reynolds. She says the vast majority of the membership also want the SEC to move forward with mandatory disclosure to help alleviate key challenges around comparing ESG data, the lack of publicly available information and corporate unwillingness to provide climate information.

“The SEC has a difficult job on its hands but it is necessary and critical,” she said.

Gensler said the current level of disclosure doesn’t allow investors to compare corporate climate preparedness, and that much of the data is inconsistent. Add to this boilerplate and generic language bereft of real detail and many investors remain in the dark. The SEC should “step in” and bring greater clarity while mandatory disclosure would bring broad consistency, he said.

Key data

Investors want more detail than just information on Scope 1 and Scope 2 greenhouse gas emissions. They want to see emissions in a company’s supply chain, he said. Only then will they be able to see a company’s vulnerability to physical climate risk and transition risk, as well as the extent to which companies are standing behind their climate commitments.

Gensler added that SEC staff are learning from external standards setters and the organisation is also working with other regulators around the world. The SEC should be in a position to “move forward” later in the year on new rules around climate disclosure, he said.

Greenwashing

He also warned that the regulator intends to clamp down on greenwashing. Clarity on the “wide range of terms” used by asset managers and verification of an underlying asset’s climate claims needs to come centre stage. If an asset is marketed as green, asset managers have obligations to investors, he said.

“Investors should be able to drill down and see what is under the hood.”

Elsewhere the conversation turned to how disclosure also benefits companies.

“Climate disclosure can prompt strategic thinking within corporates,” said the PRI’s Sagarika Chatterjee. It also builds trust in financial markets and could help safeguard companies against the growing trend in climate litigation.

“Companies benefit when the capital markets are more efficient,” said Gensler. “Investment carries risk, but disclosure takes the guess work out of it.”

Of course, new rules will only apply to public companies. However, Gensler said that the SEC’s remit does extend to helping counter systemic risk – where climate risk increasingly sits.

“The SEC does have a role to play in regard to systemic risk,” said Gensler, listing responsibilities like helping ensure fair, orderly and efficient markets and ensuring financial risk doesn’t spill out into our everyday lives.

Evolution of corporate disclosures

The first Olympics of 1896 feels very different to the current games underway in Tokyo with obvious evolutions like the presence of women athletes and a much longer list of sporting endeavour.  Gensler used the analogy of the Olympics gradual transformation and ability to change over the years to describe how corporate disclosure has also evolved to reflect the modern day.

Novel at the time, it is now hard to imagine investors ever making decisions without knowing the details of a company’s financial performance. In the 1990s a lively debate on whether to include stock compensation in corporate financial statements pushed the boundaries around disclosure. Elsewhere, it has become normal for investors to have sight of executive pay.

Now the disclosure debate has shifted gear once again as investors increasingly clamour for more information on how companies are integrating climate risk. It is why the SEC is seeking input on how it might update the way it regulates climate-related disclosures, with plans to publish findings later in the year.

“Investors are raising their hand and asking regulators for more,” said Gensler who described corporate obligations to disclose and investors’ ability to decide what risks they want to take as crucial to the smooth working of financial markets.

A group of major UK pension funds have committed to assessing diversity and inclusion as part of manager selection.

The commitment comes in signing the Diversity Charter which has been devised by some of the largest pension funds in the UK, forming a group called the Asset Owner Diversity Working Group, co-chaired by Helen Price who is stewardship manager at Brunel Pension Partnership and David Hickey, portfolio manager at Lothian Pension Fund.

The signatories include Brunel, Nest, RPMI Railpen, West Midlands Pension Fund, Lothian Pension Fund, and London CIV. Together they represent more than £125 billion in assets under management.

Diversity questions will form part of the overall assessment scores for each bidder, meaning fund managers wanting to work with these clients will have to disclose information and demonstrate real devotion on how they are tackling diversity and inclusion within their workforce.

Signatories also commit to including diversity as part of ongoing manager monitoring, a questionnaire will be provided to managers annually for completion.

A key aim of the group was to create standardisation to improve disclosure. The charter questionnaire has been developed to be progressive and equip signatories to hold firms to account for ongoing progress. It goes beyond asking about the strategic approach, to identify how managers look at diversity and inclusion across five key areas: industry perception, recruitment, culture, promotion and leadership.

It includes a range of qualitative and quantitative questions ranging from board composition to mentoring, promotion and paternity leave.

