18 November 2015

Taking our planet back from the precipice

New Zealand: As the world prepared to gather in Paris for COP21, IPCM Chief Executive Matthew Kiernan addressed the Responsible Investment Association Australasia conference in Auckland, NZ, reflecting on the highs and lows of the journey from the 1992 Earth Summit in Rio. What can we expect from COP21? And what actions do investors need to take in order to “future-proof” their portfolios to the maximum extent possible?

Here is the full text of Dr Kiernan's address.

 

Dr. Matthew Kiernan addressing the Responsible Investment Association Australasia Conference in Auckland, New Zealand, 18 November 2015

 

Investing in a Sustainable World

In 13 days’ time leaders from around the world will arrive in Paris to strike a deal that will attempt to take our planet from the precipice.

It is the 21st time that the world has gathered to attempt to make progress addressing the threat of climate change.

There have been highs and lows on this journey. At COP3 3 in Kyoto in 1997 it looked like progress had been made through the Kyoto Protocol which introduced binding targets. However the subsequent endless debates around ratification undermined the good work that was done at this meeting. COP 15 in Copenhagen in 2009 was widely regarded as a fiasco, but did actually deliver a global consensus on the 2 degree Celsius target which has been the focus of so many of the efforts since then.

My own involvement goes back to 1992 when, as a director of the World Business Council for Sustainable Development, I was appointed as a senior adviser to the Conference Secretary General for the United Nations Conference on Environment and Development, which we know as the Earth Summit.

The Earth Summit, which brought together 172 world leaders with 17,000 people attending a parallel NGO Forum, is known for many things but it was the speech of a Canadian 12 year old girl, Severn Suzuki which is most remembered.

Suzuki – known as the Girl Who Silenced the World for 5 Minutes – spoke directly about the impact of climate change during her lifetime, finishing her speech by saying “you are what you do, not what you say - make your actions reflect your words.”

Today, 13 days from another climate summit, I want to reflect on Suzuki’s words.

Today I will therefore focus on two things: what we can expect from COP21, and what actions investors need to take in order to get the planet on the pathway to keeping under 2 degrees and “future-proof” their portfolios to the maximum extent possible.

Firstly to COP21.

What we are seeing is that the French Government and outgoing Peruvian Presidency have been working closely in recent months to forge an “action agenda” for COP 21.
As a result we are likely to see pledges and commitments by cities, investors, industry sectors and a whole rainbow of civil society players.

In the lead-up to COP 21, a number of promising signs give grounds for a reasonable level of optimism. So what’s different this time around

1. For one thing, COP 21 can already be seen as at least a qualified success: unprecedented global attention has been focused on the climate challenge, and over 150 countries have already made commitments to significant reductions, and provided broad road maps for showing how they’ll be done.
2. Developing countries, conspicuous by their absence from the Kyoto Protocol, are not only involved this time around, they are front and centre (viz, China and India, among others).
3. There is a huge amount of positive momentum being generated from outside the COP 21 process. Support for strong action has been pouring in, from sources as diverse as Pope Francis, the Governor of the Bank of England, and the Financial Stability Board/G 20. Cities, corporates, and investors have all weighed in, with both advice and commitments. This time, the process is much more bottom-up than the traditional top-down approach of previous summits.
4. This time, the politicians will be involved at the beginning of the process, rather than at the end. In theory at least, this should provide some useful direction to the negotiators.
5. Back in the real world, the economic case for renewables continues to grow stronger. Just since Copenhagen, the cost of solar photovoltaic energy has dropped by fully 60%, and that of onshore wind by 15%. What this means is that there is concrete proof that a low-carbon economy is not merely possible down the road, it is already here.


So, what can we expect from COP 21? Well, we won’t see a 2 degree Celsius world emerge; the existing commitments, even if fulfilled, leave us somewhat short of that target. That said, I think we will see enough consensus and serious commitments to significantly bend an emissions curve that was on track for 4-5 degrees. The smart money is on somewhere between 2.7 and 3 degrees Celsius — no small achievement. Importantly, there will likely be a “ratchet mechanism”, obliging governments to review their commitments, with a view to strengthening them even further with the benefit of experience. The real question heading into COP 21 is how ambitious the developed country pledges to the Green Climate Fund will be. The level of contributions will likely be the most contentious part of the conference, and is likely to re-open the North-South divide which plagued Copenhagen, albeit to a much lesser degree. There is no question, however, that OECD government budgets are already stretched, and this places serious downward pressure on both the size and the credibility of the commitments. The fact that both China and India have already made substantial pledges will be hugely helpful to the negotiations.

In a clever piece of politics, the Lima-Paris Action Agenda has been whistled up to give an immediate sense of dynamism to CoP21 where perception and public opinion will hold sway.

A successful and substantive COP 21, beyond the smoke and mirrors of Paris that are part of any global summit, will be one that catalyses action, and deeper private climate financing and investment flows, in the 2016-2020 timeframe.

