Too hot. That, in two words, sums up London in late July, just weeks after it hosted Climate Action Week.
As the UK’s Met Office sought to validate whether or not 25th July was indeed the hottest day ever in the UK, Spain’s government was dispatching fire-fighters to control some of the worst forest fires ever in its Zaragoza region, the Netherlands activated their National Heat Emergency Plan, and France restricted water use in 73 of its 96 departements due to severe drops in groundwater.
Further afield, in June, researchers announced that about a quarter of the Himalayan glaciers have melted over the past 40 years, and about two thirds could disappear by the end of the century, with devastating consequences for millions of people that depend on the mountains for fresh water. A recent article in Science magazine said next-generation models predict an increase of 5°C or more.1
If these results are to be believed, the world needs to turbo-charge its collective action to limit warming to 1.5°C or 2°C above pre-industrial levels.
What does all this have to do with asset management?
The simple answer is a lot. If we can’t continue to business as normal, we must change business. Endowed with the power to appoint or fire directors on behalf of underlying shareholders (who are anyone whose savings or pensions are being invested in the stock market), asset managers are key to achieving this. But far too few people realise the central role their asset managers should be playing in driving the world onto a safer climate pathway. This needs to change. Asset managers should be required to pledge that they will align their investment and voting policies with the Paris Accord.
We are not hopeless – but everyone needs to act quickly
Given this modern day ‘tragedy of the commons’, and the profound obstacles to organising a collective response, climate change is clearly a job for governments. The Paris Climate Accord agreed in December 2015 was a powerful example of governments coming together to set an ambitious goal of keep temperature increases well below 2°C, and ideally to 1.5°C.
The problem has been implementation. Notwithstanding some positive steps, in the end, Government action is falling well short of what is needed. While politics is inevitably a messy business of balancing conflicting goals and interests, it leaves us all exposed to rising climate risks.
Frustration with what some see as government paralysis, grassroots initiatives are gaining support. The student campaigns sparked by Greta Thunberg’s strikes in Sweden or the Extinction Rebellion movement are spreading around the world. Campaigns are getting more energised, broad-based and sophisticated; they are also better financed.
Significantly, the activists are no longer just training their sights on governments. Campaigners are going after business leaders who are responsible for producing and consuming a large proportion of global fossil fuels. Companies like Exxon, Chevron, Total and BP are caught in the cross hairs. The more such companies protest that they are helpless to act, the more ire they attract.
Is it right to argue, as Ben van Beurden, Chief Executive at Shell recently did, that if there is demand then Shell must meet it, even if to do so would contribute to dangerous global warming? If there’s demand for opioids, do pharmaceutical companies have to supply it? Surely, companies can take decisions about how they deploy capital, and should take account of societal impacts of those decisions? After all, in the UK, this is a legal duty for company directors.2
Asset managers are the hidden pressure point to get us to net zero
But who is determining how companies behave? Who is signing off capital deployment that runs contrary to the Paris goals of keeping warming below 2°C?
While few may realise it, many of the largest companies around the world that take these fateful decisions are owned by the very people who want them to stop.
Ordinary savers who have allocated funds to company shares, or those putting money aside into a pension that in turn invests in shares, are all in the end shareholders. Generally, they are shareholders in hundreds of companies; frequently they do not even know which ones.
This is often because between these people and their companies sit intermediaries who are tasked with looking after their interests. Asset managers are critical players in this ownership chain, and in theory provide a valuable service. It is, for instance, the asset manager that determines how much capital to allocate to particular businesses on behalf of savers. It is also the asset manager that approves a company’s leadership through their votes at company meetings. It is within their gift to vote against directors if they believe this is in their clients’ best interest.
In practice, however, there is little sign that asset managers are reflecting climate risks in either their decisions to invest or their votes for company directors. Directors on the board of Peabody Energy, one of the world’s largest coal producers, were re-elected with an average of over 95% support prior to its bankruptcy filing in 2016. And yet, long-term declining demand for coal, and the rise of cheaper and cleaner alternatives, had been well flagged. Directors at Exxon are re-elected with an average 93% support despite their refusal to alter their strategy to take account of climate change. The picture is repeated for Shell, BP, Chevron and Total.
