It is difficult to see how the world will cap emissions in line with the Paris agreement unless asset owners drive change, aligning their portfolios to net zero and demanding more from their managers. Carbon neutrality or a net zero carbon footprint, and tapping into the opportunities rather sinking in the constraints of that transition, is possible, said two of the world’s largest asset owners speaking at PRI in Person in Paris.

“I very much agree that with ownership comes responsibility. We want our portfolio to be net zero by 2050 and what we are doing now is working on measures to achieve this,” said Dr. Guenther Thallinger, member of the board of management at German insurance giant Allianz SE. Arguing that there was a business case for pushing net zero, he said the PRI’s Inevitable Policy Response (IPR) showed it was “quite clear” asset owners needed to think about integrating climate risk into their strategy and implementation, and work with regulators and other policy makers.

Bertrand Millot, head of stewardship investing at $246 billion pension fund CDPQ told delegates the Canadian fund is equally committed. It is allocating more to green investments and has set out goals to decarbonize its portfolio from which he said net zero is a natural extension. He cited investment opportunities across numerous sectors, highlighting greening real estate and renewables, particularly.

Regarding the argument that fiduciary duty limits asset owners ability to integrating ESG, he said he hoped this argument “had come to an end by looking at the facts.” Bad news about investors being “burnt” by climate events was now commonplace, he said. The European car industry is one increasingly apparent example, where electrifying the vehicle fleet will have wide ramifications that “speak for itself.”

Millot told delegates that companies are starting to take action but big differences in responses remain, particularly across the US. He said that the debate needed “to be brought forward” and consumers needed to indicate what they want to happen. Moreover, “governments should take action and asset owners’ role was to push this on.”
Reflecting on the different pace of change between Europe and the US amongst the investment community, companies and regulators, Millot suggested that consumers would drive change in the US that would breach the divide. The transition wouldn’t just be Europe-led, he said.

“The question of consumers is an important aspect. Millennials want the same thing either side of the Atlantic and companies need to respond. Breaching national boundaries needs to happen.”

Asset owners needed to do more to lead on policy, they both suggested. Agreeing that governments are “not going far enough” to pull policy levers, they urged that rather than sit back and wait for action, asset owners should lead.

“We need to be much more active participants around many issues,” said Millot who told delegates asset owners should stand behind policy makers and play a “meaningful role.”

Thallinger added that asset owners should be committed to the same policies as governments in a clearly aligned vision. This would require investors informing governments on the kinds of policies they wanted, by working together in widespread programmes. We need to be part of it, otherwise policy will only cover certain aspects and will not apply across portfolio management, he said. The investors also agreed that as universal owners they were uniquely positioned to shape policy across jurisdictions. “Governments are forced to work in their own jurisdictions. We can be the bridges to combine these jurisdictions,” he said.

Moreover asset owners have a symbiotic relationship with government because they both liked stability and governments need investment to finance the transition. It requires a close dialogue to ensure the right policy is enacted.

“We are all facing climate change, and we all need to act,” said Millot. “There is a strength in numbers.”

Business has a key role to play in leading on sustainability in a complex world, said Cécile Cabanis, CFO of French multi-national food group Danone. In conversation with Eva Halvarsson, CEO of SEK 334 billion ($34 billion) Swedish buffer fund AP2 at PRI in Person in Paris, Cabanis told delegates in an opening session that the goal of the company is to contribute positively to all 17 Sustainable Development Goals.

Danone, which is celebrating its 100th birthday and operates in more than 100 countries with 100,000 employees worldwide, started its ESG journey nearly 50 years ago. Back then in a pioneering strategy, the company committed to its business extending beyond the factory gate. Today, a core belief is that a healthy business depends on a healthy society; that the health of the planet and its people, is intertwined.

The company has prioritised three SDGs particularly: SDGs 2, 3, and 6 around Zero Hunger, Good Health and Wellbeing and Clean Water and Sanitation, respectively. But other SDGs are just as important, said Cabanis. For example, the company is focused on better management of waste and natural resources (SDG 12) in line with its commitments towards the development of a circular economy. And it promotes inclusive growth as well as a safe and secure work environment for all. And since agriculture is responsible for about 31 per cent of global greenhouse gas emissions, Danone has also committed to contribute to the fight against climate change by becoming carbon neutral by 2050. “If you are not serious about putting this at the heart of how you do business, ultimately you will not have a business,” she warned, urging companies and investors alike to “shift the conversation” and not focus on the “short-term.”

