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Climate Change and Asset Management

J.S. Held’s Inaugural Global Risk Report Examines Potential Business Risks & Opportunities in 2024

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Introduction

Climate risk is forcing investors and money managers to rethink investments as scientists warn of the dire impact of a warming world. Climate risk is now widely considered to be a form of investment risk. It has been over two years since Larry Fink, the Chairman and Chief Executive Officer of BlackRock, called for a “fundamental reshaping of finance” in his annual letter to CEOs. As the largest asset manager in the world, BlackRock’s letter has helped to serve as a template for how the asset management industry has approached shareholder engagement including voting on shareholder resolutions and electing board directors.

While climate risk is not the only sustainability issue that companies need to be concerned with, in recent years, it has been the primary focus for investors. This is largely a result of the significant projected climate change impacts on biodiversity and ecosystems, as well as the potential for financial losses as government policy inevitably begins to accelerates the transition to a low-carbon economy. BlackRock notes that as a fiduciary, they have a responsibility to ensure that clients can navigate this transition. Confronting climate change is not optional. Every government, company, and shareholder must take notice.

In this article, we look to provide readers with an overview of some of the challenges associated with integrating climate risk considerations into sustainable investment funds. We provide an overview of investor-led sustainability organizations and reporting frameworks relevant to asset managers. Companies should seek to understand the sustainability-related issues facing the asset-management industry since their environmental claims depend on the performance of their underlying holdings. In other words, it makes sense for companies to understand what shareholders are looking for in sustainability-related disclosure and performance so they can calibrate their actions accordingly. After all, the shareholders (many of which are large asset-management firms) own the company and will have the final say in how management will evaluate, manage, and disclose sustainability-related risks.

Challenges in Sustainable Investment Reporting

Asset managers, like Blackrock, have moved to adopt climate disclosure frameworks and low-carbon investment strategies in response to public pressure, regulatory scrutiny, and environmental concerns. However, there remains an absence of a clear definition for what truly constitutes a sustainable investment. There is also a great deal of difficulty in obtaining accurate and comparable climate-related metrics from public companies in their reported disclosure. Environmental, Social, and Governance (ESG) performance means different things to different people. What is good for the environment may have inherent trade-offs with societal good. Even within the environment category of ESG, there are trade-offs. For example, utility scale solar installations may reduce carbon emissions, but have an outsized impact on land-use and wildlife habitat conservation.

There is no clear answer to the question of which ESG metric is the most important. Prioritizing a certain set of ESG indicators is really more of a human values issue than an objective truth. But whose values should prevail, and what set of ESG metrics should be prioritized? This will vary depending on what ESG standard-setting organization you are using. As a result, there is a wide variation in ESG ratings and scores for any single company. The variation depends on who is doing the assessment and values they have embedded into their disclosure templates. This lack of standardization can leave individuals and investors looking to compare sustainability performance across companies bewildered.

In addition to the problem of values-based subjectivity, there is also an issue associated with information quality. Disclosure is only useful to investors when information is accurate and defined consistently. In the absence of consistent definitions, investors have trouble assessing the true climate-related risk of a company's business activities. Investors often cope with this limitation by creating their own internal policies and frameworks rather than relying on external guidance. This practice is acknowledged by the Basel Committee on Banking Supervision, which, in 2021, published a report on climate-related financial risk measurement methodologies. Among other findings, the report highlights the necessity of using granular and forward-looking measurement methodologies to assess climate-related financial risk. This indicates that a standardized climate-risk disclosure framework may actually be a false hope. There is no substitute for high quality investment analysis. The Basel Committee report also encourages investors to use new and unique types of data to assess both physical and transition risk, and to translate climate adjusted economic risk factors into financial risk factors.

Asset managers that do not conduct proper due diligence on holdings that are marketed as climate-friendly face the risk of being accused of greenwashing. Greenwashing is a term used to describe a company or fund that markets itself as low carbon, but in fact does not actually incorporate practices to minimize adverse environmental impacts. Greenwashing presents two risks to asset managers:

  1. it results in the loss of investor confidence; and
  2. it can potentially attract regulatory action.

Recent media reports have highlighted that some sustainability funds are filled with companies that emit high amounts of carbon or are engaged in socially destructive business activities. There is an ongoing debate as to whether financing firms involved in fossil fuel extraction helps or hinders sustainability efforts. Some argue that divestment is urgent, while others take the view that investors should not withdraw funding from fossil fuel firms because it is the energy incumbents that are best positioned to transition the energy system to green sources of power. Much like ESG performance ratings, greenwashing is hard to define consistently.

Sustainable Investment Organizations

Among the many challenges facing sustainability focused investors is the abundance of international disclosure frameworks. While the disclosure landscape is difficult to navigate, each of these standards was developed with good intensions to serve a niche in the marketplace. Below we highlight some of the leading and most influential disclosure frameworks used by asset managers and corporations providing sustainability disclosure.

Principles of Responsible Investment is an organization that has the goal of incorporating sustainability issues into mainstream investment practice. The principles that guide the organization's work include incorporating ESG issues into investment analysis and decision-making, and incorporating ESG issues into ownership practices and policies.

