Business Leaders Information Centre
Climate change risk management
Prior to the UNFCCC COP21 in Paris December 2015, the global organisation, Principles for Responsible Investment issued ‘Fiduciary Duty in the 21st Century’ which stated that investors are required to integrate environment, social and governance (ESG) issues in order to mitigate risk and identify investment opportunities.
This development also came at a time of rapidly increasing awareness of climate risks, divestment from fossil fuel assets and trillions of dollars flowing into renewable energy and clean technologies.
Energetics’ Business Leaders Information Centre outlines the corporate governance issues for Boards and executives, and also describes the broader global climate change response: both from governments and business.
Key questions for business
Fiduciary duty: key issues and governance
Rising risk recognised: but when is the right time to move?
The debate in the financial community is not about the science of climate change and the timing of action to prevent dangerous levels of warming. Instead, the challenges lie in the timing of low carbon investments. The liquidity of institutional markets supports decisions over the short term which inherently conflicts with the longer term transition to a lower carbon economy.
The Paris Agreement, committing the world to limit global warming to 2°C, provides a clear market signal. Economies are, or will soon, transition to lower emissions. For Australia, Environment Minister, Greg Hunt signalled that the nation will achieve zero carbon emissions by the end of the century.
Yet this raises a further risk for institutional investors to manage. When will this be achieved? How fast will this occur? How does this transition impact my existing portfolio?
Regulatory and fiduciary responses: the example of France
The French government has recognised the issue of climate risk and has acted. France introduced a new law in July 2015, which strengthened mandatory climate disclosure requirements for listed companies. It introduced the first mandatory requirements for institutional investors as part of Article 173 of the Law for the Energy Transition and Green Growth. This decree requires greater transparency of climate related risks.
Australia has already updated the ASX’s Corporate Governance Council’s Corporate Governance Principles and Recommendations. The ASX guidance also reflects broader global concerns in the investment community around disclosure of risk. Specifically, recommendation 7.4 states: “A listed entity should disclose whether and if so how, it has regard to economic, environmental and social sustainability risks”. Whilst a broad recommendation, the intention is clear that businesses assess climate related risks.
Outcomes for investors and businesses
What is clear is that the world is transitioning to a lower carbon economy. For business, understanding how you fit within a 2°C economy will highlight any risks. The global transition will impact all businesses. The rate of change will continue to be debated. Business will continue to ask “How fast do I need to act?” What is clear is that investors do not need to provide advance warning of any divestment – it will just happen. Businesses need to be prepared for that moment.
“Failing to consider long-term investment value drivers, which include environmental, social and governance issues, in investment practice is a failure of fiduciary duty.” UNEP FI.
‘Carbon risk disclosure: a growing global movement with local implications’ Prior to the recent Australian Federal election, a Senate inquiry was underway into carbon asset risks and disclosure. It was established in recognition of the potential for climate risks to have 'destabilising impacts on financial systems'. Areas of concern being the adequacy of disclosures to mitigate financial risk; whether current voluntary disclosures are sufficient, and what, if any, policy response or oversight from Government is needed.
Global developments: changing investment trends
In a little over a year, the Montreal Carbon Pledge has been signed by investors controlling more than US$10 trillion in assets. The pledge requires large investors to commit to measuring and reporting the carbon footprint of their portfolios.
‘Is climate risk a ‘black swan’? As of December 2015 the total dollar value of institutional funds, currently earmarked for divestment is $3.4 trillion. In September 2014, this number sat at $50 billion. This is a 68 fold increase in potential divestment assets in little over 12 months.
Global developments: iconic businesses setting aggressive climate targets
COP21 saw iconic businesses commit to renewable energy and climate action through mechanisms such as RE100. During the Paris negotiations, more than 50 iconic brands pledged to go 100% renewable including Google, Adobe, BMW Group and Coca-Cola.
We Mean Business, a coalition through which more than 515 companies and investors have now committed to solid climate actions including science-based emissions reductions. The group represents $US19.8 trillion assets under management making commitments on climate action. Australia's Origin Energy became the world’s first energy company to sign up to all seven commitments. Other Australian companies include AGL, Westpac, ANZ Bank and nab are also signatories.
114 large corporations pledged to reduce emissions in accordance with the 2℃ objective. Ikea, Coca-Cola, Dell, General Mills, Kellogg, NRG Energy, Procter & Gamble, Sony and Wal-Mart are signatories and are implementing plans. Dell, for example, has pledged to reduce emissions from its facilities and logistics operations by 50% by 2020 (relative to 2011 levels), and to reduce the energy intensity of its product portfolio by 80% by 2020. Australian companies include Origin Energy, Westpac and Australian Ethical Investment.