Investing in the Environment

Over the past month, media headlines have been conquered by handshakes at Davos, where private and public sector leaders have gravitated again in an attempt to solve the world’s most pressing problems, which have over the past year only gotten more pressing. While climate change has single-handedly dominated the focus of this year’s World Economic Forum (WEF), the sleepy Swiss town was shaken by the landing over 1500 private jets, more than ever before.

Observing WEF this year, the title of a once famous Alanis Morissette song—isn’t it ironic?—definitely springs to mind. As Rutger Bregman, a Dutch historian who has surprisingly broken through the ranks of this year’s Davos invitees confessed, observing the tone of discussions at the Forum, “it feels like I am at a firefighters conference and no one is allowed to speak about water.”

On the one hand, the focus on climate change demonstrates broad consensus of actors ranging from Bono, to Bill Clinton to Jacinda Ardern to a Swedish teenager—who has captured most attention arriving in Davos after a 32-hour train ride—that it is a key global prerogative. On the other, Davos outcomes highlight the dearth of solutions to the environmental conundrum which threatens the survival of humankind.

Indeed, apart from the future of robotics and artificial intelligence—the governance of which was for the first time addressed by Singapore—the governance of climate change remains an elephant the room. The main question—and one that remains without a convincing response—is with whom responsibility for action against climate change should rest and via which mechanisms can accountability for environmental protection can be fostered.

Collective responsibility, while buzzworthy concept, does not create a commitment to a specific goal, instead invoking a “tragedy of the commons”, which key environmental goods such as air are by their very nature. At the same time, the limits of government power to curb environmental degradation were tested with the Paris Agreement, which the US administration has threatened to desert and is already effectively sidelining.

The direction of this year’s Davos talks point to a subtle yet material shift of responsibility for the environment from public to corporate spheres. The WEF has gone so far as to issue a manual on Climate Governance for Corporate Boards, suggesting that it is for boards to monitor and mitigate related risks. While the premise of this thinking is not without foundation, the process of monitoring of corporations’ environmental impact is far from clear.

Whilst a plethora of environmental, social and governance (ESG) disclosure frameworks have sprung up, their outcomes are not comparable as companies develop and present metrics they consider relevant for investors. The probability that any two companies quantify and disclose their environmental impact information in a comparable format is about the same as having identical twins from different parents.

Most existing frameworks focus on the quality of ESG disclosure by listed companies which, in principle, should allow institutional investors to assess and, if need be penalize, “ESG negative” corporations. However, in the vacuum of clear metrics that companies in different sectors are required to disclose, government or investor action to monitor corporate environmental impact is challenging.

Governments are increasingly delegating their responsibility for policy-making and monitoring of corporate environmental impact to large institutional investors many of which are boasting their growing ESG capabilities. However, institutional investors, are not subject to specific guidelines apart from stewardship codes which are vague and do not require much specific reporting on their action to protect the environment. In reality, little is known on how institutional investors vote in specific shareholder meetings, let alone how they vote on environmental resolutions. Only a few countries such as Chile actually require specific types of institutional investors to disclose their voting record publicly.

A recent report by the 5050 Climate Change Project revealed that in spite of a growing support for climate resolutions, approximately half of top asset managers opposed half of key positive climate-related proposals. The largest institutional investors such as Blackrock and Vanguard have the lowest levels of support for positive climate resolutions, whilst their backing is critical for climate positive proposals to get majority support.

Likewise, despite much noise around the subject, the record of institutional investor divestment from “environmentally-negative” firms remains abysmal. While Norway’s sovereign wealth fund Norges has recently divested from coal, the CEO of Vanguard, the second largest institutional investor globally, has recently argued that divestment is a poor strategy as it limits possibilities for engagement. This position assumes that engagement is a road widely traveled by institutional investors.

Yet, Amundi, one of the largest French investors, says in its own recent reporting that climate change was a topic of engagement with only 14 companies in the past 4 years. A similar picture prevails in its global peers, who have this year instead decided to focus on the nebulous concept of corporate culture. If governments are going to pass the responsibility for monitoring the world’s most precious resource to institutional investors, this oversight mechanism needs all 32 teeth and much more expertise than most investors currently have in house.

First, the work of the Financial Stability Board needs to result in a framework for corporate disclosure complete with industry-specific metrics that institutional investors can monitor. Based on such frameworks, governments may also choose to give fiscal breaks for environmentally conscious firms or conversely, impose higher taxes on companies with a higher than average negative environmental footprint.

Second, if institutional investors are expected to act as stewards of our environment—they too, should be required to report to the public and the regulators on their voting policy on specific resolutions and explain how their engagement has contributed to limiting environmental risks. Investors need to be provided with further incentives to assume this responsibility, through for instance, the allocation of public pension savings to specific asset managers with a positive track record.

Last but not least, for institutional investors to become more effective watchdogs of our environment, the concept of their fiduciary duty needs to be recalibrated such that they owe this duty not only to their actual investors but also to the future generations. This will effectively help them transition their mindset to the long-term perspective taken by Norges in Norway or Mubadala in the Emirates.

The transition to a low-carbon economy, estimated to require a trillion-dollar annual investment, cannot occur by polite nudging of corporate boardrooms to prioritize intangible common goods such as environment over financial performance. Likewise, if governments are to bestow institutional investors with the responsibility to monitor corporate environmental mischief, they also need to be incentivized accordingly, for the next WEF climate panel to be a little less ironic.