Ceres Investor Network looks to make the financial business case for sustainability performance. This includes not just a focus on climate, but also water and other natural resources. The organization has the objective of accelerating sustainable capital markets, and in the Ceres Ambition 2030 initiative, they outline their goal of decarbonizing the six highest emitting sectors by coordinating engagements, delivering science-based research, leading global initiatives, and mobilizing advocacy campaigns.

Climate Action 100+ has three primary goals:

  1. implement a strong climate change governance framework;
  2. encourage large emitters to take action to reduce value chain emission; and
  3. provide stakeholders with enhanced climate disclosure.

The Net Zero Asset Managers Initiative is a group of asset managers that support the goal of net zero greenhouse gas emissions by 2050 or earlier to avoid the catastrophic climate impacts of exceeding global warming of 1.5 degrees Celsius. The group is committed to supporting investments that align with this goal.

Glasgow Financial Alliance for Net Zero (GFANZ) was launched in April 2020 by Mark Carney, UN Special Envoy for Climate Action and Finance, and UK Prime Minister, Boris Johnson, ahead of the United Nations climate conference known as COP26. The alliance represents asset managers responsible for over $130 trillion in assets. The group supports new financial regulation that will enable a net-zero transition. The group also supports the ending of fossil fuel subsidies, introducing global carbon pricing, mandatory transition plans for public and private companies, the ending of illegal deforestation, and a just transition.

Reporting Frameworks

Given that sustainability-related disclosure at the fund-level depends on data provided by companies or issuers, the lack of standardized and consistent data is a significant challenge for the asset management industry. Companies are disclosing different amounts of information and reporting on different types of metrics. In addition to this, companies are also reporting under a range of different methodologies which may or may not be verified by a third party. Here, we highlight two of the leading frameworks in the space, the Task Force on Climate-Related Financial Disclosures (TCFD) and the International Sustainability Standards Board (ISSB).

The TCFD was created by the Financial Stability Board (FSB) in 2015 and seeks to promote consistent and comparable climate-related disclosures across all sectors. The framework is likely the most widely endorsed climate change reporting framework. The TCFD recommends that companies report on:

  1. the organization's governance related to climate-risk;
  2. how climate-related risks and opportunities are integrated into business strategy;
  3. how the company identifies and manages climate-related risks; and
  4. how climate-related metrics and targets are used within the company.

The Group of Five—comprised of the CDP (formerly known as the Carbon Disclosure Project), the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the Value Reporting Foundation (VR), and the Sustainability Accounting Standards Board (SASB) have integrated the four pillars of the TCFD Recommendations into their own reporting methodologies. As a result, companies that report to any one of the Group of Five can claim TCFD-compliance.

During the 2021 UN Global summit in Glasgow, the IFRS Foundation announced the formation of the ISSB. The ISSB has the goal of developing comprehensive baseline sustainability disclosure standards. The IFRS also announced a commitment to consolidate the Group of Five into the ISSB. The IFRS has published a prototype of climate and general disclosure requirements that recommend that asset managers disclose:

  1. assets under management that integrate ESG issues, sustainability themed investing, and ESG-screening;
  2. a description of its approach to incorporate ESG into investment and wealth management; and
  3. a description of proxy voting and investor engagement policies and procedures.

Conclusion

The measures that investment managers are implementing with regard to climate-risk measurement and disclosure are not optional. Climate-risk will increasingly be placed at the center of the investment process. This includes integration of climate into portfolio construction and risk management, the development of new investment products that avoid investing in fossil fuels, and engagement with shareholders to ensure commitment to sustainability and transparency. Additionally, and most significantly, asset managers may divest of investments that are deemed to present a high degree of sustainability-related risk.

If a company fails to provide a robust disclosure on sustainability-related risk, investors will assume that the risk is not being adequately managed. To compel a company to provide adequate risk disclosure, investors are increasingly willing to vote against management and board directors that are not making progress on climate-related disclosures. In short, climate-risk disclosure is no-longer voluntary, so start preparing today.

Acknowledgments

We would like to thank Steven Andersen for providing insights and expertise that greatly assisted this research.

Steven Andersen is a Senior Vice President in J.S. Held’s Environmental, Health, and Safety (EHS) practice. Steven has spent over 17 years in the EHS industry, with specific experience in air emissions management systems, information management systems, and data integration. He commonly fills the role of sponsor on large scale implementation projects, consults on Environmental, Social, and Governance (ESG) strategy and data management, and has performed the role of solution architect on many air emissions system implementations. As the founder and chief executive officer (CEO) of Frostbyte Consulting, Steven was responsible for strategy, partnerships, and business development. Under Steven’s leadership, Frostbyte grew into a company that delivers ESG and EHS advisory and information systems globally across all industry sectors.

Steven can be reached at [email protected] or +1 368 209 1012.

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This publication is for educational and general information purposes only. It may contain errors and is provided as is. It is not intended as specific advice, legal, or otherwise. Opinions and views are not necessarily those of J.S. Held or its affiliates and it should not be presumed that J.S. Held subscribes to any particular method, interpretation, or analysis merely because it appears in this publication. We disclaim any representation and/or warranty regarding the accuracy, timeliness, quality, or applicability of any of the contents. You should not act, or fail to act, in reliance on this publication and we disclaim all liability in respect to such actions or failure to act. We assume no responsibility for information contained in this publication and disclaim all liability and damages in respect to such information. This publication is not a substitute for competent legal advice. The content herein may be updated or otherwise modified without notice.

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