Scaling up sustainable finance: How can investors accelerate the net zero transition?

2020 was the year much of the investment community really started to reckon with the role it needs to play in driving the transition towards a net zero economy. Membership of the UN-backed Net Zero Asset Owner Alliance coalition snowballed, a new Net Zero Asset Managers Initiative was launched, and some of the world's largest asset managers shifted their stance on shareholder climate resolutions and fossil fuel stranded asset risks - all while environmental social and governance (ESG) stocks outperformed the wider market during a historic economic downturn.

But delivering a fundamental reshaping of the financial system, as BlackRock chief executive Larry Fink acknowledged was necessary in his influential annual shareholder letter last year, is going to require more than green ambition and the occasional coal exclusion policy. A patchy regulatory landscape and a proliferation of ratings agencies and reporting frameworks - each with their own scoring systems and sustainability criteria - has prompted some to describe the sustainable finance movement as a 'wild west' environment characterised by both impressive new low carbon investment practices and inevitable 'greenwash'. While considerable progress has been made in securing ambitious climate pledges from major players, including bold commitments to deliver net zero emission portfolios, there is clearly a long way to go before default funds and pensions are truly low carbon, climate risk reporting is standardised, ESG claims are policed, and investors can easily access the data they need to assess companies' exposure to climate and transition risks.

These were just some of the conclusions drawn during a wide-ranging webinar hosted this week by BusinessGreen in association with Schroders, which saw a panel of green investment experts weigh in on the challenges and opportunities facing the growing number of investors that have pledged to deliver net zero emission portfolios.

Sagarika Chatterjee, director of climate change at the Principles for Responsible Investment (PRI), who is currently seconded to the high-level champions finance team for the COP26 Climate Summit, said investors would have to be at the forefront of the push to deliver more standardised ESG reporting frameworks. "We really have to see convergence," she said, emphasising how a more consistent approach would allow for a much-needed review of data being submitted by companies. "The meaningfulness of the data that is coming back needs to be reviewed. Is it fit for purpose? What does it tell us about the assumptions that are being made? Is it giving us exactly what we need as investors?"

Regulators are increasingly turning their attention to the issue and are ultimately expected to play "a big role" in standardising the ESG ratings landscape, she said. The US Federal Reserve's decision to join the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) in December is likely to filter through to the development of global best practice on sustainable finance, as central bankers set out their own demands, she added - a trend that is only expected to accelerate under the incoming Biden administration.

If ESG ratings is one area where standardisation could pay dividends for wider decarbonisation efforts, climate-related risk reporting is another. A growing number of corporates are now providing annual reports in line with the recommendations of the Taskforce for Climate-related Financial Disclosures (TCFDs), but some firms are continuing to turn a blind eye to the topic, while investors have complained that the quality of TCFD reports can vary. 

However, Hannah Simons, head of sustainability strategy at asset manager Schroders, urged companies to not let incomplete data sets prevent them from submitting climate-related risk disclosures. "I would encourage every company to start disclosing, because then year on year or even month on month, as you're making those changes and that evolution is happening, you can keep updating." she said. "If we just all held back till everything was perfect, we wouldn't see an increase in the level of companies disclosing quickly enough."

Moreover, those businesses and investors that are reluctant to report on the climate-related risks and the wider sustainability issues they face may not have a choice for much longer. The UK government has signalled plans to make TCFD reporting mandatory and, as Simons noted, landmark sustainable finance disclosure regulations coming into play in the EU from March are set to be felt in the UK. "Helping clients navigate what it is your fund or product is seeking to do is critical, and that is at the heart of the [EU] disclosure regulations," she said. "To really be able to convey and articulate how your fund is sustainable, and how you are investing in line with the objectives that you've set… So, while there have been historically have been potential challenges, as we go forward clients will be able to navigate that more easily."

Simons added that emerging regulations should also help clients navigate the "spectrum of different approaches", such as ESG integration, best-in-class exclusions, thematic and impact investing, with more ease.

However, Mark Campanale, founder and executive chairman of financial think tank Carbon Tracker, cautioned that more radical work was required to restructure the investment sector if it is to deliver net zero emissions, repeatedly emphasising that enhancing the ESG market alone is unlikely to deliver the wholesale transformations necessary to futureproof investors' portfolios and shift capital towards zero emission industries.