In a particularly landmark innovation, Cabanis told delegates about how the company has tied its financing to ESG criteria. Two years ago Danone partnered with 12 global banks to lower its cost of borrowing if it increased its verified positive impact in the world. The deal on Danone’s $2 billion syndicated credit facility means its ESG performance (verified by a third party) will directly impact – upwards or downwards – the margin payable to the banks over the entire duration of the facility. “We are making progress, but it is still a drop in the ocean,” said Cabanis. “There is a tension between the short-term and what we need to do for the long-term. It is a tension that we need to manage.”

Cabanis also called for more homogenous reporting. She said the number of indices was “a mess” that required “teams and teams” at Danone to manage, with everyone measuring different things. “Everyone reporting in their own way is a waste of resources,” she said. She also urged delegates that reporting needs to be followed up with actions. “We can do it if we are all together,” she concluded.

Empowering long-term influential asset owners to invest responsibly is the key to hastening take-up in responsible investment. Yet asset owners face barriers that include their culture and governance, and concerns around their fiduciary duty, delegates in Paris at the PRI in Person heard. It stops many pension funds, insurance groups and Sovereign Wealth Funds from punching above their weight as a group when it comes to ESG. Encouragingly, once they find ESG, for many there is no turning back.

“Asset owners are emerging from their shadows; they have got to make a big push to be titans of influence,” said Roger Urwin, global head of investment content, Willis Towers Watson. “Leadership comes with purpose and vision. It amplifies and creates an avalanche.”

Urwin noted that the defined benefit sector has the longest investment timelines, making sustainability integration easier; insurance companies are also playing a bigger part, he said. In contrast, the corporate DB sector, which is de-risking resulting in a shorter time horizon, finds sustainability more difficult. Nor are SWF’s on a coherent path.

Asset owners which view themselves as universal owners are more inclined to think sustainably. Universal owners invest without borders, acting in a different way to governments and corporations. Urwin said this leaves them uniquely positioned to make a difference on the issues that also have no borders, like climate change. The concept of universal ownership naturally fits with large, long-term, leadership-minded asset owners. These investors, which invest in a hyper-integrated way, are large enough to change the system, and the long-term returns they need can only come from a system, and investment world, that works better.

Urwin added that the benefits they pay their beneficiaries are also worth more in a better world, in what he called a utility of outcomes.

“The transition needs to be accelerated for asset owners to get the returns they need,” he said. This will also become easier if asset owners work with regulators, collaborate together and draw on the lake of data that is emerging, he said. “Asset owners are too important to fail in their mission; they carry the wellbeing of billions.”

Next, delegates heard from the asset owners which are leading on ESG. Jimmy Yan, special counsel to the CIO, Office of NYC Comptroller Scott Stringer, who leads the ESG and sustainability for NYC’s five pension funds with a combined $200 billion, has made diversity a central policy. Drawing on research that diversity is correlated to strong economic performance and better risk management, the organisation has focused on ensuring diversity within its stable of asset managers.

“We could only pursue initiatives like this based on fiduciary duty,” said Yan. “But there is a correlation between diversity and performance; it prevents group think.”

The investor asks deep dive diversity questions of all its external managers’ investment teams; it also asks for information on the different compensation levels within the investment teams. The initiative, which began in 2014, has helped other asset owners focus on the importance of diversity, said Yan. In another initiative the organisation’s Boardroom Accountability Project has also become a ground-breaking campaign. It gives share owners the right to nominate directors at U.S. companies using the corporate ballot, known as “proxy access.”

Delegates also heard how $98.5 billion Australian pension fund, First State Super is leading on ESG by engaging with investee companies. With the bulk of its portfolio externally managed, the pension fund focuses its engagement activities through its asset managers – ordinarily. Something it did when it sought to push domestic portfolio company Domino’s Pizza on ESG issues including underpayment of workers and safety.

