Climate change is disrupting markets and economies across the world. To combat the risks posed by global warming, an increasing number of national, state, and local governments are implementing policies to price carbon emissions. Investors are growing concerned with this source of risk and are working to reduce the carbon footprints of their investments. The financial consequences will be revolutionary.

Following the financial crisis, global investors have increasingly recognized that the ability to generate long-term, sustainable financial returns depends on stable, well-governed social, environmental and economic systems. Over the past decade, investors have specifically sought to gain a better understanding of how firms manage risks and opportunities through their climate change policies. BlackRock, the world’s largest asset manager, has recently announced plans to put more pressure on companies to disclose how climate change could impact their businesses.

BlackRock is far from alone. More than 2,000 global investors managing over US$80 trillion of assets have signed the United Nations-supported Principles for Responsible Investment (PRI), which commit them to effectively incorporate sustainability criteria into their investment processes and assign a key role to the environmental footprints associated with their investments.   

Within this framework, financial companies are adopting various approaches to make their investments less exposed to climate and carbon risks. Some investors work to “greenify” existing investments, while others seek to mitigate climate risks or channel capital directly to green investments. One strategy involves using a negative screening process to exclude investments in companies associated with excessive emissions: high emitters get divested and become uninvestable. For example, Norway’s sovereign wealth fund – the world’s largest sovereign fund – announced that it was dropping its investments in oil and gas stocks in November 2017.

“Many of our clients are long-term investors and, as a fiduciary, we’re working to help them integrate environmental, social and governance factors across an entire portfolio to enhance long-term risk adjusted returns with built-in resilience”

Brian Deese, Global Head of Sustainable Investing, BlackRock, April 2019[1]

 

Improved reporting transparency

At the very least, negative screening forces companies to report their climate-exposure metrics more transparently for fear of falling into exclusion lists. More importantly, negative screening by investors may prompt companies with non-green assets and operations to consider divesting them, so as not to fall into exclusion lists.

Shareholders want better disclosure of business risks

Active ownership is an investment approach based on the full exercise of the rights attached to the status of shareholder. Many institutional investors engage with the managements and boards of investee companies, in order to make them carbon ready. Climate-related engagements include proxy voting on issues regarding corporate environmental strategies: investors file and vote on shareholder resolutions, so as to draw management’s attention to climate policy risks. One recent example concerns the 2017 Exxon Mobil resolution – approved by 62% of shareholders – calling on the company to improve its disclosure on business risks resulting from global climate change policies.

Public or behind-the-scenes actions

Active ownership campaigns sometimes involve mobilizing public opinion and the media, particularly to bring attention to the impact that proxy voting can have on environmental-related issues at upcoming shareholders’ meetings. Other initiatives take place behind the scenes and involve discreet dialogues and interactions between investors and corporate senior executives or directors. These collaborative engagements aim to encourage companies to disclose their climate change strategies, set emission-reduction targets and take action on sector-specific issues such as gas flaring in the oil and gas sector.

Collaborative engagement

Effective engagement on climate risks between boards, managements and institutional investors are win-win-win situations. Companies benefit from the collaboration this engagement engenders among their three lead players: management, which develops the company’s long-term strategy including the environmental aspects; the board, which oversees implementation of strategy and acts as a fiduciary for shareholders; and institutional investors, which hold the board accountable for its policies and actions. Developing a solid base of stable institutional investors is in the company’s ultimate interest, as it helps stabilize stock performance and allows the company to tap deep pockets when it needs to finance future projects.

Dedicated metrics

Carbon readiness and resilience is a core component of sustainability research geared to assessing the environmental, social and governance (ESG) performance of corporations. This research translates into a range of ESG ratings, rankings and indices aimed at capturing the external costs and benefits disregarded by financial accounting and reporting. Rising investor demand has fueled strong growth in the ESG information market over last two decades. Many asset managers now use sustainability analyses and ratings to manage and map their portfolios, by benchmarking issuers on various quantitative metrics.

Regardless of the approach used by investors to factor in the climate-risk exposure associated with their investee companies, carbon prices are useful metrics for governing the transition to low–carbon business models and for communicating on this transformation to shareholders and asset managers. Companies capable of demonstrating their ability to navigate and act on carbon price risks so as to effectively reduce their carbon footprints, enjoy a strategy advantage which can translate into better financial performance.