The Asset Owner: How climate change affects investment decisions

Anne Simpson leads the environmental, social and governance (ESG) integration programme at CalPERS, the largest US public pension fund, with total assets of $401 billion. Here, Simpson discusses the responsibility of companies in fostering sustainable growth.

4 minute read

Anne Simpson
Anne Simpson, director of board governance and strategy, CalPERS

Why should investors consider the impact of climate change on their portfolios?

We need to move from the “why” to the “how”. When you’ve got Bank of England Governor Mark Carney arguing banking regulators need to look at climate change risks, then financial markets need to start taking the problem seriously. And they need something better than the fabled “piece of string” to measure what is going on.

We’re in the middle of constructing our first asset-owner report for the Task Force on Climate-related Financial Disclosures (TCFD). CalPERS was an early and prominent supporter of the TCFD, because there needs to be a globally recognised framework for climate-risk reporting.

Sustainability data needs to be included in mandatory reporting

However, we are all having to improvise, because there isn’t a consistent base of reporting around the world. Our view, as a global institutional investor, is that sustainability data needs to be included in mandatory reporting. Doing so would ensure consistency, reliability, and integration with the financials, and allow us to make comparisons between companies and sectors over time. Right now, we just can’t do that.

We’ve articulated the case for mandatory reporting of not only financial capital, but also the human and physical capital at risk from climate change.

How can companies be incentivised to provide more relevant information on their climate change exposures?

The current situation is entirely unsatisfactory, and we’re very pleased certain markets intend to make TCFD reporting mandatory. We have argued climate risks need to be included in the considerations that go into Form 10-K [a document summarising a company’s financial performance], which is required by the US Securities and Exchange Commission (SEC).

We need to bring demand for fossil fuels down. That will have to happen in different ways, from energy-efficiency gains to substitution of fossil fuels for renewables

However, this pressure has not triggered an improvement in reporting. The reason, at least in the US, is the fear of liability. We need some form of safe harbour for reporting. Businesses perceive a first-mover disadvantage: Why would they stand up and say, “Wow, look at all my climate change risks and exposures”, when such disclosures are not a requirement for all their competitors? Whether it is the SEC or the International Accounting Standards Board, it really is time for regulators to step up and address this.

How might TCFD reporting evolve, particularly around Scope 3 emissions?

Scope 1 and 2 just make sense. Let’s take a company like Shell. Scope 1 concerns the emissions associated with its extracting oil, gas and so forth. Scope 2 is about the energy the company uses when it refines that product. The big emissions, however, come when Shell passes that refined product to its customers; that’s Scope 3. It encompasses utilities, transport, transportation, airlines, etc.

Thanks to Climate Action 100+, an investor initiative to which CalPERS is a signatory, Shell has agreed to take responsibility for its Scope 3 emissions. This means it will need to be in dialogue with other sectors of the economy.

How will other sectors of the economy need to adapt?

We need to bring overall demand for fossil fuels down. That will have to happen in a mixture of different ways, from energy-efficiency gains to substitution of fossil fuels for renewables in certain areas. The net-zero concept is important because it involves an acceptance that the carbon emissions associated with certain essential functions need to be offset in some form or another.

Does the focus on greenhouse-gas emissions mean we are overlooking other climate-related risks, such as water pollution?

What we have done on the climate change agenda is to take emissions reduction as our priority. The reason for that is simple: We’re on a timetable; the clock is ticking; and we can’t be fiddling while Rome burns – in this case almost literally, because of the heightened risk of wildfires.

We need to assess the exposure of our assets to the physical changes brought about by climate change

We need to bring emissions down. To meet the goals of the Paris Agreement, we need about an 80 per cent cut in emissions. The latest United Nations Environment Programme report estimates we need an eight per cent cut every year for the next decade.

How does all this fit into your investment process?

We’ve started to reconsider how we think about the physical risks of climate change: what I call “ZIP-code risk”. We need to assess the exposure of our assets to the physical changes brought about by climate change, such as sea-level rise, extreme-weather events, drought, you name it. Interestingly, the insurance industry has been way ahead of us in this regard, because it has had to price that ZIP-code risk for the purposes of writing insurance.

There is much room for error if consistent reporting standards are not integrated into financial reports

We want to encourage companies to start reporting on the resilience of their assets to these risks. For example, we are building a framework with one of our managers to look at meteorological data, and are starting to map the related climate risks to our portfolios. We have quite a simple framework at the moment, but it is progressing.

Are you looking at big data and artificial intelligence to help collect and analyse climate-related information?

No, is the answer at this stage. AI requires many data points that can then be recognised in a pattern that provides indications about the future, often more accurately than we as human beings can manage. That’s AI’s advantage. However, to apply this to monitor climate information, we would have to work out what the underlying data should be, such as what the observations are to begin with, where you make the observations and the quality of those observations.

One initiative that is very interesting and innovative is Carbon Tracker’s collaboration with Google on using satellites to track carbon emissions

One initiative that is very interesting and innovative is Carbon Tracker’s collaboration with Google on using satellites to track carbon emissions. If we start to use technology in that way – and I believe Singapore’s regulator is doing this as well – it might be possible, for example, to verify or to validate whether certain loans are associated with the destruction of rainforests for the purpose of palm-oil production. That makes perfect use of big data.

However, using AI to track Scope 3 emissions is far more complicated, and there is much room for error if consistent reporting standards are not integrated into financial reports. We’re back to the question of “how long is a piece of string?”, and we need to make sure the string is at least long enough to cover Scope 3 emissions.

What are the key changes you would like companies to make?

What we’re calling for at Climate Action 100+: First, companies need to take responsibility and support the energy transition – and that means being accountable; second, they need to set targets to support the goals of the Paris Agreement; third, companies should all report under the TCFD framework.

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