Climate change moves to top of investors' list of ESG issues

As institutional investors spend an increasing amount of time thinking about environmental, social and governance risks and strategies for dealing with them, the issue of climate change continues to push its way to the top of the list.

According to the U.S. SIF Foundation's biennial Report on U.S. Sustainable, Responsible and Impact Investing Trends, released late last year, "climate change/carbon" was the top ESG criterion for money managers representing $3 trillion in assets and the third-biggest issue for institutional investors with a collective $2.24 trillion in assets.

Climate change made a dramatic jump to first from third place in the latest Extreme Risks report from Willis Towers Watson Investments' Thinking Ahead Institute. "We now think it's more likely, and the climate science is also worse," said Tim Hodgson, London-based head of the Thinking Ahead Institute.

A discouraging report from the Asset Owners Disclosure Project in 2018 found that 63 of the world's 100 largest public pension funds have "little or no strategy" for managing climate change's impact on their portfolios.

But that may be changing.

"Climate change is clearly on the minds of institutional investors all around the world, for a variety of reasons," said Amit Bouri, CEO of the non-profit Global Impact Investing Network in New York. "I think fundamentally the driver of interest among institutional investors is the recognition that if you are seeking long-term financial stability, you have to think about climate change. There is a growing recognition that it is a source of risk, and if you're paying attention to financial performance, you need to pay attention to climate risk."

Leadership on climate risk and other sustainable investing issues from the largest institutional investors, such as Japan's ¥159.2 trillion ($1.5 trillion) Government Pension Investment Fund, Tokyo, and Norway's 9.16 trillion Norwegian kroner ($1 trillion) Government Pension Fund Global, Olso, "is rippling through the markets," Mr. Bouri said.

"We see U.S. pension funds and insurance companies ramping up significantly. There is a lot activity to look at ESG impacts in their portfolio. They want to make sure they are not just managing risk, but also putting their money to work where they see opportunities," he said.

In North America, geography can make the difference when it comes to regulatory and political climates, said Rob Rowan, director of the CFA Society of New York, who works with asset owners. "In the U.S., we have less regulation and maybe not a clear message from beneficiaries," said Mr. Rowan, who notes that Canadian pension fund beneficiaries "have made it a high priority and (the funds) have moved very quickly."

In June, the C$201.4 billion ($151.2 billion) Ontario Teachers' Pension Plan, Toronto, released its first climate change report on how it integrates climate factors into investment decisions and engages with companies, partners and policymakers. Calling climate change "one of the biggest and most daunting challenges facing the world," Barbara Zvan, chief risk and strategy officer, said in the report that actively managing the related opportunities and risks is central to its investment strategy "and will be a critical factor to our future success."

OTPP officials say they will analyze the potential impacts of climate change at the individual investments and total portfolio levels.

In the U.S., public pension fund action on climate change seems to be happening primarily on the coasts, with California and New York at the forefront.

In June, New York state Comptroller Thomas P. DiNapoli released a Climate Action Plan to address "increasingly dire" warnings about climate risk. Officials with the $216.2 billion New York State Common Retirement Fund, Albany, will start by setting standards for thermal coal companies and then other major industries that present climate risk. Those failing to meet the standards could face divestment.

To Mr. DiNapoli, the sole trustee of the pension fund, it is about mitigating climate risk while capitalizing on opportunities in the growing low-carbon economy, with plans to double the current $10 billion commitment to a climate solutions program over the next decade. The fund will also continue engaging with companies to encourage climate risk management, evaluate external managers for their climate-related strategies, and encourage index providers to integrate climate risks and opportunities.

The $378.4 billion California Public Employees' Retirement System, Sacramento, and investment management firm Wellington Management Co., now have a framework to help companies assess and disclose the potential risks of climate change on their business and help asset owners and investment managers better evaluate how the companies they hold will be able to adapt to risks.

The $241.3 billion California State Teachers' Retirement System, West Sacramento, has a $2.5 billion program to invest in the stock of companies with low-carbon emissions while also monitoring its external equity managers to see that they are incorporating sustainability factors in making investment decisions.

CalSTRS officials who see such steps as fulfilling their fiduciary duty to plan beneficiaries, are also part of a global coalition of investors and are engaging with major fossil-fuel companies to advance a transition to a low-carbon economy.

Formalized carbon-pricing-friendly language in its investment policy makes clear that the investment committee "needs to … consider actions we can take to mitigate (climate change) risk and identify related investment opportunities."

One clear U.S. and global trend is investor demand for sustainable reporting, with emphasis on performance and transparency. Remy Briand, head of ESG at MSCI Inc., sees a growing focus on investors' climate risk management practices and disclosures, along with increased demand for standardized metrics across various strategies and markets in Europe and the North America. "Climate-related risks pose a potential threat to the long-term resilience of investment portfolios," he said.

"A lot of it is fundamental bottom-up decisions," said Sarah Bratton, an investment director for sustainability for Schroders PLC in New York who works with institutional clients. "You are getting some louder voices in the U.S. and globally on holding these companies accountable."

To Mr. Hodgson of Willis Towers Watson Investments' Thinking Ahead Institute, an essential question when it comes to climate change is, " 'Is the investment industry going to be a spectator or a participant?' European asset owners and managers are leading that conversation, but the U.K. may be catching up, and in the U.S., people do seem to be open to talking about it," he said.

"There is not a lot of action, but it means that the conversation moves on. Europe has basically accepted that climate change is a thing and we now need to move onto the next phase," Mr. Hodgson said.

While there are a lot of things to sort out, including how changing portfolios to address climate change will mesh with fiduciary duty, he said, "I think the issue is going to boil down to, how much of the current value of our portfolio are we willing to destroy in order to save the rest of the portfolio?"