Green finance: Europe gets serious

Recently published for Pensions for Purpose. Richard Folland and Shuen Chan reflect on the implications of two recent major reports for green finance.

The low-carbon transition is underway and – judging by the way that clean energy costs continue to fall and becoming increasingly competitive against fossil fuels – it is accelerating. However, this transition has to be funded. The scale of investment needed to meet the national emission reductions targets submitted to the Paris Climate Agreement (the Nationally Determined Contributions – NDCs) is estimated to be more than $3.5 trillion, and that doesn’t take into account developments in other areas such as infrastructure and agriculture.Ultimately, major flows of finance and investment will need to move from fossil fuels (“brown”) to low-carbon sources of energy (“green). Policymakers and markets have done much to disincentivise investing in brown (from regulating to phase out coal, to establishing carbon pricing schemes), although much more remains to be done. But since the Paris Agreement was signed in December 2015, there has been a growing recognition of the need to incentivise investing in the green. And Europe in particular has been getting serious.Since the start of 2018, two major reports have been published: one from the European Commission-appointed High Level Expert Group on Sustainable Finance (HLEG); the other, more recently, by the UK Government-appointed Green Finance Taskforce (GFT). The Commission has already responded to the HLEG; the UK Government may not reply substantively until much later in the year. But what both initiatives demonstrate is the recognition that, if the transition is to be funded in the narrow window that the climate science tells us it must, green finance can no longer be niche but must go mainstream.To take the HLEG report first, its recommendation on a green taxonomy – in effect an EU-wide classification for sustainable activities – is key, in order to set benchmark standards for green bonds and potentially other forms of low-carbon financing. The Commission in its sustainable finance action plan has acknowledged the importance of putting a taxonomy in place. The Commission also recognises that (as highlighted by Governor of the Bank of England Mark Carney in his landmark “Breaking the Tragedy of the Horizons” speech in 2015) the establishment of a long-term approach towards responsible investing will help influence attitudes and behaviour change in respect of climate change and the green economy. This is why the Commission has made it a priority – reflecting a thread that ran right through the HLEG –  to address the role of institutional investors through fiduciary duty and the disclosure of non-financial and material information (picking up on where the Taskforce on Climate-Related Disclosures (TCFD) left off).The UK GFT report similarly emphasizes the importance of mainstreaming the TCFD recommendations (which were endorsed in the Government’s Green Growth Strategy last autumn) and maintains that existing UK law and practice makes the disclosure of material climate-related risks mandatory. There is also a host of recommendations covering green finance: from highlighting the symbolic importance of the UK issuing a sovereign green bond to driving a market in green lending products. There is even, as has been mooted in European Commission circles, a suggestion that the Government should examine whether it is feasible to consider a regime for banks and insurers where there is a better reflection of the different financial risks associated with brown and green assets – the so-called “green supporting factor”.Of course Europe is not the only place where the action is. China has been commended for its international leadership on the development of green finance; domestically, it has established guidelines for “establishing a green financial system”. However, what marks out the EU, including the UK, on green finance is its ambition to make it a core part of the financial ecosystem – from both an opportunity and a risk perspective.2018 is an important year for action on climate change. In Poland in December, the international community will for the first time since Paris take stock of their collective progress against the NDC targets. Calls for greater ambition will probably accompany that stock take and be an important part of the story. Another key international meeting will take place in September this year, when Governor Jerry Brown will convene a meeting on global climate action where business and finance will play a central role. No doubt we will hear time and again from these meetings how the transition has to be financed if we are to stave off a world of 2 degrees-plus. It will therefore be essential to create a global green economy – right now, Europe (as London and Paris battle it out to be a global green finance hub) has given itself a good chance of showing the way.

The low-carbon transition and the disconnect between companies and their pension funds

May 2018 – Sustineri writes for The Aldersgate Group about the disconnect between corporates and their pension funds in the way they are approaching the low-carbon transition

There is growing evidence that business is serious about addressing the low-carbon transition. Over 100 companies now have approved science-based targets, i.e. they have set an emissions reduction target in line with accepted climate science. Even major fossil fuel companies are being more pro-active: witness Shell’s recent energy transition report, and Exxon’s 2 degrees C scenario analysis report (even if there remain major question marks about the assumptions the sector continues to make).

Action by corporates on climate change is of course vital. However, the institutional investor sector is equally important: mobilising their immense pools of capital will be fundamental to securing a low-carbon future for us all.

Action by pension funds – incorporating and mainstreaming the transition and its implications into the DNA of their investment practices – is something that we should all welcome. Public pension funds are in overall terms taking a greater interest in sustainable investment; but the same perhaps (although there will always be exceptions) can’t be said about corporate pension funds.

Transparency and corporate pension funds

Some fairly cursory research would indicate that there is a lack of transparency about how corporate pension funds approach climate and sustainability and general integration of Environmental, Social and Governance (ESG) factors into their investment process. Do they accept the scientific case? Would they agree, as Mark Carney argues, that climate change will have major implications for financial stability? Do they have the governance and risk frameworks – and the integrated expertise – to address this agenda? Are they selecting their investment managers based on specific criteria that address these risks? Where do they stand on initiatives such as the Climate Action100+, the global investor-led initiative to engage with the largest greenhouse gas emitters?

Overall, the most important question worth asking of pension funds is whether they have a policy on the transition. Enough guidance has now been published – from The Pensions Regulator to the industry-backed Taskforce on Climate-Related Financial Disclosures, which makes major recommendations on how institutional investors should address strategic, governance, risk management and targets considerations  – that, respectively, pension funds and the broader range of companies and investors should be taking climate risk seriously. So it ought to be a subject that is hard to ignore.

The other key question should probably be directed more at the corporate sector. They may well be taking action (including serious structural changes to their business model) on the transition; but are they in a dialogue with their pension fund, who may well be exacerbating the problem (eg by investing in more carbon-intensive stocks) that their parent corporate is trying to mitigate?

Food for thought

All this should give food for thought to the corporate sector and to the pension funds sector. But there are two other dimensions that they might care to consider.

First, the direction of travel on policy. In its response last month to its High-Level Group on Sustainable Finance (HLEG), the European Commission acknowledged the theme of fiduciary duty picked out by the HLEG. In its action plan, the Commission has therefore said that it plans to bring forward a proposal shortly to clarify investor duties – set within the context of fiduciary duty – and how they should consider sustainable finance within their asset allocation. The Green Finance Taskforce, which reported to the UK Government just before Easter, has been thinking along similar lines, recommending that regulations on fiduciary duty should clearly incorporate ESG issues.

But perhaps more importantly than that, corporates might reflect on whether their pension fund is adopting the types of values that their employees and beneficiaries would like to see. In its latest Global Shapers Survey (covering more than 30,000 individuals under 30 from 186 countries), the World Economic Forum says that, for young people, climate change and the destruction of nature is their number one global issue. The view of millennials is one reason why public sector pension funds are coming under increasing pressure from external groups and stakeholders – perhaps the time is approaching when corporate pension funds will also start to come under this spotlight too, and they can no longer hide behind the CSR practices of their corporate business.