Four Key Issues
The last decade was hotter than any other period in the previous 125,000 years, attributable to rising greenhouse gas (GHG) emissions — principally carbon dioxide, methane and nitrous oxide — primarily released from the combustion of coal, oil and gas. Although these fossil fuels have powered dramatic economic progress in the global economy over the past hundred years, they have also increased the concentration of CO2 in the atmosphere, causing global warming. This, in turn, has contributed towards drought, famine, rising sea levels, extreme weather events, flash floods, all causing property damage and severe dislocation within communities — all with increasing frequency.
In a joint effort KPMG International, CREATE-Research, and Chartered Alternative Investment Analyst (CAIA) Association examine in detail the role of capital markets in the transition to a low-carbon world. The report, “Can Capital Markets Save the Planet?” investigates the experiences to date of climate investing and the changes we can expect in the next 3 years, as we move towards a new investment paradigm. The research includes insights from 90 institutional investors, alternative investment managers, long only managers and pension consultants in 20 countries in all the key regions.
Download the new report from KPMG International, CREATE-Research and CAIA Association.
The research highlights four key issues:
- What is the current state of organization’s progress with respect to climate investing?
- Based on organization’s experiences so far, are global capital markets adequately factoring climate risks in securities prices?
- Are capital markets likely to accelerate the pricing process, in response to Covid-19, and COP26?
- Over the next 3 years, which asset classes are likely to advance further in pricing climate risks?
Climate change heralds the birth of a new investment belief
There has been an unprecedented global surge in climate-related disasters since 2019. Wet places are getting wetter and dry places drier.
There is a responsible investment agreement among Dutch pension plans. Whole portfolios, apart from sovereign bonds, are targeted at climate action. Regulatory requirements aside, climate change has forced a shift in our own investment beliefs that is shaped by adaptive learning.
First, global warming is happening and is approaching an irreversible tipping point. This presents risks and opportunities. Their scale and timelines are hard to predict because there are too many interdependencies. Things will evolve and we shall adapt as companies are exposed to a vastly different world to the one they have known.
Second, as owners of shares in a company, we are not held responsible for its actions. But that does not absolve us of our moral responsibility when its activities cause uncompensated harm to wider society. As ‘universal owners’ we have stakes in thousands of companies, so we are indirectly responsible for their carbon pollution. Divesting our shares does not reduce it.
So, we see stewardship as a powerful tool. It means active engagement on climate and other strategic issues in order to improve the quality of our alpha and beta assets. Using the Global Reporting Initiative Standards, we focus on narrative disclosures that highlight real-life stories of the challenges, actions and outcomes behind the dry numbers in regulatory filings. We are acting as long-term owners of businesses, rather than holders of paper assets.
A Dutch pension plan
Already have a mature approach to climate investing or are in the process of implementing one via active management
Believe that active stewardship is the linchpin of progress towards a greener planet
Target good risk-adjusted long-term returns from climate investing
Target a double bottom line: doing well financially and doing good environmentally
Capital markets can’t easily detect risks and opportunities, until they are clear on how governmental actions will create hard incentives as well as sanctions.
The average person doesn’t know what COP26 is
We are starting to show interest in climate risks and the opportunities they present.
Also, thus far, there is inconsistency between those already hit by climate change — via rising sea levels, hurricanes, wildfires, droughts — and those who are not. Until the effects are felt more widely, change will be slow. The change in administration in the US is less important than the effect of the media in shaping public opinion positively towards the Biden agenda and the critical role of COP26. People need to be convinced that these are transformational initiatives that will improve their daily lives.
Encouraging the right behaviors will require carbon taxes and subsidies for renewables. But the overly partisan approach in the US remains a big hurdle. As an endowment, we have a 25-year horizon versus the four years of a presidential term. For their part, regulators operate in a different timeframe depending on who’s in office. You need consistent policy, since price signals are super important. But these are not easy to detect in today’s divisive political environment in the US.
A US university endowment fund
Believe that markets are pricing in climate risks in public equities with a further 33% believing that they are doing so only selectively
Believe that markets are pricing in climate risks in alternative investments with a further 28% believing that they are doing so only selectively
Believe that markets are pricing in climate risks in bonds with a further 25% believing that they are doing so only selectively
Attribute this slower progress to weaker policy signals from governments and regulators worldwide
Our best hope is that the pandemic and climate action become part of the same story — one of human ingenuity in the face of acute adversity.
Rate as ‘high’ or ‘medium’ the likelihood that the new US administration will drive concerted international efforts
Rate as ‘high’ or ‘medium’ the likelihood that COP26 will drive concerted international efforts
Rate as ‘high’ or ‘medium’ the likelihood that Covid-19 will drive concerted international efforts
Anticipate fresh policy momentum towards ‘clean’ energy standards
The price discovery process will get fresh signals
Financial markets struggle to price in slow-burn issues that do not grab regular media headlines. The underlying transmission mechanism from climate change to value creation has remained unclear without greater clarity on complex feedback loops involving two mutually reinforcing value drivers. On the public policy side, they cover international actions on carbon pricing, energy standards, subsidies on green energy, and mandatory carbon disclosure within a well defined taxonomy.
On the innovation side, they cover breakthrough advances in the newly emerging fields of renewable energy, hydrogen, energy storage batteries, carbon offsets and carbon capture systems. In market economies, predicting the
We are no longer peering through the mist, however. America rejoining the Paris accord is a game changer. The deliberations at COP26 will face fewer impediments, given the global economic heft of the US The pace of progress may be slow, as too many parties are involved and each has their own vested interests to protect. But the direction of travel will be a lot clearer for innovators and investors alike.
In the meantime, we have been capturing alpha returns by focusing on companies with good and/or rising ESG scores that are overlooked by exclusionary screening that avoids the ‘sinners’ and ignores future ‘winners’. We expect a bigger and faster reallocation of capital towards green projects in private and public markets alike.
A French asset manager
Say ‘yes’ or ‘maybe’ to the prospect of further progress in factoring climate risks in securities prices
Anticipate that equities will progress towards pricing climate risks
Anticipate that alternative investments will progress towards pricing climate risks
Anticipate that bonds will progress towards pricing climate risks
Capital markets alone cannot resolve the market failure and market inefficiency associated with climate change. Rechannelling trillions of dollars of capital toward the technologies needed to power a low-carbon economy requires huge concerted action as well as incentives. As the aphorism goes, the best way to predict the future is to invent it. Investors can only do that if they foresee potential benefits. What they need most is policy certainty. Without it, some fear a ‘Minsky moment’: a collapse in securities’ prices due to sudden panic at some future date as risks are allowed to build up. Or, as the former governor of the Bank of England Mark Carney stated in 2015: “Once climate change becomes a defining issue for financial stability, it may already be too late.”
Interested in learning more? Download the full report for the full findings.