“We expect fund managers to manage diversity as a material investment issue, but we question how well they’re doing this if they’re doing little to address it in their own organisations,” Brunel’s Price says. “We want to help raise the bar on diversity disclosure across the investment industry by requesting data that is meaningful to us but also to the managers themselves.  By asking for this information fund managers will have to confront poor performance and begin taking much needed action on diversity.”

Other signatories outside the initial steering group include: Avon Pension Fund, Barnett-Waddingham, Church of England Pension Board, Coal Pension Trustees Investment, Cornwall Pension Fund, Environment Agency Pension Fund, LCP, LGPS Central Limited, Local Pensions Partnership Investments Ltd, Redington and Willis Towers Watson.

The £9.2 billion portfolio managed for the Church Commissioners for England has returned 9.7 per cent over 10 years through a focus on sustainability and a willingness to try things early, such as forestry and venture capital. Amanda White spoke to CIO Tom Joy about where the fund looks for alpha and the need for a non-traditional allocation.

The Church Commissioners of England invests 90 per cent of its portfolio in risk assets and doesn’t own any bonds except for 1 per cent invested in an eclectic emerging market debt portfolio. It counters that aggressive allocation with a 10 per cent allocation to cash which acts as a liquidity buffer.

“Holding nominal assets, which are often viewed as defensive, is a path to wealth destruction,” says the fund’s chief investment officer, Tom Joy. “I’m not a big worrier about inflation but it will be higher so holding nominal assets today is a sure fire way to destroy your wealth, I wouldn’t label them defensive. When people wake up to that fact and yields rise it will lead to capital losses. This comes back to the fragility of markets and the fact that a traditional portfolio won’t meet the needs of investors.”

Instead of a 60:40 the fund looks to enduring diversification which has meant a diverse and long-standing allocation to real assets that includes rural, timberland and strategic land allocations.

In 2020 timberland, which makes up about 5 per cent of the portfolio, returned 41.3 per cent partly due to the sale of a number of forests in Scotland and the US.

“We saw a tremendous increase in valuation last year. We made some sales because investor demand was so big and that was incredibly fruitful,” Joy says.

“We started investing in forestry a decade ago and it’s a core part of the portfolio. With the huge rise in the importance and thinking of the E in ESG and the role that sustainable forestry can play and the rise of the importance of biodiversity, we think that will be the next big leg in thinking about the environment.”

Joy believes the genuine diversification that the real assets portfolio provides – across farmland, forestry, UK residential and strategic land – has been beneficial in the periods where there have been big meltdowns in equities.

“2020 was the 12th year in a row we have delivered positive returns including 2018 when equities were down and other asset classes were negative,” he says. “It sits well with our stakeholders and clients and we have never had to cut distributions. I’m pretty happy with how the portfolio is positioned.”

Private equity and venture capital, which makes up 10 per cent of the portfolio, was also an outstanding contributor to the fund’s return with 33.6 per cent for the year. Nearly half a billion pounds in further private equity commitments were made in 2020 and the fund also committed venture capital to seven managers across 20 funds in the year.

Joy is aware that unlike many other asset classes where manager returns are bunched, the dispersion of manager returns in venture capital is enormous.

“It’s the one asset class where there’s a persistence of returns but you have to be with the best managers. It’s all about securing access to the best managers,” he says.

With that in mind the fund recently hired Michelle Ashworth, who Joy describes as “one of the best investors in venture capital outside of Silicon Valley”, with the purpose of gaining access to the best venture managers.

“She has been tremendously successful at that and we have made good allocations to the best managers who have deployed quite quickly,” he says.

All of the portfolio is managed by external managers and the fund continues to support active management.

In public equities active management was a big contributor to the return of 18 per cent in the asset class verses the index of 13 per cent.

“That wasn’t achieved by avoiding the value space and being long large cap technology, which was the pandemic winners. It was achieved with good balance in the portfolio and we’ve done that over a decade,” Joy says. “Everyone else had given up on active management we think we have a process where we can access good managers.”

The fund employs only a small number of managers it thinks can beat the market over time.

“Over a decade we have delivered 1.5 per cent above the market, compounded over time adds a lot of value,” he says.

Backing best ideas

But perhaps one of the more innovative things Joy and the team have implemented over the past five years, with complete transparency and agreement of its external managers, is a best ideas portfolio.

“We think that managers over-diversify their portfolios and if they just backed their best ideas they would do better. They can’t do that because of career and business risk reasons., so what we have done in agreement with them is we are loading up or buying more of what we strategically believe is their best ideas.”

