Originally published in Investment Magazine (May 2019)

 

Uncertainty does not excuse inaction

Climate change is the greatest ESG challenge facing investors today. The World Economic Forum rates ‘extreme weather events’ and ‘failure to mitigate or adapt to climate change’ as two of its top global risks. In recent times, all three of Australia’s financial regulators – APRA, ASIC and the RBA, have acknowledged the potential magnitude of climate-related impacts.

Investors need regulatory certainty to deploy capital. The policy uncertainty that has plagued Australia for more than a decade has delayed much needed investment in projects to support the transition to a low carbon economy. This notwithstanding, there is sufficient evidence that the financial risks of climate change will materialize.

Earlier this year, climate change claimed its first bankruptcy in United States (US) utilities company, PG&E Corp. The company estimated that it faces a US$30 billion liability from two years of wildfires, the intensity of which has been blamed on worsening droughts linked to global warming.

The law, traditionally slow to respond to societal change, is showing a willingness to recognise causation. The recent NSW Land and Environment Court’s decision to oppose the Rocky Hill open-cut mine in part due to potential emissions and climate change impacts is a bell-weather for the future.

One notable development overseas is Juliana v the United States and the concept of inter-generational equity. The plaintiffs in this case assert that the US Government has failed in its obligations to protect the environment. Initially regarded as a long-shot, the case has since gathered momentum, with one Federal Court judge saying, “I have no doubt that the right to a climate system capable of sustaining human life is fundamental to a free and ordered society.”

Closer to home, it is inevitable that our Australian regulators’ current stance of encouraging climate-risk disclosure will harden towards mandatory disclosure – for businesses and ultimately investors. Therefore, uncertainty over long-term policy settings is not an excuse for doing nothing. Investors must ready themselves to respond.

Investors can take action now

Climate change risks are deeply embedded in the financial system and apply beyond extractive companies and energy utilities. Large asset owners invest over long-term horizons and universally across the economy. Consequently, it is essential that they fully understand their risk exposure.

What investors need is better and more reliable data to price climate risk into their investment decisions. This was recognised in the recently revised ASX Corporate Governance Principles and Recommendations which provide that:

“A listed entity should disclose whether it has any material exposure to environmental or social risks and, if it does, how it manages or intends to manage those risks” (Recommendation 7.4).

The ASX Corporate Governance Council encourages entities that do not believe they are materially exposed to “consider carefully their basis for that belief and to benchmark their disclosures in this regard against those made by their peers.”

Investors should ensure they have sufficient information from investee companies to understand whether a company can:

  1. Successfully identify and manage the climate change risks and opportunities it faces.
  2. Demonstrate future viability and resilience by testing business strategy against a range of plausible but divergent climate futures.
  3. Achieve cost savings through efficiencies and identify low carbon opportunities.

Investors should make clear their expectation that companies will make substantive improvements in their climate-related reporting. We recommend that companies with material exposures use the Taskforce on Climate-related Financial Disclosure (TCFD) framework for risk assessment and reporting. It’s worth noting that the United Nations’ Principles for Responsible Investment (PRI) has announced that TCFD-based reporting will be mandatory for PRI signatories from 2020.

Investors also need to be mindful of the need to address adverse impacts to local workforces and economies as the transition to a low carbon world occurs. Currently done on an ad hoc basis, we need economy-wide solutions for affected communities and regions. Investors should inquire about a company’s strategy to ensure a just transition.

At the same time, large asset owners and managers should demonstrate good practice when it comes to climate change disclosure. They should publicly report on:

  • The fund's position on climate change
  • How the fund incorporates climate change in its decision making
  • The key priorities and actions of the fund
  • Case studies in relation to the fund’s actions.

Change is coming

One day, I anticipate that climate consideration will be a mainstay of investing. Investors will tailor their investments and fulfil their stewardship obligations through better quality and more widely available performance data, superior data analytics and more informed judgements of companies’ climate resilience.

Although ACSI would welcome legislative or regulatory clarification of the need to consider climate change risks and opportunities, investors do not need this to act. Besides, it is highly likely that it will be the weight of money, spurred on by consumer expectations and investor demand, that finally forces politicians to act on climate change. If investors respond now, we may well end up leading the way.  

 

Louise Davidson, CEO, Australian Council of Superannuation Investors