“We reached out to our fund managers and asked questions around how this could impact the valuation and if they had concerns,” recalls Liza McDonald, head of responsible investment at the fund. But the investor only received a “mixed response” from its two active managers who “loved” the growth story of Domino’s. It gave the pension fund “little confidence” that they would engage on these issues, she said.  In a next step, First State Super engaged with the company itself, reaching out for a direct meeting in a drawn out, and challenging process.

“We eventually thought it was better to go direct than through the managers. If you have an engagement programme think what is effective. Even though we asked the managers for information, that information flow wasn’t enough.”

First State Super now has regular interaction with Domino’s which has committed to changes – although McDonald notes their pizza is “cheap for a reason.” She added that active ownership involves a great deal of resources, research, and firm plans of action. She also noted that collaboration was key. It is for this reason the fund is now working with asset manager Hermes to influence and engage its non-domestic portfolio companies.

“It’s time to act,” said Bruno Le Maire, France’s Minister of the Economy and Finance in the opening keynote speech at PRI in Person in Paris, which underscored with a sense of urgency that the financial world is not doing enough to meet today’s ESG challenges.

Welcoming 1600 delegates from some 54 countries to the home of the historic Paris agreement, he said people will no longer wait for decisions. Populations are asking for action now and demanding a new form of capitalism. To avoid populism, we need to give concrete answers to what young people are calling for, he urged.

Citing the impact of climate change, growing inequality and conflict, he called for “concrete” public and private policy responses that go beyond “fine words” to affect real change.

“We may be the last generation with the opportunity to act, any later and it will be too late,” he said. Arguing that the world economy is at cross roads, Le Maire called on “all stakeholders” to shift their positions and help create a responsible economy that creates a new economic model and capitalism for the 21st century that is based on social responsibility, sustainability and equality among and within nations.

In what he called “a glimmer of hope” he saw encouraging signs of change from the US’s recent Business RoundTable. Marking a divergence from its traditional stance, it stated that the country’s large corporations should be run not just in the interests of shareholders, but also in the interests of stakeholders. Other signs of real progress include France’s recent decision to enshrine in legislation company managers’ social and environmental responsibility, he said.

Le Maire told delegates that France’s financial sector plays a key role in putting France’s economy on a sustainable pathway.

“Without a strong signal from investors, bankers and insurers, significant change in our economic system will not be possible. Change is in our hands,” he said.

He added that it was in the interests of financial firms to engage, lest climate risk or stranded assets suddenly disrupt their business models. Responsible investment is also necessary to promote socially inclusive businesses, which favour worker’s participation and social cohesiveness, he said.

Le Maire praised domestic progress where initiatives include clear common targets to reduce emissions, including a national low carbon strategy targeting curbing emissions by 75 per cent by 2050.

Elsewhere, financial institutions have committed to shift away from coal. Effective ESG disclosure of large public and private companies has been in force since 2001 and he praised France’s ambitious climate risk management and disclosure framework for institutional investors and asset managers, in place since 2015. He also cited the government’s 2017 green bond issuance (now valued at €19 billion) and initiatives to encourage, and meet demand, from retail investors seeking to invest more in sustainability.

Now he said companies and financial organizations also need “effective supervision” and “monitoring” to ensure that their behaviour “is changing.” Companies need to improve the quality of their data, and statements and commitments are no longer enough: radical changes under supervision are order of the day.

More in Europe
Citing EU-wide efforts like the EU’s action plan on sustainable finance, introduced in March 2018 as part of a strategy to integrate ESG into its financial policy framework and mobilise finance for sustainable growth, and the EU’s new taxonomy that classifies sustainable activities, he said the EU was working to be at the “forefront of sustainable finance” and the “new capitalism needed for the 21st Century.” Other important initiatives include the EU’s Technical Expert Group, (TEG) proposals to create an EU Green Bond Standard to enhance the effectiveness, transparency, comparability and credibility of the green bond market.

However, Le Maire urged Europe to move much faster, where he said France would “put forward” the arguments and lessons learnt from its own initiatives. Working to convince EU partners to follow the same path and fight to tackle shared threats and promote shared economic interests was now paramount. “We need to move faster and build a toolbox at a European and global level,” he said.

