LPs & climate change risk: Numbers game

Nearly 12,000 members of UniSuper – the default superannuation fund for Australia’s academics and university employees – signed a petition earlier this year demanding the divestment of their retirement funds. Rather than leading the charge on climate change, UniSuper is plowing billions of dollars into “companies whose operations and plans are completely incompatible with the climate goals of the Paris Agreement,” the petition stated.

They were responding to The Age and The Sydney Morning Herald branding UniSuper a hypocrite for publicly endorsing emissions reduction while holding substantial positions in fossil fuel companies. Hostplus, HESTA and Australian Super faced the same accusations.

UniSuper, which managed A$80 billion ($57 billion) for 450,000 members as of June 2019, said it had no plans to unwind its holdings. In an open letter to the petition organizer, the superannuation fund’s board expressed a preference for engaging these companies – encouraging the adoption of lower carbon solutions – to a general fossil fuel exclusion policy.

The controversy came at a uniquely sensitive time, towards the end of a devastating bushfire season in which drought and record temperatures contributed to the destruction of 18.6 million hectares of bush, forest, and parks. Scientists made the connection to global warming. It is an example of how a groundswell of public opinion can shake institutional thinking.

“Climate change has become more mainstream in recent years,” says Ted Dow, a director at Australian private debt player Paddington Finance and a former CIO of the government-backed Clean Energy Finance Corporation. “Members of superfunds in Australia and pension funds overseas want to know their money is used for good. That moral majority element has extended from guns, gambling, and tobacco to climate change.”

Several global investors have revisited their climate change policies in the past 18 months following similar backlashes, among them BlackRock and J.P. Morgan.

In Australia, HESTA recently unveiled a climate change transition plan that features a commitment to reduce portfolio emissions to net zero by 2050. CEO Debby Blakey described the plan as “one of the most comprehensive of its kind undertaken by a superannuation fund, mapping out how we’re going to manage climate risk, align our actions to a below-2-degrees world and support the transition to a low-carbon economy.”

Data dump

There are numerous interrelated reasons why LPs globally are being more proactive on climate change. Public pressure is one, but the availability of reliable data might be more significant.

“We don’t have reliable inputs on many of the metrics to determine risk, even something as simple as where companies derive revenues. There is no common reporting framework for sales and assets by any industry globally. They all report their home markets and then carve up the rest of the world at different levels,” says Richard Manley, head of sustainable investing at Canada Pension Plan Investment Board (CPPIB). “It’s a lot of work just getting data to help determine where risk exists.”

However, he admits the situation is now improving, in terms of breadth and consistency of information. CPPIB recently updated its sustainable investment policy to align reporting with guidelines issued by two groups partly responsible for this emerging standardization, the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD).

The TCFD guidelines are frequently cited as the definitive reference work on climate risk globally. With this as a starting point, it is easier for institutional investors in one region to learn from their peers in another. However, much of the progress has been made in the public market sphere simply because that is where most of the data reside. 

“Listed companies have been requested to publish climate-related data, for example by the Carbon Disclosure Project, for well over a decade. In private markets, having LPs address climate change issues is relatively new, so the sector is not used to providing carbon footprint or other climate-related data associated with funds or portfolio companies,” says David Russell, head of responsible investment at USS Investment Management, which runs a pension fund for university employees in the UK.

First State Super, which claims to be one of only two Australian superannuation funds with clear coal divestment and emissions reduction targets, is a case in point. Specifically, it plans to exit all businesses that get over 10% of their revenue from coal by October and achieve a 30% cut in emissions in its listed equities portfolio by 2023. It also wants to invest more in renewables, engage companies on low carbon transition strategies, and understand portfolio exposure to physical risks like severe weather events.

There are no numerical targets for other asset classes because they remain a work in progress. “We are looking at emissions reductions for the likes of real estate and infrastructure,” says Liza McDonald, head of responsible investments at First State Super. “There is more work to be done in the private equity space, but it’s a much easier conversation to have now with managers. There is a real dialogue as to what climate risk means and how it might manifest in portfolios.”

