In America, the world’s largest economy and its second biggest polluter, climate change is becoming hard to ignore. Extreme weather has grown more frequent. In November wildfires scorched California; last week Chicago was colder than parts of Mars. Scientists are sounding the alarm more urgently and people have noticed—73% of Americans polled by Yale University late last year said that climate change is real. The left of the Democratic Party wants to put a “Green New Deal” at the heart of the election in 2020. As expectations shift, the private sector is showing signs of adapting. Last year around 20 coal mines shut. Fund managers are prodding firms to become greener. Warren Buffett, no sucker for fads, is staking $30bn on clean energy and Elon Musk plans to fill America’s highways with electric cars.
Yet amid the clamour is a single, jarring truth. Demand for oil is rising and the energy industry, in America and globally, is planning multi-trillion-dollar investments to satisfy it. No firm embodies this strategy better than ExxonMobil, the giant that rivals admire and green activists love to hate. As our briefing explains, it plans to pump 25% more oil and gas in 2025 than in 2017. If the rest of the industry pursues even modest growth, the consequence for the climate could be disastrous.
The International Organization of Securities Commissions (IOSCO) is this month publishing a statement setting out the importance for issuers of considering the inclusion of environmental, social and governance (ESG) matters when disclosing information material to investors’ decisions.
The statement does not supersede existing laws, regulations, guidance or standards or relevant regulatory or supervisory frameworks in specific jurisdictions, or any IOSCO Principles.
As underlined by IOSCO in its Objectives and Principles of Securities Regulation, securities regulation has three key objectives: protecting investors, ensuring that markets are fair, efficient, and transparent, and reducing systemic risk. IOSCO Principle 16 states that issuers should provide “full, accurate, and timely disclosure of financial results, risk, and other information which is material to investors’ decisions.” With regard to this Principle, IOSCO emphasizes that ESG matters, though sometimes characterized as non-financial, may have a material short-term and long-term impact on the business operations of the issuers as well as on risks and returns for investors and their investment and voting decisions.
II. Developments in the disclosure of ESG information
Disclosure of ESG information in the market has increased in recent years. Examples of ESG matters that issuers are disclosing include environmental factors related to sustainability and climate change, social factors including labor practices and diversity, and general governance- related factors that have a material impact on the issuer’s business.
PG&E Corp.’s PCG 13.68% bankruptcy could mark a business milestone: the first major corporate casualty of climate change. Few people expect it will be the last.
California’s largest utility was overwhelmed by rapid climatic changes as a prolonged drought dried out much of the state and decimated forests, dramatically increasing the risk of fire. On Monday, PG&E said it planned to file for Chapter 11 protection by month’s end, citing an estimated $30 billion in liabilities and 750 lawsuits from wildfires potentially caused by its power lines.
The PG&E bankruptcy could be a wake-up call for corporations, forcing them to expand how they think about climate-related risks, management consultants and other experts said.
Previously, companies mainly worried over risks from new governmental regulations related to climate change, said Christophe Brognaux, a managing director at Boston Consulting Group. The PG&E case makes clear that companies also have to worry about sudden, and potentially unexpected, impacts to their core assets and liabilities, he added.
“Physical risks have only recently manifested themselves. This is a fairly new development,” said Bruce Usher, a professor at Columbia University’s business school who teaches a course on climate and finance. “If you are not already considering extreme weather and other climatic events as one of many risk factors affecting business today, you are not doing your job.”
This, Cohen believes, will ultimately lead to an impact ecosystem that has the potential to cover all major assets classes and create the emergence of a multitrillion-dollar market within the next 10 to 12 years.So, if you add it all up, we are talking about tens of trillions, perhaps $30 trillion by 2030.”
Impact investing has been gaining traction over the last decade, as investors, consumers, and—to an extent—policymakers come to recognise that new ideas are needed in order to address some of the largest societal and environmental challenges facing humankind.
However, as is often the case with new ideas, impact investing continues to face big challenges and misconceptions. How to actually define this type of investing is one of those challenges, while the biggest obstacle perhaps remains the general belief that doing good with investments will almost always result in lower-than-market-rate returns.
But according to Cohen, at least, the scepticism is due to a somewhat dogmatic approach by traditional practitioners. “Many people have the notion that optimising risk and return is sacrosanct, and therefore refuse to even contemplate any alteration to the system which might affect their two dimensions of the decision-making process.
“The reason I am putting weight behind this is that if we can apply the usual tools of financial analysis—such as price-earning ratios and return on equity—on an impact-weighted basis, then we will have the most versatile set of tools to be able to make comparisons between companies. This is a huge, but totally achievable goal.”
According to Cohen, the impact revolution will be driven to a large extent by consumers, contributors to pension funds and asset owners. Living in times of systemic challenges such as extreme poverty, geopolitical tensions and environmental disruption on a global scale appears to be leading a growing part of the western population to question, if not outright challenge, the status quo.