Financial models need to be redesigned from the ground up, he said, warning that the "fundamental wholesale rebuilding of the global economy" would require trillions of dollars of new investment, as well as trillions of dollars of asset write-downs. "This is not an ESG rating issue," he said. "You can't just buy a rating and use it as a proxy for managing risk. We have to actually rebuild the models today to allow investors to futureproof their portfolios and make them more resilient. Rating agencies, in my experience, rarely pick this up. You have to go straight to the heart of financial models: all the assumptions within them, how you rebuild them, and how you stress test them."

The webinar also saw panellists weigh in on the merits of engagement and divestment strategies as a means of encouraging climate laggard companies to embrace the transition to net zero emission business models. 

On both fronts, activity has dramatically picked up over the last year. BlackRock, the world's largest asset manager, promised to pursue both approaches as part of a major pivot towards sustainability unveiled last January and has since voted against directors in favour of climate resolutions at a number of high carbon companies, while ending its active investments in major coal miners. Meanwhile, UK hedge fund manager Sir Christopher Hohn recently launched a major campaign calling on fellow investors to demand an annual say on corporates' climate plans, and just last week, Amundi and Man Group filed a climate resolution at HSBC, calling on the bank to publish a strategy and targets to reduce its exposure to fossil fuel assets in the wake of its net zero announcement. 

Shipra Gupta, head of investment stewardship at pension provider Scottish Widows, argued divestment was a "blunt tool", but she acknowledged it could be effective when applied in a "limited way". However, she stressed that exclusion by one investor does not prevent a high carbon company from tapping alternative pots of capital to pursue environmentally destructive activities. "Our objective ultimately is not just cleaning our portfolios, but actually having a real-world impact," she said.

Schroders' Simons broadly agreed with Gupta, detailing how the asset manager's policy was to only consider divestment after all efforts to constructively engage the company to reduce its emissions have been exhausted. "Divestment is an option, but once you've done it you can't come back," she explained. "So, we take a very active approach to our ownership and engage heavily with companies. Critical to that is setting out what the objective is that you're seeking, because if you set out the key milestone you're expecting, you can then work with the company."

But Campanale emphasised that engagement policies can run the risk of damaging investors' bottom line and lumbering them with stranded assets in the future. Reports this week revealed Dutch pension fund PMT had sold its stake in ExxonMobil, after failing to convince the firm to disclose in line with the Paris Agreement and losing €60m in the value of its shares in the past year, he noted. "Not a very profitable form of investment there," he said. "What individuals need to do is realise that they are trusting fund managers to take these decisions, but many fund managers are stuck with old conventional thinking that says: 'This is an ESG issue, not a risk issue, we'll engage these businesses to transform'."

As such, the public should be given a more active role in investment, Campanale said, commending Legal & General for introducing a new initiative that allows individuals to input how they want to vote with shares held by their personal pension and insurance schemes. "That really will introduce shareholder democracy, and the public relies on large institutional investors to decide how to vote. Let's empower individuals," he said. The government should also introduce a policy mandating that companies make the default pension schemes for staff "low-carbon or no carbon", he said.

While it is undeniable that there are major challenges that need to be addressed before the investment sector can begin to channel the bulk of its financial might into the transition towards net zero emissions, it is equally clear that asset owners and managers are increasingly aware of the vital role they must play in directing the development of a net zero emission economy from their position at the top of the investment value chain. The plunging valuations of oil and gas firms seen this year are likely just a precursor of trends that will accelerate over the coming decades as carbon taxes and climate laws proliferate, and the decarbonisation of industry, transport and energy  gathers pace. If 2020 is any indication of the decade to come, investors that fail to embrace a new role as active participants in the net zero transition will lose out.

Or, as Scottish Widows' Gupta put it: "there are decades when things don't happen, and then there's one year in which an entire decade happens... [Investors] are on top of the value of the investment value chain; we oversee asset managers and they oversee the corporates and the securities that they invest in - meaning we can actually have a really huge top down impact."

The 'Net zero investment: What role do investors play?' webinar was hosted by BusinessGreen in association with Schroders.