Le Maire closed his keynote acknowledging that the “difficulties we face are huge” and “the stakes are high.” Concluding, “France will always be supportive to encourage the development of sustainable finance. You can count on us to be a leading force in Europe and at the global level in the coming years.”

There has been an “evolution” among private equity managers in integrating ESG over the last three years, said Michael Cappucci, senior vice president, compliance and sustainable investing at the $37.1 billion Harvard Management Co, speaking at PRI in Person in Paris. In a session focused on the private equity industry’s progress and challenges integrating ESG into its processes and policies, Cappucci noted GPs are hiring ESG teams, and no longer “pushing back.”

Instead, there is a recognition that ESG is now a core LP expectation, he said.
For some asset owners, demanding more from their GPs, and not investing with managers that don’t integrate ESG, has become more commonplace. LPs have a “maximum leverage” whereby they can “walk away,” noted moderator Jennifer Choi, managing director, industry affairs at The Institutional Limited Partners Association (ILPA), which has recently published an updated third edition of its Private Equity Principles, going into more depth on ESG issues.

Hearts and minds
Swedish buffer fund AP2 recently turned down an “interesting opportunity” and a “potential new relationship” because the manager “didn’t want to talk about ESG,” noted Anders Strömblad, head of external management at the SEK 334 billion ($34 billion) fund.

A PRI signatory since 2006 and describing ESG as in AP2’s “DNA,” Strömblad detailed that the GP in question didn’t want to give AP2 access to all its investment team. Something the fund values in its quest for long term relationships, built on trust.

“What we want to find out is, does the GP believe in ESG, does it touch their heart and brain. The only way to find out is to spend time with the investment team,” he said.

Over the years, AP2 has developed a due diligence tool that allows the buffer fund to update ESG data and proficiency amongst its private equity GPs.

Other asset owners aren’t as far down the road regarding their processes, however. Harvard has no “silver bullet” that cuts through potential green washing. It does ask its GPs if they have an ESG policy, but Cappucci stressed ESG engagement with its manager cohort was an ongoing process, rather than box ticking.

“We have struggled with a framework for an upfront due diligence process,” he said.Instead, the asset owner favours long term conversations with its GPs, checking in to mark progress and share best practice.

Gaining insight into GPs intentionality around ESG is challenging to combine with the time constraints around manager selection in the pressurised fund-raising process, he said. It was possible to identify ESG intentions over the long term however, seeing if GPs are following through on commitments they’ve made. Nor does Harvard require that its GPs are PRI signatories.

“We try not to be prescriptive; it is not necessary for a firm to perform well to be a signatory. All firms go on their journey; on their own path,” he said.

Paris-based private equity company Ardian became a PRI signatory in 2009, said Philippe Poletti, CEO of the group. He noted that Dutch LPs were among the toughest ESG taskmasters. Being “pushed” by LPs has led the firm to pursue ESG strands and themes it “wouldn’t have done without their support,” he noted. As for portfolio companies, Ardian audits each company noting, however, that the best ESG performers are characterised by a belief in ESG “at top of company.”

The session touched on the importance of the private equity industry doing more to sell itself, winning over hearts and minds, and personalising this industry.

“The industry has grown a lot, both in terms of AUM and the size of companies private equity managers have bought,” said Strömblad. While private equity-backed companies grow faster, and are transformative for companies and sectors, the positive message rarely gets out.

Shared profits

However, some initiatives are helping change the image of the industry. When Ardian exits a company the GP shares part of that value with employees. Depending on the performance of the fund, it’s not only top managers who get a financial pay out, said Poletti. Under this policy the GP has allocated around €52 million to employees in companies across Europe. “Other GPs have started to do the same thing,” he said.

The private equity industry is also working to improve its diversity.

“We try to walk the talk,” said Strömblad who notes the industry has the perception of “living in a bubble”.

By way of example, AP2’s team is diverse, and when the fund meets a new GP, their diversity across gender, ethnicity, education and age is a first conversation.

Elsewhere, Harvard is embarking on discovering the diversity of its GPs for the first time, galvanised after being asked by the university about the demography of its external manager cohort.

