Energy

Where the ‘radical change’ in sustainable investing is going next

Two years ago, not a single institutional investor had made a goal to reach net zero greenhouse gas emissions. Today, nearly 300 asset managers have made such commitments, and so have thousands of the world’s largest companies.

That’s according to Ceres President and CEO Mindy Lubber, describing extraordinary progress in a short amount of time. “The large companies, the biggest players in the capital markets, aren’t questioning whether issues like equity and justice and climate and water are real business and financial issues,” she said Tuesday at GreenBiz Group’s GreenFin 22 event in New York City.

Lubber lauded Wendy Cromwell for being among the vanguard of this movement that treats sustainable investing “as part of the real investing world, not some cute little category over here.” Cromwell is vice chair and head of sustainable investment at Wellington Management, a private Boston-based firm advising $1.4 trillion for over 2,000 institutional investors in more than 60 countries.

Wellington became one of 30 co-founding members of the Net Zero Asset Managers initiative in December 2020, and Cromwell is one of its six advisory group members. The initiative reached 273 signatories in May, from Abrdn to JPMorgan Asset Management to zCapital, collectively representing $61.3 trillion in assets under management. Each organization has committed to work toward net zero both in their organizations and the assets they manage, with interim targets for 2030 and reviews every five years, using tools from the 2021 Net Zero Investment Framework.

Is it just ‘woke capitalism’?

“Given that these issues are becoming entrenched in our markets and systems, now, all of a sudden, people want to question: Are they real? Are they material? Is it real finance and money, or is it just woke capitalism I’m reading about?” Lubber said.

Lubber’s answer to questions that were largely rhetorical for the GreenFin audience: “The key is for all of us, every single one in this room to make the case: This is about financial materiality, climate risk in the tens of billions of dollars a year, even in the U.S. alone… where four years from now, we will have 25 percent less water than we need as a world community. By any standard, that is a material, financial risk. It’s a human risk. It’s a planetary limitation.”

Is it real finance and money, or is it just woke capitalism I’m reading about?

So how should the investment and corporate community respond? Is sustainability really embedded in our financial systems? If not, what needs to happen to get there? What are the financial implications of sustainability?

How are regulations changing markets?

Cromwell agreed that capital markets are transforming rapidly as material risks posed by the climate crisis accelerate. “It’s not really a guess,” she said, explaining that regulators in Europe, Hong Kong and Singapore are aiming specifically to transform capital markets. “That’s their express goal. And they’re introducing new regulation with a theory of change, touching every single point of that value chain and capital markets every year. And that’s going to continue for at least the next five years.”

For example, the European Union’s Sustainable Finance Disclosure Regulation (SFDR) requires asset managers to disclose about ESG issues. Europe classifies funds in three categories, as either Article 6, 8 or 9. Article 6 funds may include things such as fossil fuel or tobacco companies, which must be labeled for their lack of sustainability. Article 8 are known as “light green” funds, which promote “environmental or social characteristics” and follow sound governance practices. Article 9 are “dark green” funds that explicitly make sustainable investment or carbon emissions an express objective.

Wellington’s clients in Asia are asking for Article 8 funds even though they are not beholden to European rules. “They want to follow that guidepost because of the leadership that we’re seeing, and the fact that they want to be part of sustainable investment, because they believe that it’s going to impact capital markets over the next 10 and 20 years,” Cromwell said.

Meanwhile, the U.S. Securities and Exchange Commission is pushing for climate risk to be addressed as a material financial risk. The public comment period ended last week on its proposed rules to require climate disclosures by companies for investors. Wellington has engaged consistently with the SEC about the proposed regulations, including advocating for more disclosures on corporate geographic locations, Cromwell said.

Investors are going to use the data whether you provide it or not. It’s currently being provided by third party data sources. It’s not as good as what you can do yourselves.

“Just disclose where you have material business and the market will help you figure out if if we think you’ve got material climate risk, because maybe you don’t have the tools yet to figure out if you’ve got material climate risk,” she added.

Cromwell also reassured businesses apprehensive about the 2025 deadline for the proposed rule that they have enough time to act now. Those who are ahead will get credit, while others can find opportunities and efficiencies through beginning that analysis, she said.

“The other thing I would say for issuers is, investors are going to use the data whether you provide it or not. It’s currently being provided by third party data sources. It’s not as good as what you can do yourselves.”

How do climate risks impact markets?

Wellington partnered in 2018 with the Woodwell Climate Research Center on research to bridge the gap between finance and climate science. An early question was how to understand drought, wildfire, hurricanes, floods in terms of basis points, which represent one one-hundredth of one percent in terms of an interest rate. Cromwell recalled that early on, Woodwell President Phil Duffy (now a Biden administration climate science adviser) asked what a basis point was. And Wellington’s staff did not yet understand the meaning of Representative Concentration Pathway (RCP) scenarios, which are used in climate modeling.

“That’s when we knew we were on to something,” Cromwell said of the realization that climate researchers and finance experts needed to work together to understand the impact of physical climate risks on markets. “And what we’ve learned since then working with them is climate change isn’t too far away to matter… The impacts are happening within an investable timeframe, they’re not being accurately priced, and you need to focus on adaptation as well as mitigation. Because a lot of what’s happening over the next 10 years is already baked into the system because of the long half life of greenhouse gases in the environment.”

To illustrate that to a company, Wellington will present a map in a meeting, showing a pair of municipal bonds in different locations that are identical in their financial characteristics. If one bond has more degraded climate characteristics, which one does the client want to buy? “That’s when it starts to click for people, when we can show them, ‘OK, we’re gonna buy this one and not that one, because they’re priced the same, and this one has a lot more risk,'” Cromwell said.

[Interested in more coverage of GreenFin22? Read more here.]

As those physical risks become more severe and affect more people, she insists that demand will grow to keep the net zero transition going. That requires understanding the transition better and learning who is prepared and has a plan. “It opens up a whole world of exploration, in terms of fundamental analysis for the companies that we have,” she added.

What are the challenges of net zero for asset managers?

With this paradigm shift in the transformation of capital markets, Cromwell believes that Wellington must transform across the board in order to remain a leader in asset management. All employees should see how sustainable investment is part of their day jobs, she said.

“That means if you’re a lawyer, you need to understand the new regulations,” Cromwell explained. “If you’re writing RFPs, you need to understand the content to answer the questions. If you’re representing portfolios and product management, you need to be able to build it into your representation, build it into your philosophy and process reviews with investors. If you’re an investor, if you’re a researcher, obviously, you need to build it into your investment philosophy and build it into your research process.”

The transition is happening. We need to understand it; companies need to have a plan for it.

When Wellington became part of the Net Zero Asset Managers initiative nearly two years ago, it took a deep look at each asset class and investment philosophy at a time, taking into account the varied challenges for emerging market investors and contrarian investors. 

Since then, the commitment has been unfolding in two key ways for Wellington, one of which is to work with asset owners on their decarbonization goals, Cromwell said. While Wellington can’t change a client’s mandate, it will work with them “to help them understand why we think it’s in their best interest in terms of achieving investment outcomes, for them to adopt this orientation,” she said.

In addition, Wellington prioritizes real-world emissions reductions for its clients. Simply divesting and selling securities doesn’t do anything to slash emissions or reduce physical climate risks, she said. “So engagement is the key there, and engagement on science-based targets, having a transition plan. The transition is happening. We need to understand it; companies need to have a plan for it.”

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