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Esmé van Herwijnen: Climate change and why it matters to investment

27 Mar 2017 Expert insight

Esmé van Herwijnen states the case for why climate change should matter to charities.

Climate change is undeniably one of the biggest challenges of the 21st century and it is affecting our environment, society and economy. Current levels of greenhouse gas concentrations in the atmosphere are not sustainable, and they are rising. This upward trend means catastrophic global warming is unavoidable if current emission levels are not reduced. Weather patterns are expected to change, sea levels will rise, biodiversity will decline and populations will be affected – especially those who are already vulnerable.

The world is determined, however, to ensure that the increase in average global temperature is kept well below two degrees when compared to pre-industrial levels. This was agreed at the United Nations Climate Change Conference (COP21), in Paris in December 2015. Post COP21, 188 countries have committed to reducing their greenhouse gas emissions and the momentum from politicians, corporates and investors has been maintained. This is welcome given that the challenge is too big to be left to governments to solve on their own.

Investors have a crucial role and responsibility in tackling this issue as the text of the Paris agreement states that financial flows should be consistent with a pathway towards low greenhouse gas emissions and climate resilient development. Investors have already affirmed their commitment to a safer climate when in December 2015 over 120 global investors signed the Paris pledge for action during COP21. Over 1,300 non-party stakeholders signed the pledge in total. Nonetheless, this now needs to be reaffirmed in practice.

Why does climate change matter to charities?

We believe that companies that are not taking action to reduce their emissions could run into reputational, regulatory and financial difficulties in the future, which in turn will impact shareholder returns. Companies which proactively manage their environmental impact are more likely to be better positioned to adapt to a carbon-constrained world. We believe failure to consider climate change in portfolio construction could therefore negatively impact financial returns.

Charities with defined mission statements should consider whether their investments are in line with their objectives and ethical principles. Investments that conflict with a charity’s mission or values can cause severe reputational risk. Obvious examples include the exclusion of tobacco for health-oriented charities or a ban on weapons for charities focused on peace or emergency relief. It may be less obvious at first sight, but investments that contribute to climate change could easily be added to the list.

Climate change is not only an environmental issue, but also a social and an economic one. It should therefore be considered by a range of charities and not just those with an environmental focus. Climate change not only impacts the environment, it is much more complex. It is a human rights issue, especially for island nations that are at risk of rising sea levels and may become climate refugees. Additionally, it negatively impacts human health. In the UK alone, more than 50,000 deaths a year are estimated to be caused by air pollution, according to Dr Tim Chatterton and Prof Graham Parkhurst of the University of the West of England, Bristol. It is also likely to further increase inequalities, as climate change will mostly affect those who are vulnerable and unable to protect themselves.

A recent legal opinion in November 2015 highlighted that investments which have the possibility to alienate those who supposedly benefit from the charity’s work may represent a “latent conflict” with the charity’s mission. Christopher McCall QC, on behalf of Bates Wells Braithwaite, suggested that additional due diligence is required from charities when it comes to investing in companies that contribute to climate change. Specifically he stated: “The potential financial risks attaching to carbon-intensive assets are of such a nature and magnitude that they should at least be considered and assessed by any prudent charity trustee.”

Divestment and engagement on climate change

Fossil fuel extractives have received the highest level of scrutiny from civil society and NGOs. Various campaigns including 350.org and The Guardian’s ‘Keep it in the Ground’ have targeted investors and advocated fossil fuel divestment. Current fossil fuel reserves on the balance sheets of oil majors alone exceed the carbon budget needed to avoid global warming of two degrees. Technically these reserves are unburnable and therefore potentially represent stranded assets. To date 595 institutions have pledged to withdraw investment from fossil fuels, representing $3.4tn in total assets. Fossil fuel divestment certainly removes the exposure to carbon reserves, but despite growing momentum around divestment it is not the only question to ask. Our economies still heavily depend on fossil fuels and other sectors such as materials, industrials or consumer staples rely on oil, gas and coal for their operation. Utilities are also responsible for a large amount of greenhouse gas emissions. Engagement with the extractives sector has been another way for investors to raise their concerns and demand better reporting on risks and opportunities related to climate change. The ‘Aiming for A’ investor coalition, through shareholder resolutions filed at oil and mining companies, has been encouraging companies to prepare for a low-carbon transition and report publicly on their portfolio resilience.

The extractives sector is, however, not the only sector responsible for climate change and divestment from oil majors does not make a portfolio fossil-free and certainly not carbon-free. Investment strategies that exclude extractives can still be harmful and generate greenhouse gases as most companies have a carbon footprint. Conducting a portfolio carbon footprint of investments is key in order to understand and manage risks in a carbon-constrained world.

Conducting a carbon footprint of EdenTree portfolios revealed some surprises. For instance, the emissions are highly concentrated and a handful of companies in a variety of sectors including utilities, paper and pulp, waste management and cement are responsible for the majority of them.

The carbon footprint also revealed the added value from stock picking. Investing in emission-intensive sectors such as utilities or materials did not prevent the funds’ outperformance on greenhouse gases. Selecting the right companies that have strong ESG performance can help ensure that the company’s carbon footprint is managed and reducing. More interestingly it became the starting point of detailed engagement with the largest emitters in the funds in order to understand how they are managing their impact and how they aim to reduce it in the future.

What more can charities do?

More tools are becoming available and an increasing number of investor initiatives address the materiality of climate change and greenhouse gases. This also means that it becomes easier for charities to challenge their managers. Trustees should ask their managers whether they have signed up to the Montréal pledge – a voluntary commitment by investors to monitor and publicly report the emissions related to their investments – and challenge them on their climate change positions. Charities should also review how their managers voted on climaterelated resolutions and whether they supported shareholder resolutions asking for improved reporting on climate change risks such as the Aiming for A resolutions. Charities also have the ability to participate in public policy debate by joining like-minded investors in groups such as IIGCC (Institutional Investors Group on Climate Change), which aims to encourage public policies that address long-term risks and opportunities associated with climate change.

With more than 55 countries that account for over 55 per cent of global greenhouse gas emissions having accepted and signed the Paris agreement, this agreement has now been ratified and subsequently can be enforced. It is clear that the reduction of greenhouse emissions can no longer be avoided – how will your charity respond?

Esmé van Herwijnen is responsible investment analyst at EdenTree

Civil Society Media wishes to thank EdenTree for its support with this article

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