This best ideas fund, which consists of a small number of best ideas from each fund manager, is managed in an internal systematic process with reduced fees and has been very successful.

“We were always going to do it in a transparent way and if our managers said no we wouldn’t do it. We only put together a small number of best ideas from each manager, less than 10,” he says. “It’s not a huge allocation at the moment (about £100 million), but we do want to grow it, it’s been quite successful.”

Outside of the front office there are a lot of other areas where Church Commissioners seeks to add alpha.

“We have done other things that are more nuanced,” Joy says. “Middle and back office and operations functions can genuinely deliver alpha. If that is a very well-resourced part of your business it can lead to much better control over the custody and legal spend for example.”

Portfolio efficiency also adds alpha, he says, with the fund adding 30 basis points of return at total fund level.

“In 2018-19 I became increasingly aware of the view that markets are fragile, being able to hedge your portfolio was more difficult because of where bond yields were and the 60:40 model was broken,” he says. “I felt markets would be vulnerable because we had a massive growth in algorithmic trading and when volatility hits, that pool of liquidity evaporates and markets are prone to shocks. We looked at how to capitalise on that and protect our portfolio.”

The team decided this was a job better done in-house as tail risk hedging is defined largely by inaction due to the associated fees.

“External managers want to earn their fees so they’re always doing things but 90 per cent of the time you don’t want to be doing anything. Insurance costs you,” he says. “In markets if you’re contrarian you can add incremental return to the portfolio but you have to do it yourself.”

James Barty, a former hedge fund manager and expert in global markets and derivatives, was hired as director of investment strategy and he came to the fund from Bank of America to build models that would give signals to when markets were stretched and prone to a setback. An internal derivative overlay strategy was set up to manage equity risk.

“We do that in a time varying contrarian way and it was quite fortuitous as we were able to add risk in March and April and have added a useful amount of return,” he says. “Because we had invested so much in our operational and backoffice functions we could bring that capability internally and that will be increasingly important for us.”

Responsible investment alpha

Not surprisingly, given its stakeholders, Church Commissioners has an ambition to be at the forefront of responsible investment globally. This ambition has been vindicated with the inclusion in the PRI’s Leaders Group for the past two years.

Joy believes that responsible investment alpha is going to be the “area of the future and the next leg of our journey”, and he continues to invest in building out a team which now consists of seven people – almost as many as in the manager selection team.

“A team of seven dedicated RI professionals is quite a big team but if you have ambition you have to resource it properly,” Joy says.

At the start of 2020 the fund’s head of RI, Edward Mason, left to join Generation Investment Management, considered to be the leading manager in responsible investment and one of the fund’s managers.

Bess Joffe was hired as head of responsible investment and in a sign of the lockdown times Joy is still yet to meet her in person.

“She’s been fantastic and has a wealth of experience working for managers and an asset owner which has been really helpful in looking at what works from an engagement perspective and has given us an advantage.”

The fund has just completed a natural capital baseline assessment across the portfolio and was the first asset owner to sign the taskforce on nature related frameworks.

“That’s the big next discussion and focus on the environment side,” he says.

In 2020 it also joined the net zero asset owner alliance and has just released its target for carbon reductions of 25 per cent by 2025. Last year it also released its impact investing framework measuring the real world impact of its investments.

Through tracking and analysing the portfolio through the real world impact, it can see for example that it has £600 million dedicated to climate solutions.

“The integration of the RI team with the investment team means that the RI team are spotting themes before the investment team sees them from a risk perspective, then we are able to think about what our exposure is and should we make changes. We have come up with ideas that are win win investments, they have good impact and good returns, like energy charging infrastructure. The symbiotic integrated approach is paying dividends.”

Joy says the fund is really focused on making sure all initiatives it is involved in focus on the real world impact.

“We don’t want to lose sight of the fact the critical focus needs to be on real world impact. It’s easy to adjust your carbon footprint via a few sales in your portfolio but selling shares does not make impact in the real world.”

Two asset owners explain how working with asset managers is central to reaching their net zero targets.

Climate change is not only perceived as the biggest risk to the $65 million David Rockefeller Fund, it is also a potential source of opportunity to lean into, said Nili Gilbert, investment committee chair of the David Rockefeller Fund which supports non-profit groups working in the environment, criminal justice and the arts.

Speaking at an ‘Investor Agenda’ webinar hosted by the PRI, UNEP-FI and CDP on how investors can climb the ladder to net zero Gilbert, who focuses on the fund’s relationships with its investment consultants, manager selection and overall asset allocation, said tackling climate change has a double materiality given the foundation also makes grants in the climate space.