‘We reported back that we didn’t know,’ said Cappucci in a candid response.

Some 1,700 delegates will converge on Paris this week for PRI In Person, the annual conference for the influential UN-backed Principles of Responsible Investment. Established in 2006, it has over 2,000 signatories comprising global asset owners, managers and consultants representing $80 trillion AUM, all of whom have committed to its six principles designed to integrate ESG considerations into investment practice.

In a wide-ranging agenda that includes keynote speeches from French politicians, the President of the European Central Bank, global asset owners and company CEOs, the conference will delve into every corner of ESG. Sessions range from a deep dive into regulatory developments over the last year, to investor progress around integrating the UN’s Sustainable Development Goals and how to foster ESG in passive investment. Experts will offer insight on ESG integration in private equity and sovereign debt, and the pivotal role of Central Banks in meeting climate challenges. Diversity, human rights and how investors can influence plastic reduction in supply chains are also on the agenda.

It reflect the organization’s increasing reach. “The PRI has had a good year,” enthuses CEO Fiona Reynolds. It has seen rapid growth (adding over 100 signatories) and take-up of responsible investment has increased in more countries and more organizations around the world. For example, the PRI now operates in South Africa and China, where insurance group Ping An become China’s first asset owner signatory in August.

Elsewhere, more governments are integrating sustainable investment policies like the EU’s new taxonomy, a green encyclopaedia for investors seeking to finance a green economy, the UK’s green finance strategy and similar initiatives in Australia and Canada. In the US, America’s Business RoundTable has just strikingly diverged from its traditional stance, stating that the country’s large corporations should be run not just in the interests of shareholders, but also in the interests of stakeholders, a change that Reynolds views as particularly important.

“Responsible investment is an issue that is taken much more seriously. It no longer sits on the fringes,” she says. Moreover, that growth in take-up has been accompanied by an increasing depth of practices. “In the early days it was all about active ownership and engagement. Now ESG is being integrated across asset classes and investors are engaging in policy discussions.”

One key conference session will also focus on the PRI’s flagship Inevitable Policy Response (IPR). Here, the organization argues that governments will inevitably have to legislate to limit global warming, and that the longer legislation is delayed, the more disruptive those policies will be. “We believe that a policy response is inevitable and that governments will be forced to take action. This is a risk for investors,” says Reynolds. Over the last year the PRI has built out is IPR work, highlighting eight areas where significant policy action is most likely. “Policy intervention is not priced into markets effectively,” she warns.

The organization has also made progress in getting more out of its signatories, particularly asset managers. In 2018 it drew up new minimum requirements and found that 152 signatories didn’t meet them. Out of those, 83 signatories met the new requirements in 2019. The remainder have the next reporting cycle to get in shape before they will be delisted. “176 signatories were on our watch list this year. 49 per cent of those were on the list for the first time and we are engaging with them. If by end of our reporting cycle in 2020 they don’t meet those requirements, we will delist them,” says Reynolds.

The PRI is also planning to revamp its reporting framework, used to measure signatories accountability and as a benchmarking and learning tool. “As part of this review we will make our reporting simpler and streamlined so it doesn’t take so long. It will also be harder to get the good scores,” however Reynolds stresses the organization is a broad church. “Not everyone is at the same level and we don’t expect someone starting out on their journey to be the same as everyone else. What we want is for everyone to be moving.”

With this mind she adds that it’s not just about pulling up the laggards either. The PRI is increasingly focused on celebrating its leaders in a race to the top. At this year’s conference the organization will present its annual awards for the first time.

Reynolds over-riding aim for PRI in Person 2019 is to get further, faster. Despite the “great numbers” and landmark progress, when she looks at the real world the responsible investment story isn’t translating. Emissions are increasing, the Amazon is on fire, inequality is growing (here she cites new Federal data revealing US CEOs earned 287 times more than average workers in 2018) and demands for more from governments are being ignored. “Responsible investment isn’t going to solve all the problems in the world, but it’s got a role to play. We need to do more, act now and do it with far greater ambition. On one hand I am excited about our growth and direction of travel, on the other I am concerned we are not going anyway fast enough. This is what keeps me up at night.”