New York fund takes long road on fossil fuels

When the New York State Teachers' Retirement System, Albany, announced its strategy last month for fossil fuel investing, the decision represented a delicate balancing act between environmental stewardship and fiduciary responsibility.

The highlights of the Dec. 28 announcement included divesting $66.3 million in thermal coal assets "in a timely and prudent manner" and freezing $1.04 billion in certain investments covering thermal coal, oil, gas and oil sands. The pension system has $3.8 billion in fossil fuel investments — or 2.7% of total plan assets — based on the Global Industry Classification Standard asset categories provided by MSCI Inc. and S&P Dow Jones Indices LLC.

The pension system's strategy was the product of 16 months of research and the hiring of consultants, plus meetings with legislators, state regulators and environmentalists.

The common theme of those meetings was to explain how the pension system's governing board "was thoughtfully and diligently going through a deliberative process to consider complex ESG matters and how they relate to the system's long-term investments and the board's fiduciary responsibility," said Thomas K. Lee, the executive director and CIO of the $148.1 billion pension system, in an interview.

In addition, Mr. Lee said, "The board was evaluating the long-term economic risks facing the companies in the fossil fuel industry and the long-term risks they pose to the system's investment in such companies."

In discussions with state legislators who want the pension system to move faster and more comprehensively to divest from fossil fuel investments, "we did not disagree with the intent of the legislation," Mr. Lee said. "We explained our fiduciary responsibility."

In fact, the environmental stewardship guidelines covering coal, oil and gas in the pension system's ESG strategy are almost identical to the carbon dioxide risk and fossil fuel revenue percentages outlined in legislators' divestiture bills. The pension system's environmental criteria cover certain investments in oil sands companies. The Assembly and Senate bills don't cite oil sands.

And in his "multiple meetings" with environmentalists, "I wanted to convey to them that this is a complex issue and that the board has its process," said Mr. Lee, adding that he emphasized to them the board's acknowledgment of climate risk.

One of the earliest steps in NYSTRS' research was the system's investment advisory committee meeting with environmentalists, including Divest NY, to discuss fossil fuel investments.

The pension system hasn't yet disclosed the names of the companies covered by the divestment announcement or the companies in which investments have been frozen.

In its Dec. 28 report to the state Legislature, the pension system said companies subject to divestment are those that derive more than 10% of revenue from thermal coal.

The frozen investments, the report added, are placed on a restricted list that includes:

The 10 largest companies in its portfolio that have more than 0.3 gigaton of potential carbon dioxide emissions from thermal coal reserves.

The 10 largest holdings in companies that derive more than 20% of their revenue from oil and gas or have more than 0.1 gigaton of potential carbon dioxide emissions from oil and gas reserves.

Companies that derive more than 10% of their revenue from activities related to oil sands.

The initial foray into fossil fuel divesting and investing restrictions reflected both an assessment of staff resources and a focus on large fossil fuel companies in which many of NYSTRS pension fund peers also have invested, he said.

As for encouraging companies in the restricted list to improve their environmental efforts, "we're still on the engagement path," Mr. Lee said. The board hasn't publicized a strategy on what happens if engagement isn't successful.

The Dec. 28 report to the Legislature also said the pension system will revise its stock proxy voting policy "to more clearly articulate" efforts to "affect climate-friendly change" among the system's holdings. The report didn't provide a specific timetable for divesting, details about the engagement process or details about the proxy voting policy. The pension fund's governing board is expected to discuss these issues at its Jan. 27 quarterly meeting.

The pension system began examining the financial impact of fossil fuel investing in March 2019 when the board's investment committee members met with a Goldman Sachs research executive on how energy companies can adapt to climate change and with executives of S&P Dow Jones Indices about low-carbon investment strategies, according to a timeline presented by the board to the state Legislature.

Intensive efforts began in September 2020 when investment committee members met with environmentalists about fossil fuel divestment and also with an executive of BlackRock Inc. about sustainable investing.

After that, members of the board and/or its investment advisory committee met nearly every month on the subject with representatives from firms that included Mercer, its ESG consultant; Reed Smith LLP, its fiduciary consultant; Callan LLC, its general investment consultant; and some of its asset managers.

Among the topics discussed: fossil fuel divestment; proxy voting guidelines; ESG investment processes; the geopolitics of energy transition; climate risk assessments; the integration of climate data into the investment process; and disclosure of sustainable investing.

Staff members also consulted with state legislators who have introduced fossil fuel divestment bills, and they discussed ESG investing with organizations such as the climate advocacy group Ceres, of which the pension system is a member.

They also discussed the issues with officials at the $267.8 billion New York State Common Retirement Fund, Albany, and the $270.7 billion New York City Retirement Systems, which have already launched fossil fuel divestment and engagement policies.

A few months before the Dec. 28 announcement, the pension system held a virtual meeting with officials of the New York Department of Financial Services, including Nina Chen, director of sustainability and climate initiatives, Mr. Lee said. The department conducts an audit of NYSTRS every five years, and the latest audit is scheduled to start this month. Climate change is a new feature of the review.

They discussed the department's role "in supporting pension plans assessing the financial risks from climate change and how such risk assessment can best be integrated into the governance structure, business strategies and risk management framework" of pensions plans, Mr. Lee said of the Sept. 8 meeting. "System staff also discussed the climate action plan being deliberated by the board."

On Dec. 20, eight days before the pension system unveiled its ESG strategy, several environmental groups filed a complaint with the Department of Financial Services accusing the system of failing to manage climate risk, adding that it "may be in breach" of state insurance regulations and a state law covering retirement. The groups asked the department in its audit to make sure the pension system develops and implements "a comprehensive and transparent plan to prudently divest from fossil fuels."

Mr. Lee, who said he was surprised by the complaint, noted that the department hasn't given the pension system clearance to publicize its formal response. "We welcome any recommendations" from the department, he said.