For all the environmental, social and governance (ESG) challenges companies face today, there is one which unites them all – a challenge dwarfing all others in its urgency. ‘E’ for the environment. ‘E’ for the elephant in the room. ‘E’ for the emergency we all now face: the failure of our fossil-fuel civilisation to address climate change.
The urgent threat of global warming demands a revolution in our energy systems. We are already late – but not too late. As asset managers and investors, we still have the power to change the world by helping to shift trillions of dollars towards climate-friendly investments.
Accepting the challenge1
By providing for the limiting of global warming to “well below 2°C above pre-industrial levels” and to “pursue efforts to limit the increase in temperatures to 1.5°C”, the 2015 Paris Agreement committed 195 countries to radical and meaningful change in their emissions and climate policies.
Thanks to the work done by organisations such as CDP (formerly the Carbon Disclosure Project), the Taskforce for Climate-Related Financial Disclosures (TCFD) and the Science Based Targets (SBT) Initiative, there is now a framework for calculating, forecasting and disclosing data on companies’ carbon emissions. SBTs in particular make the link between a company’s projected CO2 emissions and its temperature impact.
Linking an investment portfolio to a specific temperature figure is an extremely simple measure for investors big and small to grasp. Sadly, the figures don’t make for pleasant reading. All major equity benchmarks currently imply temperature rises of around 4°C or more – a disastrous outcome for the planet.2
Climate benchmarks: the missing link
Right now, the EU is updating its benchmark regulations to force index creators to disclose whether existing benchmarks are aligned with the Paris Agreement’s warming targets.
Alongside this, the EU is endorsing the creation of Climate Transition Benchmarks (CTB) and Paris-Aligned Benchmarks (PAB). These benchmarks will make it much simpler to create investment instruments which comply with the Agreement’s temperature targets.
CTB and PAB labels could become as commonplace as organic labels for food products, and serve a similar purpose – a quick way to see if something is being done properly or is “clean”. The indirect effect will be to stigmatise “dirty” indices, including most major benchmarks still used by investors.
The EU’s benchmark regulation changes could start an investing revolution, and lead to a world in which equity flows and company valuations are dependent on carbon footprint.
A virtuous circle
Publishing the temperature scenarios of the major benchmarks will affect almost everybody: institutions and big-name brands, fund and wealth managers, private banks and advisory networks. Each could become associated with a certain temperature scenario and a de facto position on climate change by clients, prospects and even the media.
Amid such scrutiny, we’d expect institutions to start migrating their investments towards CTBs or PABs. Meanwhile, if company valuations are influenced by carbon footprint, we’d expect shareholders to pressure management teams to hasten their energy transition. We could see a race to the bottom of the thermometer.
Thus, a virtuous circle is born, fuelled by forward-looking regulation and the court of public opinion.
The highway to transition
We believe a quantitative, rules-based approach is the best way to employ the enormous and growing quantity of climate data now available. The world’s leading index companies agree: S&P and MSCI have been building their climate expertise through corporate acquisitions, and are now sharing it in climate indices eligible for the EU’s CTB and PAB labels.
Of course, just building these indices isn’t enough. Investors must actually use them. Shifting money en masse to these indices is what will help turn the tide.
‘Investment influencers’ and early adopters can play a key role: it would only take a few sizeable, active and engaged asset owners to seed certain climate ETFs, and prompt many others to follow – others who lack the time and resource to build their own climate-friendly portfolios.
Once in a lifetime
We’re on the cusp of a paradigm shift for listed markets comparable to the rise of the digital age. The sweeping changes to benchmark regulations could be the catalyst for a cleaner, greener future.
Everyone can play a part in this revolution, from the world’s biggest asset owners to the individual investor planning for retirement. One person clicking that button and moving their savings into a climate-action fund or ETF would be far more impactful than that same person quitting flying, or using public transport, or becoming a vegan.3 What happens if millions of us do it?
Never think it’s too late. Never believe your contribution is too small. Never say never. We all have the power to change the world.
12015 Paris agreement.
2Source: EU Technical Expert Group (TEG) on Sustainable Finance Interim Report on Climate Benchmarks, June 2019.
3Source: Nordea’s illustrative analysis on carbon footprint from savings