Motivated by its fiduciary duty, the fund which was founded in 1989 and separate from the $5 billion foundation, published net zero targets for the first time this year. It also committed to decarbonise the portfolio by 25 per cent by 2025 in alignment with government goals of net zero emissions by 2050 under the Paris Agreement.

In addition, the fund plans to invest 10 per cent of the portfolio in investments to finance the transition in the next five years.

“The biggest risk is the world missing the mark on climate change,” said Gilbert. “This is why we’ve put the investment of the endowment at the centre of our climate strategy.”

The fund’s decarbonisation strategy comprises engagement with portfolio companies and sectors, engagement with external asset mangers and policymakers, and collaboration with peers in the Net Zero Asset Owner Alliance which it joined last year.

Gilbert also advised webinar attendees on the importance of not just tinkering with integrating net zero but focusing on engaging with companies and sectors in the real economy. Rockefeller embarked on a huge engagement program with its asset managers to drive integration working alongside its investment consultants.

Jake Barnett, director, sustainable investment services at Wespath Institutional Investments (WII) explained how his focus is also on engaging with asset managers. WII, a not-for-profit subsidiary of Wespath Benefits and Investments (WBI) which together manage $28 billion in assets rooted in the principles of the United Methodist Church, is also targeting net zero in the portfolio by 2025.

Asset managers are often better positioned to take on stewardship roles with portfolio companies; they have larger holdings and make the buy sell decisions and also have more capacity and resources when it comes to stewardship, he said.

“We are direct clients of asset managers and should lean into this,” he said.

This year Wespath asked its asset manager cohort to answer how they would support the organisation in its net zero goals to ensure alignment.

Elsewhere, collaborative engagement is increasingly incorporated into the asset owner’s selection of managers, said Barnett.

“This is a market signal you should pay attention to,” he advised managers.

Board buy-in

The conversation also centred on how best to build a case for change within an organisation. Bringing an organisation’s leadership and governance arms together around net zero targets is one of the most challenging elements of a net zero strategy.

“Our commitment emanated from board and executive level,” said Gilbert explaining that this built energy for change across the organization that has been crucial for success.

Another component of success is working with other asset owners, she said. Large US pension funds also on the road to net zero presented to the fund’s own investment committee. These conversations led to the committee making a formal recommendation to the board on net zero commitments.

First steps

Amongst the proliferation of initiatives helping investors reach net zero emissions in their portfolio, the Investor Climate Action Plans (ICAPs) Expectations Ladder stands out, offering comprehensive guidance towards achieving a net-zero carbon economy by 2050.

The ladder defines opportunities for investor action on climate across four interlocking areas – investment strategy, corporate engagement, policy advocacy and investor disclosure and governance.

The ICAPs approach helps investors no matter where they are in their journey to better integrate climate change risks and opportunities into their investment process, and climb up the ladder to net-zero, explained Rahnuma Chowdhury, investor climate action lead at UNEP FI.

She concluded that the tier process is also meant to be inclusive, regardless of where individual investors are on their net zero path. It allows investors to see where they sit on the ladder and how to scale up their ambition, she said.

 

How asset owners are implementing net zero targets in their investment portfolios will be a key focus of the Sustainability in Practice event to be held online on September 8 and 9. To find out more or register click here. 

Key takeaways:

  • Failure to address climate change will have severe economic and social repercussions.
  • Pressure for a just transition, a systemic and ‘whole of economy’ approach to sustainability, is growing.
  • The human causes of climate change are now firmly established, but the human response, and impacts, are still very much to be determined.

Climate change is a human issue. There is now scientific consensus that the greenhouse-gas emissions causing climate change are predominantly man-made. This means that climate change is unequivocally a human issue – as a society, we can influence the course of that change, by adapting our individual and collective behavior. There are, of course, many uncertainties about the potential impacts of climate change but the choices that we make also add to this uncertainty.

Failure to address climate change will have economic and social repercussions. Global action, or indeed inaction, will affect the global workforce, human wellbeing, and society at large. No one expects these impacts to be equally distributed; some estimate that 75% of climate change damage may affect developing countries, despite the poorest half of the world’s population contributing to just 10% of global carbon emissions.1

The Role of the Just Transition

The phrase ‘just transition’ refers to the balancing of these interests: addressing the environmental risks that climate change presents, while ensuring that workers and communities are not left behind, and that the ‘green’ solutions deployed do not carry an ugly human cost. As a society, how we address this complex and increasingly politicized issue will be a considerable challenge in the coming years.

