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1. How did
you become involved in the study?
We were approached to do it by the Universities Superannuation Scheme (USS), which is responsible for the pensions of the teachers in the higher education sector of the United Kingdom, and is one of the largest pension funds in the country. It decided that it should take a lead in investigating corporate performance on social responsibility issues (eg treatment of workers, harmfulness of products) and the implications for long term investors like pension funds, which direct much of their assets into the corporate sector. USS chose to tackle Climate Change first, because it has the potential to be a source of considerable opportunity and risk for the corporate sector, from the point of impacts (adaptation) and also from government policy aimed at abating greenhouse gases (mitigation).
Mark Mansley had already written
a study of the longterm financial risks to the carbon fuel industry, while
I had been publicly involved for 15 years in looking at the implications
of Climate Change for the financial sector, particularly the insurance
industry, and we have both contributed to the major IPCC reports on Climate
Change. The fact that we had established reputations in the field made
us obvious candidates for the study.
2. What was the aim of the study?
The study was to identify the implications
of climate change for the corporate sector, and how this might affect longterm
investors in that area. It was then to suggest possible actions that pension
funds might take, either collectively or individually, to safeguard the
interests of their members.
3. How important is the institutional investment sector?
The size varies enormously around
the world, because nations handle the issue of funding financial support
for the retired differently. The assets controlled by institutional investors
like pension funds and insurance companies globally currently amount to
around $24 trillion, and much of that money is invested in property and
corporate assets, not only in government stock. Given the trend towards
an older population, and the popular reluctance to pay higher taxes, it
seems certain that the size of pre-funded pensions will grow even further.
4. What are the main risks that institutional investors will face in the near future?
Institutional investors and pension funds in particular, aim to provide pensions and other benefits to their members through longterm management of their money. Because of their sheer size, they have to invest these funds widely, across the whole economy, so that they are really "universal investors". If climate change threatens economic development significantly, either by direct damage from the altered climate, or through the diversion or inefficient use of resources to lessen these threats, then that means that the expected returns from the investments will be compromised.
Looking at impacts first, figures from global reinsurers like Munich Re show that the economic cost of natural disasters has been rising exponentially, at over 10% per year. Historically, most of this was due to the generally unsustainable nature of economic development, not because of climate change, but climate change is now starting to have a distinct effect on economic and ecological systems. Even without climate change therefore, we face great problems, particularly in poorer countries. The likelihood is that global warming will exacerbate these trends seriously, and my own projections suggest that on current trends the cost of natural disasters, including extreme weather events like droughts, floods, and storms, could wipe out economic production by the middle of this century. Scientists also warn that there could be major "discontinuities" in the progress of global warming, through the demise of tropical rain forests, or the cessation of important ocean currents. All of these possibilities of course pose a threat to economic and political stability, and are therefore contrary to the basic aim of a longterm investor.
Secondly, looking at greenhouse gas
emissions policy, the absence of a global longterm strategy to deal with
the problem is a great concern. It means that when society finally wakens
up to the problem of climate change, then it will be as a result of a crisis
situation, so there will be draconian measures to tackle fossil fuel consumption
urgently. This will result in economic disruption, and will mean that much
of the investment in "carbon" technologies will have to be discarded before
those assets are due to be replaced. It will also mean that the new technologies
will not be developed carefully and so mistakes will be made that could
have been avoided with proper research and development. In that scenario,
it is evident that companies that are dependent on carbon-heavy products
and technologies are likely to perform badly. If some nations (like the
EU) try to avoid this situation by earlier action, then they face the potential
of putting their industries at a competitive disadvantage to those using
carbon technologies, which is also a risk for investors!
5. How will the action points in the recommendations address these?
There are ten action points for institutional investors, and they fall under five main strategies:
6. Where do
you see the greatest ecological and social benefits from the involvement
of institutional investors?
Such benefits will be indirect, because institutions deal with financial matters. However, already in the UK and Germany I think too, the trustees of pension funds must state how "soft" issues are taken account of in their investment policy. It is no longer acceptable to say that only financial security and financial returns are considered. With regard to climate change, of course if we can slow it down or stop it, then that means that the natural environment will not be irreversibly changed, so that rare habitats and species will be preserved for posterity.
