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Investors are demanding green credentials

Investors are ramping up pressure on companies to sharpen their climate credentials - leading companies to grapple with a rapidly-emerging arena in corporate risk, strategy and long-term planning.

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" Investors are signalling they are expecting much more robust and thorough reckonings of climate risk from the companies they invest in."
Kate Mackenzie, Head of finance and investment, The Climate Institute

Few would be unaware of how dramatically the prospects for thermal coal – used to produce energy - have declined in the past few years.

Despite a recent resurgence in seaborne prices, only diehard coal optimists expect a true renaissance now China's coal use has peaked and India is determined to cut out coal imports and focus on ever-cheaper solar power.

Newly-published research conducted by KPMG explores how large companies are seeking to understand and disclose how they might fare in a world that limits warming to well below 2C, as outlined in the Paris Agreement which came into effect in November 2016.

Those efforts include developing scenarios of how the company would fare in such a future and making some or all of the results available to the public and investors.

Key staff involved in these efforts at the companies identified growing concern among investors, increasing evidence of impacts of climate change, and evolving policies as key drivers of these efforts.

IMPOSSIBLE

It’s impossible to know exactly how a below-2C future - or even the Paris stretch goal of 1.5C - will play out. This is behind the focus on scenario developments such as those undertaken by AGL and BHP.

What’s interesting is many of these efforts, and the KPMG interviews, have since been followed by much clearer signals investors, regulators, and other stakeholders will expect robust climate change risk analysis.

The release in December of draft climate disclosure guidelines from a task force created by the global Financial Stability Board is prompting queries from investors to big Australian companies.

In March the world's biggest asset manager, Blackrock, said it would be focusing on climate change and would even vote against the re-election of company directors who failed to take this into account.

A few weeks later Legal & General Investment Management, the UK's biggest asset manager, wrote to 84 companies, also indicating it was willing to take up the issue of climate risk at director elections.

Crucially, both these firms were talking about climate-related risks to their entire portfolios; not just in specialist ‘sustainable’ investment products.  

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UNTHINKABLE

These are announcements which would have been unthinkable just 18 months ago - large, universal share owners publicly stating they may take a stand, even in the absence of a specific shareholder resolution, on governance relating to climate risk.

What this suggests is that investors won’t be reassured a company is managing climate risks by beautifully laid-out sustainability reports or by using the right phrases to acknowledge the seriousness of climate change.

Investors are signalling they are expecting much more robust and thorough reckonings of climate risk from the companies they invest in.

Take this example from State Street, the world's third-largest asset manager, which said it would begin dividing the most exposed companies into "Tier 1" and the less-impressive "Tier 2".

A Tier 2 company might be "…an energy company that identified climate risk as a concern in its financial reports but only provided emission data against annual goals,” State Street said.

“Therefore, it failed to demonstrate to investors how the company is managing the potential impacts of climate change on the company’s long-term strategy.”

In other words, simply measuring your emissions - also known as ‘carbon footprinting’ - simply isn't enough. To become Tier 1, State Street says, a company might have to conduct a "board[s] assessment of regulatory and investment/consumer trends pertaining to climate change" - and then it would need to disclose how it was responding to the assessment.

ARGUABLE

Of course, investors too are still building up their expertise in climate risk - some investors are arguably much further advanced in understanding climate risks than the companies they invest in.

This is in part because of the long-term focus of pension and superannuation funds, but it's becoming ramping up as asset owners and managers are identified as exposed to climate risks by the FSB taskforce. APRA meanwhile has clearly stated banks, insurers and superannuation funds will all be increasingly expected to show how they are managing climate risk.

The Investor Group on Climate Change, which represents more than $A1 trillion of Australian assets under management, and the last week published a guide for investors to conduct their own climate disclosure.

It takes them through four stages: from developing their investment beliefs regarding climate risk to future-proofing against the shifts and policies required to limit warming to 1.5C - 2C, reviewing proxy voting policies, and fully assessing vulnerability and exposure to the physical impacts of climate change.

It explores the merits and shortcomings of using different metric approaches, such as carbon footprinting, using specialist ratings providers, and appropriate responses to findings. It demonstrates climate risk is being thought about in an unprecedented level of detail.

Kate Mackenzie Head of finance and investment at The Climate Institute.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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