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Climate change becoming mainstream consideration for asset owners

For the world's biggest institutional investors, climate change has evolved quickly in recent years from a theoretical threat to one demanding a fiduciary response.

It's an open question whether that has made climate change a mainstream investment risk yet, but market veterans agree that the 1 years since almost 200 nations signed the Paris climate agreement — targeting a ceiling of 2 degrees Celsius increase for global temperatures — have seen the world's highest-profile asset owners broadly embrace that goal.

“It feels like over the last 18 months there's been a substantial shift. It will be interesting in a few years' time to see whether 2017 was the tipping point,” said Emma Herd, Sydney-based CEO of Australia's Investor Group on Climate Change.

The shift in the climate change debate over the past couple of years has been transformational, even if it's too early to call it entirely mainstream, said Jennifer Anderson, London-based investment officer in charge of responsible investing with the 9 billion ($11.6 billion) multiemployer TPT Retirement Solutions, Leeds, England. “Now it's increasingly spoken about as an investment risk,” she said.

The past few weeks have seen major milestones in the climate change debate — including landmark shareholder votes backed by the U.S.' biggest pension funds and money managers, calling on oil giants Exxon Mobil Corp. and Occidental Petroleum Corp. to provide disclosure regarding the climate-related risks they face, as well as President Donald Trump's decision to pull the U.S. from the 2015 Paris accord.

On balance, observers say climate risk should continue to move up the list of institutional investor priorities as markets focus more on what needs to happen — in terms of government policies and market-driven changes — to stay within the Paris accord's 2-degree ceiling target.

Regional differences persist, even if the top funds in almost every corner of the globe — including Japan's 144.8 trillion ($1.3 trillion) Government Pension Investment Fund, Tokyo; the $322.3 billion California Public Employees' Retirement System, Sacramento; the $206.5 billion California State Teachers' Retirement System, West Sacramento; and the $192 billion New York State Common Retirement Fund, Albany — have accepted climate change as a risk.


Taking steps to insulate institutional portfolios from climate risks is fast becoming mainstream, something that couldn't have been said even two years ago, said Frederic Samama, Paris-based deputy global head of institutional and sovereign clients with Amundi Asset Management. But it's further along in Europe, where the issue really took root first, he said.

Likewise, Australia's almost $2 trillion retirement market is one where the belief among asset owners and policymakers that climate change poses a “material financial risk” can be called mainstream, said Nicki Ashton, Sydney-based head of strategic partnerships with Russell Investments in Australia.

Ms. Ashton pointed to a February speech in Sydney by Geoff Summerhayes, executive board member of the Australian Prudential Regulation Authority, which oversees the country's superannuation funds, as evidence of the inflection point climate change has reached in terms of the fiduciary responsibilities of retirement overseers.

In that speech, Mr. Summerhayes said it's no longer the case that climate-related risk can be dismissed as “a future problem or a non-financial problem.” Some climate risks “are distinctly 'financial' in nature. Many … are foreseeable, material and actionable now,” he warned, according to a transcript of the speech posted on the APRA website.

For the most part, market players said the U.S. and Asia remain behind Europe and Australia in addressing climate change risks, even if the number of asset owners studying the issue is growing in all parts of the world.

Nascent science

Still, the science of insulating institutional portfolios from climate-related risks remains nascent.

There's “very broad interest” in climate change among institutional investors but most are just starting to look into the impact of climate change risks on their investments, said Alexis Cheang, Sydney-based senior responsible investment consultant with Mercer Investments.

In that sense, interest in the topic can be called mainstream but “now the question is 'what are you going to do about it?'” said Ms. Cheang.

The foundations needed to arrive at answers to that question are being put in place, some argue.

Ms. Herd, noting the inevitable lag from when asset owners begin thinking about an issue and when they're prepared to talk publicly about their conclusions, said “we're seeing more and more mainstream asset owners developing policies and principals that articulate what their views are (in) managing these issues.”

A couple of years ago, investors were talking about climate change but now, increasingly, they're becoming full engaged – trying to understand when they buy XYZ company at A$12, what are the underlying assumptions in that share price, what are the resources being developed and which of those reserves could end up being stranded, said Ian Woods, head of ESG investment research with AMP Capital Investors Ltd., Sydney.

Meanwhile, both TPT's Ms. Anderson and Ms. Herd pointed to the profusion of climate-related strategies — mostly passive — being brought to market by money managers over the past year or so as another sign of an investment idea whose time has come.

UBS Asset Management, Amundi Asset Management and Legal & General Investment Management are among the global money managers that have introduced low-carbon strategies, developed in tandem with major institutional investors, over the past 18 months.

Robert Fowler, HESTA executive – investment execution with the A$39 billion ($29.5 billion) Health Employees Superannuation Trust Australia, said in an interview that Melbourne-based HESTA's conviction that it had to prepare for better market pricing of climate change risk led it 18 months ago to introduce, in tandem with Russell Investments, a custom low-carbon global equities index strategy aimed at halving the carbon footprint of its MSCI benchmark.

'Stranded asset' risks

Among other things, the strategy is designed to consider the “stranded asset” risks energy companies could face should government steps to limit global temperature rises leave them holding fossil-fuel reserves they won't be able to exploit, said Mr. Fowler. “If we do see a stronger regulatory response globally, we'll have a portfolio in place” positioned to perform relatively well in that low-carbon environment, he said.

In a separate interview, Scott Bennett, Seattle-based director, equity strategy and research with Russell Investments, said eight months after the HESTA strategy went live, “material changes” were introduced to focus more on climate-related opportunities as well as risks, such as favoring energy companies with greater reliance on renewable energy sources.

Russell runs that particular strategy, in separate accounts, for big clients in Europe, North America and the Asia-Pacific region as well now, but in August it will introduce a pooled vehicle in Europe and Australia to meet growing demand from smaller institutional investors in those regions, said Ms. Ashton, in the same interview.

While the pooled vehicle won't be offered in North America at this time, Mr. Bennett said Russell executives believe it's just a matter of time before demand for its low-carbon strategies broadens there as well.

Mr. Samama said Amundi launched open-end funds and an ETF for its low-carbon strategies since 2014, and they now account for more than €750 million of the firm's e4.6 billion low carbon business as of March 31. The remainder is mainly in separate accounts.

Mr. Bennett predicted the recommendations the Financial Stability Board's Taskforce on Climate-related Financial Disclosures is due to announce to G-20 leaders in late June could provide the framework needed for asset owners to take the “rich mosaic” of disclosure data and “come up with some robust insights.”

The promise of that report, meanwhile, might rest in part on the fact that it focuses as much on opportunities asset owners should look to take advantage of in the transition to a low-carbon economy as on the risks they should look to avoid, analysts say.

Previously, disclosure had the aura of a “penalty function,” used to identify “companies we want to avoid having exposure to,” but the TCFD report's focus on investment opportunities will give firms added incentives, for example, to boost the share of renewables in their energy products, he said.