A survey is being prepared for all fund managers to assess where they are in terms of carbon footprinting. Most other Asian LPs are in a similar position. When the Asia Investor Group on Climate Change (AIGCC) – which promotes awareness of climate risks and opportunities among asset owners and financial institutions – polled its members last year, only about 30% of respondents had carbon footprints for PE compared to more than half for listed equities.

Drip down

Rebecca Mikula-Wright, executive director of AIGCC, notes it is logical for institutional investors to start with public market because data is more widely available and standardized. “It is beginning to trickle through to private markets in Asia as well,” she adds.

Asked which groups within Asia Pacific are most advanced in their climate change strategies, industry participants point to Singapore’s Temasek Holdings and the Japan’s Government Pension Investment Fund (GPIF). The former has pledged to halve portfolio emissions by 2030 and investigate how it can become carbon neutral. The latter benchmarks its public equities against low carbon indices and has started tracking the overall temperature of its portfolio. Insurance companies and banks are also singled out, as well as a handful of Australian superannuation funds.

A study published last year by China Water Risk, Manulife Asset Management and AIGCC, stressed that asset owners in the region must do more, given climate change poses grave economic threats to Asia. It made several recommendations: mapping out the physical risk exposure of portfolios to water shortages and extreme weather events; considering the potential impact of regulation on resource costs; creating diversified portfolios; and making sure companies track their own risks.

Limited internal resources are a longstanding impediment to execution. “There might have been one person covering ESG and trying to do everything from reporting to being involved in engagement with portfolio companies across all areas, including climate,” says Mikula-Wright. “Resource constraints are still an issue, but we are starting to see those team sizes increase.”

It goes hand-in-hand with having executive-level buy-in on climate-related initiatives. This helps establish a clear belief system around climate and its impact on the portfolio, making it easier to implement and scale coverage across asset classes without encountering internal roadblocks.

Dow of Paddington Finance believes the shift is inevitable, suggesting that Australian superannuation funds look to Australian Ethical as a model for hardwiring climate risk awareness in their DNA. “The largest Australian superfunds have quadrupled their resources covering ESG and climate change specifically,” he adds. “Their approaches will become more systemized. The box-ticking and list-checking, the non-meaningful processes and standards, they will fall by the wayside and you will see fundamental reporting rather than greenwashing.”

 

SIDEBAR: Engagement works? 

Royal Dutch Shell, Glencore, Xcel Energy, Maersk, Rio Tinto, Nestle, Volkswagen, Duke Energy Corporation, and HeidelbergCement. These are some of the companies that have made public commitments on climate change – including pledges to achieve net zero emissions by 2050 – as a result of shareholder engagement, according to Climate Action 100+, one of the largest initiatives in the space with more than 450 institutional investor signatories.

“Climate Action 100+ has produced significant results through collaborative engagement. Some ambitious commitments have been announced across several sectors, and investors will assess short and medium-term progress towards these targets” says Rebecca Mikula-Wright, executive director of the Asia Investor Group on Climate Change (AIGCC) and a steering committee member at Climate Action 100+. “We want a halo effect – it starts with a few companies and expands to others in their sector and region.”

The engagement model has its critics, notably those who argue that no amount of public or private cajoling could bring about change in a company that relies on fossil fuels for almost all its earnings. Investors respond by saying that they pick their battles carefully.

“Active engagement is a large component of what we are aiming to achieve in terms of emissions reductions. However, we cannot engage with companies that purely produce thermal coal about transitioning their business to a low carbon economy. Where a company has a more diverse set of energy sources – gas, renewables and coal – we can engage with them,” explains Liza McDonald, head of responsible investments at First State Super.

Moreover, if straight divestment is preferred to engagement, it can be disruptive if poorly managed. Various international climate change agreements include long-term adjustment curves that map out a gradual transition to a lower-carbon economy.

 

 

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• Topics
• LPs
• Regulation
• Cleantech
• Asia
• ESG
• Canada Pension Plan Investment Board (CPPIB)
• USS Investment Management
• HESTA
• First State Super