How Should Investors Manage the Risk of

Runaway Climate Change?

BMW  Founda+on    

Raj  Thamotheram,  CEO,  Preventable  Surprises    (with  thanks  to  Howard  Covington  &  Robert  Schwarz)  

   23rd  October  2014    

Ignorance is not bliss!:

Climate Change (CC) threatens the core business model of investors:

The consequences for collective inaction will be very serious

“If we were told - in any sphere - that we had at least a 90% chance of averting disaster through changes we ourselves could make, wouldn’t we take action?”

- Olympia Snow - former U.S. Senator representing Maine

Climate scientists agree:

Temperature Rise Relevance Tangible Negative Outcomes0 Pre-industrial base level None

0.8°C (1.4°F) Current level Local & sporadic1°C (1.8°F) Maximum Climate Scientists say is prudent Local & sporadic2°C (3.6°F) Maximum gov'ts have vowed to permit Regional & sporadic

3°C to 4°C (5.4°F to 7.2°F) Likely to occur by 2100 Regional & persistent

4°C (7.2°F)Likely to trigger rolling collapse of

regional economies, societies and statesGlobal, persistent and material as a

fraction of gross world product

5°C to 6°C (9.0°F to 10.8°F)Upper-end projections in the absence of

immediate mitigation measuresGlobal, persistent and large as afraction of gross world product

Inflection Point - Inflection Point - Inflection Point - Inflection Point - Inflection Point - Inflection Point

Security specialists agree:

Climate change is… “a ‘threat multiplier’ because it has the potential to exacerbate many of the challenges we are dealing with today – from infectious disease to terrorism….. Politics or ideology must not get in the way of sound planning.” - Chuck Hagel, US Defense Secretary

“ABC” investor imperatives:

A. Understand the nature of Climate Change

B. Evaluate the associated investment risks

C. Determine how to avoid portfolio losses

http://www.reversethefuture.org/discussions/47/resource-efficiency-shareholder-value/ (29:15)

Change is possible

Like most other corporate pension funds – incl sustainability leaders – Unilever used to have many

reasons why it could not invest sustainably. That has now changed with its pension fund joining PRI and it

is now reporting out-performance from its ESG investing.

De-carbonise the global economy:

²  Low carbon development paths are possible

²  ~ 50 year timeline demands beginning within 10 years

²  Technology has a large role in adaptation & mitigation

²  Valuations will adjust as CC plays out for better or worse ²  Proactive policy and economic and social stability are key

A paradigm change is needed:

Future

Present

Transition state:

10 – 50 years

Uncertainty

High volatility

Investors must actively demand de-carbonisation, a shift to RE and

BE POSITIONED TO CAPITALIZE

Tough decisions:

Balance risk & return

Technology bets (CCS & geo engineering)

Value alignment

2015 Paris climate conference is critical: ²  A robust policy agreement to keep warming < 2 degrees will

result in FF “stranded assets”

²  FF’s power renders such an agreement is quite unlikely

²  An agreement that keeps warming <4 degrees is more likely

²  But that kind of policy creates a high risk of “rolling collapses” and virtually certain “delay & panic” scenarios

²  Current choices appears to be either: put at risk ~ US $10 Tn in FF in the short-term or put at risk ~ $70 Tn in non FF sectors in the medium to long term

²  There are no non-radical options left to consider; the “procrastinators penalty” has well and truly kicked in

Likely responses to climate change:

Scenario Defining Characteristic

Rapid Decarbonization Climate Change effects peak in the 2020s

Lucky Break Climate Change is not as bad as we expected

Delay and PanicClimate Change is worse than we expected, which results frantic

acts of adaptation and mitigation

Rolling Collapse4°C or more of warming disrupts economic, social, and political

systems while global asset values crash

Prognosis for investors:

²  ‘BAU +’ is the norm despite growing investor appreciation for CC

²  IEA figures show that only 5 -10% of US $1 Tn/yr needed to de-carbonise has been committed

²  Investors haven’t acknowledged that emissions per unit of world GDP have to fall 6%/yr. through 2100 to stay within 2 degrees

²  Few are actively supporting political efforts to hold warming to 2°C (vested FF interests have much greater influence)

²  A “delay then panic” scenario accompanied by economic, social, and political turmoil remains the most likely outcome

²  FFs are needed for a transition to REs

²  FF company push back against deep change & have captured politics

²  Investor engagement so far has been ineffectual

²  And investors continue to take baby-steps

Market realities demand new thinking:

A simple “divestment – reinvestment”

strategy won’t, by itself, work!

Practical issues get in the way: Do the Math: The Alternative Energy Matrix

Mind the gap!