The ILO (International Labor Organization) defines just transition as “… a bridge from where we are today to a future where all jobs are green and decent, poverty is eradicated, and communities are thriving and resilient. More precisely, it is a systemic and whole-of-economy approach to sustainability.”2

The role of the just transition, and questions of fairness and equity, also have the capacity to undermine attempts to meet the Paris Agreement on climate change. The transition to a low-carbon economy could not only lead to ‘stranded assets’ but also ‘stranded workers’ and ‘stranded communities’. Higher levels of social trust enable institutions to undertake policy reforms that are in the general long-term interests of society. Where there is no societal buy-in, there are often adverse impacts on the overall impacts that policies seek to achieve. This can have significant economic and human costs too, as was seen with the gilets jaunes (‘yellow vest’) protests in central Paris. These started in late 2018 over substantial fuel-tax increases to tackle climate change and the resulting impact on lower-income workers.

What Does This Mean in Practice?

A key requirement of addressing climate change is changing our energy system, and reducing the use of fossil fuels. Understandably, workers in fossil fuel-related industries may feel vulnerable and oppose the changes that threaten their jobs, livelihoods and communities, as we have seen within the European Union. Taking the UK as an example, it is estimated that one in five UK workers could be affected by climate change – 10% of jobs may have less demand, and 10% may have more, with significant changes in structural employment. There will also be changes in the types and locations of jobs across and within these economic sectors.

Employment Implications of the Transition on Different Sectors in the UK

Source:
 Robins N, Tickell S, Irwin W, Sudmant A. July 2020, Financing climate action with positive social impact: How banking can support a just transition in the UK. London: Grantham Research Institute on Climate Change and the Environment, London School of Economics and Political Science 

An additional challenge is that these impacts will often be concentrated in specific communities reliant on industry, and new employment opportunities may not be created in these regions. Some workers may easily adapt – an engineer at an oil and gas company may be well suited to being an engineer at a renewables company. But not all skills are transferable. For example, it is estimated that the north of the UK may see 28,000 direct job losses resulting from the closure of coal-fired power plants alone.3 In less clear-cut cases, there will need to be research and investigation to understand the net impact of jobs, in order to manage this.4 Subsequently, there will be the need to generate new jobs in regions affected and to retrain and reskill workers.

Moreover, the transition is not just away from fossil fuels but also towards renewables. We need to consider the social implications of renewables technology, construction and operations as their role in our energy system increases. There have been numerous allegations of human-rights abuses at renewables companies, primarily related to project construction, ranging from intimidation, to indigenous rights and land-rights disputes. More recently, we have also seen this with increasing scrutiny over the use of forced labor of minorities in solar industry supply chains. This is material for our transition to a lower-carbon society: for those whose human rights have been adversely affected, and also for investors, as project delays and cancellations can have financial consequences. With increasing discussions of mandatory human rights due diligence requirements, this is only likely to become more salient.

The human causes of climate change are now firmly established, but the human response, and impacts, are still very much to be determined. There are no silver-bullet solutions, nor is there clear responsibility for any single actor. For example, who should be accountable for the reskilling of employees, and who should bear this cost? As always, collaborative action between all stakeholders – governments, corporates, investors, NGOs (non-governmental organizations), trade unions, and employees – would be ideal. But what does this mean in practice? And how can this collaboration be facilitated? It is clear that this will not be a simple task, nor one that any single stakeholder can achieve individually. It is a deeply political, cultural and social challenge, but it is a challenge which must be addressed as we continue to shape the way climate change develops, and the human impacts it will have.

Sources
  1. United Nations, Human Rights Council Forty-First session, July 17, 2019
  2. UNPRI, Why a just transition is crucial for effective climate action, September 2019
  3. ShareAction, Laying the track: The race to zero, June 2021
  4. Volkswagen, Fraunhofer study: Employment at Volkswagen in 2030, December 2020
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From the ‘Great Moderation’ of the 1980’s, to the current day, the inflation environment has been relatively benign, with the policies of recent years mostly concerned with preventing deflation. However, as economies begin to rebound from the Covid crisis, inflation has ticked up. Is the current rise in inflation transitory, or could we see Central banks move to tighten policy? David Parsons and David Lloyd walk through the history of what has led us to this point and what to look out for.

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