While adopting a supportive approach to companies will be in many cases sensible, there is evidence that a passive approach to ownership by asset managers results in weaker governance. In the case of climate change, the potential ramifications of this failure are grave. Asset managers need to think harder about both their investment analysis and their votes. Their actions should be scrutinised.
There are signs of change. Led by the US pension scheme Calpers, asset managers and asset owners responsible for over $34 trillion have come together to call on the 100 largest carbon emitters to act on climate change. Sarasin has been a signatory to this initiative, Climate Action 100+, since launch, and good progress is being made in getting companies to commit to better climate risk disclosure and more action.
Asset managers should pledge to align with Paris goals
The problem is that time is running out. More determined action is needed. Asset managers should be required to take account of climate change in their investment processes. They should pledge to only vote to appoint directors that make a binding commitment to align their business strategy with the Paris goals of keeping global warming to well below 2°C. They should hold executives to account for delivery of this promise, and refuse bonuses where earnings are based on actions that run contrary to these goals. This needs to be rolled out for the next voting season in Spring 2020.
These steps are proportionate to the enormity of the challenge we face. They are also entirely consistent with clients’ interests. Indeed, ignoring climate change puts capital at risk.
In January, Sarasin published a “Climate Pledge”, in which we set out the actions we are taking to protect and enhance client capital in a warming world, including:
- ensuring that we avoid companies at risk of destroying value;
- pressing companies to align with the Paris climate goals (and thus a zero-emission world by 2050-70) through engagement and voting; and
- promoting policy reforms to drive alignment with the Paris goals.
In 2019, we voted against numerous directors at a range of fossil fuel related companies for a lack of action on climate change. Wherever we believe the risk-reward balance at a company has shifted such that it no longer makes sense to hold its shares, we will not hesitate to divest as we did with Royal Dutch Shell in June. (see Exhibit A below on Shell).
In the end, climate change and the policy response to drive decarbonisation are not just ethical or environmental issues; they are also powerful economic phenomenon that have the ability to upend entire industries and indeed economies. A failure to recognise and act on this fact could cost all of us dearly.
Following the rollout of our climate stress-testing analysis, which led to the divestment of BP and Total, Shell was the last remaining fossil fuel extractor held within our climate active strategies.
We decided to keep Shell initially due to the company’s sector leadership in addressing climate change, and what we perceived to be a determination at board level to prepare the business for a global move away from fossil fuels. Shell was the first, and remains the only, oil and gas company to set a Net Carbon Footprint Ambition that covers emissions linked to the final use of its products (known as “Scope 3” emissions)
However, following two years of involved engagement with the Chair as well as other Board directors, following Shell’s publication of its 5-year capital expenditure strategy in June, we decided that the momentum behind Shell’s transition to a clean energy company had stalled. The company was not only forecasting that 90% plus of capital will be deployed towards fossil fuel projects, but that is was planning to grow its production of fossil fuels to at least 2030, with no clear indication that this would come down thereafter.
We judged that this was not just mis-aligned with the Paris goals, but it left our clients’ capital exposed. We, therefore, exited our positions in our Climate Active and Global Thematic equity strategies. Elsewhere, holdings in Shell are being reviewed.
We do not shy away from responsibility
At Sarasin, we see ourselves as having a responsibility to protect and enhance our clients capital in a way that is aligned with society. To invest in and support management teams of companies acting against society’s interests cannot, in our mind, be a sensible long-term investment strategy; not least because it creates financial risks that are often hard to quantify or predict in terms of when they will crystallise, but this makes them no less real. On the flip side, we believe our clients’ will ultimately benefit from responsible corporate behaviour.
Savers suffered from asset managers’ failure to act as engaged owners in the run up to the financial crisis. Asset managers won’t be forgiven for failing to do their utmost to protect our planet.
1 Science (2019) New climate models predict a warming surge. Available online from: https://www.sciencemag.org/news/2019/04/new-climate-models-predict-warming-surge
2 CA06 s172 sets out director’s duties to promote the success of the company, having regard to “the long term”, and “the impact of the company’s operations on the community and the environment” amongst other things.