Many practical considerations:

Blue (+1) Yellow (0) Red (−1)

NB: FFs beat alternatives:

•  Rough adjustment ahead

•  Lots of electricity sources

•  Few transportation options

Chart created for “Do the Math” each topic has its own blog page

Thanks to Tom Murphy, UCSD

The ONLY realistic solution is to catalyse an energy sector transformation:

1.  Raise FF’s cost of capital by opposing investments that have a high risk of stranded assets

2.  Demand FF companies de-carbonise at needed pace (how is up to companies to decide)

3.  Lower RE’s cost of capital by encouraging viable new companies and projects

4.  Push regulators, legislators, and leaders to facilitate a transition from FF to RE

http://www.abc.net.au/news/2013-11-13/bhp-criticised-for-backing-carbon-change/5088774

Divested from coal and oil sands companies and speak out against projects likely to be stranded.

Coordinated research that resulted in 50% of participants committing to consider climate risk in its asset allocations.

Raise FF’s cost of capital:

Lower renewables’ cost of capital: Mobilizing US $100 trillion bond market to support of a

rapid transition to a low-carbon an economy

Lobby companies & legislators: “The longer we take on achieving final clarity on policy, the more the risk goes up for investors and it is in the investor community interest to have policy sooner rather than later.” “A key first step in support of the UN Secretary-General’s Summit would be for asset owners and managers to request that all companies within their portfolios end the practice of spending shareholder funds on opposing government clean energy policies and action nationally and globally on climate change.”

Christiana Figueres, Executive Secretary

18  

Now we need to grow our ambitions:

ESG professionals, themselves, agree: ²  Integration of FF and CC risks is weak

²  Investors are poor stewards of corporate & market health

²  More criticism of investors is needed to trigger change

“Talking about climate change in terms of [US] averages is like saying, ‘My head is in the refrigerator, and my feet are in the

oven, so overall I’m average.” - Tom Steyer

http://www.responsible-investor.com/images/uploads/articles/RI_Divestment_Survey_.pdf  

²  98% say investors are not doing enough to evaluate and integrate the risk of FF exposure and CC into valuations and buy-sell decisions [Q2]

²  Stewardship: 94% say investors are not doing enough to safeguard corporate and market health [Q3]

²  3 of the top 4 things that investors should do to have maximum impact are about lobbying (ie where funds are weakest in practice) [Q8]

²  Is the criticism of investors fair? 53% say yes. 40% say the criticism is too light! [Q4]

²  Strong support for public reporting & accountability (which contrasts with organisational views) - 93% partially or fully agreed that “public accountability with a methodology independent of investor control is a good thing” [Q10]

ESG staff: an honest self audit:

http://www.responsible-investor.com/images/uploads/articles/RI_Divestment_Survey_.pdf

ESG staff: an honest self audit: ²  Even though they are divided about whether divestment will help in the

real world [Q6], 49% agreed fully and 34% agreed partially that campaigns gives ESG professionals more internal space to manoeuvre [Q7]

²  Very bullish about climate bonds: 88% strongly or partially disagreed with the comment that there’s nothing new about climate bonds or fundamentally flawed [Q18]

²  NGOs and the media are the most effective agent for change, whilst investment CEOs the least [Q9]

²  Biggest block to stronger action is investor short-termism and how performance is measured and rewarded [Q5]

²  Long-termism ranks highly in solutions [Q8]

http://www.responsible-investor.com/images/uploads/articles/RI_Divestment_Survey_.pdf

Biggest challenge = weak stewardship:

Issues: ²  Short-termism and a focus

on relative returns cause ‘preventable surprises’

²  Responsibility is delegated to roles with little influence on traditional investment processes and practices

²  Risk management is more about CYA than about managing members’ risks

Shockingly negligent pockets:

Serious enough for systemic risk regulators to engage

NGOs are now really targetting finance :

http://oxfamblogs.org/fp2p/why-social-entrepreneurship-has-become-a-distraction-its-mainstream-capitalism-that-needs-to-change/  

Social entrepreneurship isn’t a panacea:

More INTRA-preneurship is what’s needed:

“In short, it's in the mainstream economy that many of our next generation impact leaders should be training. It's in the mainstream economy where most of the current jobs reside. And it's from the mainstream economy that the next impact leaders might emerge. Now, we just have to start teaching those intra-preneurial skills.”  

What needs to be done now:

1) Much better top-down support - including “aircover”, project funding etc. – from trustees, directors, CEOs, and CIOs of institutional investors, starting now and maintained for at least 10 years.

2) Much more assertive and collaborative stewardship – possibly a dedicated “engagement overlay provider” – to deliver necessary corporate change. Enough corporate tummy tickling! Think hedge funds!

3) Much stronger push to get credit rating agencies, sell side research, investment consultants, auditors, and lawyers to mainstream climate risk as part of their “day job,” i.e. no more “bolt-ons”!

“Hidden” information intermediaries:

Companies

Pension Funds

Investment Consultants

Investment Managers

Sell-side Analysts

Credit Rating

Agencies

Fees Deals

Selection

Returns

Fees

Brokering

Information

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

Lawyers &

Auditors

A question for us all:

As social entrepreneurs, ESG professionals, consumers, and

citizens, what can we do to encourage institutional investors to

rise to this challenge so they are more “fit for purpose”?

If you want more info….

Thank you.

Any questions?