Also, it is clear that the countries which are most at risk are not the rich OECD members, but the poorer nations. So again, the indirect benefits of abating climate change will reach them. In fact, if we can develop clean sources of energy such as wind, geothermal and solar power, there could be even greater benefits for those countries, because they will no longer need to import expensive carbon energy, and they could avoid the problems of pollution, and, with decentralised power units, the social problems of urban slums and rural poverty.
Finally, if we can prevent climate
change, that will provide a far more secure world for the members of pension
funds and their families to live in. What is the point of saving for the
future, if the future is made worse by our very investments?
7. What has happened since the study was completed?
Concretely, not much has changed
yet. What the study has done is to begin the process of getting the investment
community to realise that the issue of climate change is relevant to
them, and then do something about it. In the UK, USS has begun
discussions with a number of other institutional investors about how to
take forward the ten action points. In the USA, CERES (Coalition for Environmentally
Responsible Economies) commissioned Innovest, a respected research consultancy
for the investment industry, to carry out a similar study to our one. This
has just been published, and recommends that investors and company
directors should take a much more responsible line on climate change
than has been customary in the USA, for the same reasons that we found.
The UNEP Financial Institutions Initiatives, of which I am an associate
member, (and where I formerly chaired the Insurance Initiative) has also
commissioned Innovest to carry out a study of how the financial sector
can help to stop global warming. The first part of the study has been done,
and the final report is expected in July. Many influential companies belong
to UNEPFI (including Munich Re and Gerling in Germany), so this will be
an important contribution to the debate on how to operationalise Kyoto,
and then go beyond it. Finally, the Carbon Disclosure Project has just
been launched. This is an initiative supported by over 30 major investment
houses, among them Allianz/Dresdner, who between them control over 3 trillion
$ of assets. Its objective is to ask the biggest 500 industrial companies
in the world to reveal their greenhouse gas emissions, and their strategies
for dealing with climate change.
8. The ten-point action plan is voluntary. Should there be any obligatory measures, and what would you recommend?
Generally, one should try to keep regulation as light as possible I believe. In fact climate change is so different from the other issues that businesses and politicians deal with, that it would be futile to simply hope that some regulations will solve the problem. The key factor is that it is a longterm issue, which will only become really serious in many decades, but will require big changes in the way we behave right now. This is not popular with voters or shareholders, if there is a penalty now, but the reward comes much later. It is also difficult to mobilise them, when even now scientists are unable to determine how quickly the climate will change, or how such things as storm patterns will change in future. So, at this point, I believe the key thing is to ensure that there is better information widely available about greenhouse gas emissions, at the level of products, companies, and investment portfolios. Hopefully this will be done voluntarily, but if necessary regulations should be made. Once information is in the public domain, it will inevitably be used by company analysts and others to judge corporate performance along with other traditional factors.
Above all, it is important to move away from the "instantaneous" league tables, where success is deemed to be the profit achieved in the last quarter, and management bonuses depend on these ephemeral targets.
But this is a matter for all of society.
The media and educationalists have an important job to do in informing
the public, and the public must continually ask its politicians and investment
managers what they are doing about global warming.
9. What is your greatest hope in terms of solving the problem of global warming?
I believe that the [?] only way to
beat climate change is with a longterm framework which places the precautionary
principle first, and involves all nations in an equitable manner. The best
plan that I have heard of is called "Contraction and Convergence" (C&C),
which was proposed by Aubrey Meyer of the Global Commons Institute ten
years ago. One of its key features is the principle that all people have
an equal right to "pollute" the atmosphere, and so the present inequalities
in carbon consumption will be eliminated. I sincerely hope that C &
C will be adopted soon as the next step after the Kyoto Protocol arrangements
which currently are due to end in 2012. I have spent much of my time recently
bringing C&C to the attention of the financial sector, because I do
not think we can leave such important matters to the haphazard bargaining
that seems to emerge from a purely political process. It seems to me that
if business leaders could declare at Davos in February 2000, that global
warming was the biggest potential threat to world development, well then
they have a responsibility to try to identify suitable strategies to tackle
the problem. C & C is such a policy - it can provide safety and fairness,
it meets the USA objection that all countries must play a part, and it
also allows market mechanisms like emissions trading to bridge the period
until we have developed truly sustainable alternatives for our energy requirements.
Dr Andrew Dlugolecki
31.05.02