This, Cohen believes, will ultimately lead to an impact ecosystem that has the potential to cover all major assets classes and create the emergence of a multitrillion-dollar market within the next 10 to 12 years.
“This is not a dream. If you look at the potential application of agreed impact principles across all asset classes, the numbers are absolutely huge. It is not a stretch to imagine that in a few years’ time a small percentage of the public markets, government and corporate debt, private equity and venture capital will all be investing under the agreed impact principals. So, if you add it all up, we are talking about tens of trillions, perhaps $30 trillion by 2030.”
In the coming months, we call on governments, the global business community and financial executives to work with us to help build on these successes with three objectives in mind: First, mobilize public investments in combination with private capital flows to support vulnerable countries and communities. Second, ask companies how they manage climate risks while anticipating the opportunities of a low-carbon future. Third, promote standardized methods for climate-related disclosure and investment decision-making.
As the person who leads the organisation behind the finance industry’s main professional qualification, I am frequently questioned about how the investment profession can more clearly demonstrate its mission of fostering business growth and generating prosperity.
The bigger question underlying these concerns is a simple one: what is finance for?
One possible way in which our profession can prove purpose is through greater focus on environmental, social and governance (ESG) investing. ESG investing is growing in popularity but still divides opinion on its merits.
Some argue, for example, that applying ESG factors to investing constitutes undue activism and may breach an asset manager’s duty to focus solely on investment returns.
However, integrating material ESG data into the investment process is about taking a more complete approach to understanding the environment and social impact, both positive and negative, that a company can have on the wider world.
This reality is becoming increasingly clear to professionals in the financial markets, although we are, as yet, far from a consensus view on how to integrate these factors into formulating an investment thesis.
We must work harder to quantify the benefits of ESG investing, so that we can accelerate its adoption into mainstream practices.
A recent survey of CFA Institute members based largely in Europe, The Evolving Future of ESG Integration in Investment Analysis, reveals a growing conviction that the investment management industry has a responsibility to consider ESG information as part of its analysis.
In fact, a full 85 per cent of respondents now believe it appropriate for institutional investors to take ESG factors into account when making investment decisions.
The fact that a fund manager’s fiduciary duty is not compromised by the inclusion of material ESG data in the investment process needs to be reinforced.
Analysing any public company is not only about the potential financial returns to shareholders. It is about the social and environmental factors that both affect the business and that the company’s operations can also shape.
While these so-called externalities present challenges to financial analysts who are tasked with valuing them, ignoring them fails to account for the true cost they may have on society, the economy and, ultimately, on our investments.
Take smoking for example. According to a World Health Organization (WHO) report in 2017, smoking and its side effects costs the world’s economies more than $1tn every year.
Climate change will carry an even bigger cost to society. According to the UN Intergovernmental Panel on Climate Change, extreme weather and the health impact of burning fossil fuels have cost the American economy at least $240bn a year over the past decade.
This burden will rise by 50 per cent in the coming decade alone. By 2030, the report estimates that the loss of productivity caused by a hotter world could cost the global economy $2tn.
These are material numbers in any context. Timely, consistent and comparable information will allow governments and investors to set a proper price on the externalities that flow from a company’s operations for which it is currently not charged.
Fortunately, some in the industry are placing a stake in the ground: BlackRock is forecasting that the ESG investment market will grow 16-fold, from $25bn to $400bn, over the next decade.
Anne Richards, who over the summer was named as chief executive of Fidelity International, recently called for investment management firms to adopt ESG considerations as part of a much broader set of performance metrics.
Governments across Europe and the European Commission itself are actively considering how they can create an environment that promotes ESG considerations.
The next generation of investors, and a growing number in this generation, will not accept the absence of precise quantitative frameworks as an excuse for inactivity.
They are demanding that the investment industry responds to their desire to proactively address some of society’s most intractable problems. This will take vision.
Our profession relies overly much on historical data to inform its future investment decisions. This framework is not appropriate for challenges whose impacts are so difficult to quantify with certainty. Judgment and courage are required.
It brings us back to that question: what is finance for? Answering it to our clients’ satisfaction will mean showing them that it is for the ultimate benefit of society.
The tipping point for ESG is coming.
Paul Smith is president and chief executive of CFA Institute
In the past, the words ESG and Responsible Investing were primarily understood in terms of clients’ ethical value judgements—and were often deemed as potential detriments to performance. However, an increasing number of the managers we surveyed have adapted their understanding of ESG and now see ESG factor assessment as an integral part of their risk management exercises. In our opinion, this makes sense, because capital appreciation opportunities are typically much more limited for bond investments than for stock investments—making downside management a crucial component of bond investing.