COP 21 needs to also banish the Ghosts created in the public mind by the chaotic ending to the Copenhagen CoP in 2009 where expectations peaked way beyond the intergovernmental process to deliver - - a sure recipe for political and perception failure.

The French have been both masterful and brutal in their focus on ensuring COP 21 in Paris, at the very least, appears successful. As we have seen, national commitments by more than 150 nations will also give a sense of global ownership that Copenhagen failed to do but rather smacked of the ultimate North-South split.

Whatever their financial reality, climate commitments by China, India and the US in the run up to COP 21 are a huge signal to the emerging economies, developing countries and frontier markets whose numbers, rather than financial or political power, count in the one country-one vote system that nominally holds sway in the UN system.

The giants are moving and so now will the rest of the world.

What are the next steps for investors?

I have long been on the record as saying that we should not regard COP summits as single, historical, end-state , make-or-break events; but simply another, important , step in a longer voyage.

One of the key insights from Inflection Point Capital’s Climate Change Dinner Series – which we have held over the last twelve months in Tokyo, Paris, Davos, London and Stockholm – to channel investor views to CoP21, is that the shift to a low carbon future will be driven by investors and corporations and not by politicians.

For institutional investors, the question is not only what is happening at COP21, but what will we be doing over the next five and ten years to both propel and benefit from the necessary mega-shift to a low-carbon economy?

Institutional investors clearly have a — perhaps THE — critical role to play in the transition to a low-carbon economy.

Why?

Because they are the purveyors of financial oxygen to the actors which have the most immediate and direct impact: the corporations. The signals they send when allocating capital to certain companies in preference to others can have a major impact on corporate behaviour, and thus on the climate question directly.

And I’m encouraged by some early, promising signs that at least some institutional investors are prepared to lead through not only through their words but their actions. Among the examples:

  • In Sweden, AP-4 has invested fully € 1 billion in a low-carbon index
  • In France, the FRR has done the same thing, and is currently conducting an RFP for a second low-carbon strategy
  • Also in France, ERAPF is currently running an innovative competition to elicit creative low-carbon investment strategies, the best of which will be funded as mandates
  • In the U.K., the Environment Agency’s pension fund has shifted its entire passive portfolio into a low-carbon index
  • In Denmark, Pensions Denmark has made significant investments in low-carbon infrastructure, chiefly wind farms
  • Here in New Zealand, New Zealand Super has now made a USD 100 million investment directly into California fuel cell company Bloom Energy.

These are only a few early examples of what I’m confident will become a major trend, and ultimately even a new “business as usual” for institutional investors everywhere.

In concert with initiatives from national governments, regional ones, cities, corporations, and civil society, we can definitely begin to bend the emissions curve in the right direction.

However whilst globally we are seeing green shoots, there is a need for more action.

The following statistics are telling:

Signatories to the UN backed Principles for Responsible Investment: 1410
Signatories to the Montreal Carbon Pledge: 110
Signatories to the Portfolio Decarbonization Coalition: 18


Why are we seeing this gap in action?

We fear that the biggest unstated issue is that some asset owners fear that they cannot meet the needs of their beneficiaries and de-carbonize their portfolio at the same time. Ironically, fiduciary duty is often trotted out as a rationale for not taking action on climate, which seems a bit counter-intuitive to us.

We don’t believe that there is a trade- off between de-carbonizing an asset portfolio and meeting the needs of beneficiaries. On the contrary…

We only have to look at the corporate sector to see examples of companies that are setting targets, voluntarily de-carbonising their businesses, and at the same time delivering strong profits.

Examples include:

  • Apple has committed that its corporate facilities and data centres will run on 100% renewable energy and is investing in a range of renewable energy facilities including investment in a Chinese solar energy project in Sichuan Province that will generate up to 80 million kilowatt?hours per year of clean energy.
  • Google is improving the carbon footprint of its data centres through a range of range of measures such as externally purchased power from wind turbines.
  • Ingersoll Rand has committed to a 35% reduction in greenhouse gas footprint by 2020 and is implementing this commitment by focusing on energy efficiency and changing fleet procurement requirements to include lower fuel consumption options.
  • Marine Harvest, Norwegian based salmon farmer reduced greenhouse gas (GHG) emissions per tonne of fish produced by 11% in 2014 by focusing on its energy mix and energy efficiency.
  • Novo Nordisk, which committed to a 10% CO2 reduction from 2004 to 2014, signed a partnership with Dong Energy where energy savings at the company’s Denmark plants were used to purchase electricity from a new wind farm in the North Sea.
  • BUPA, a British health insurer, launched an internal competition for carbon reduction ideas, and funded five of the most promising.

The point of all these examples is that companies are focusing on carbon reduction in very different ways, making both small and big changes to the way they operate in order to reduce their carbon consumption and emissions. The simple act of setting a concrete reduction target creates a new level of focus, and can catalyse a wide variety of creative solutions.

We believe that asset owners need to follow the example of the best practice companies in the corporate sector and set their own carbon targets.

This is something that the PRI, in its Climate Strategy Report has specifically encouraged.

On the eve of COP21, declaring a target to reduce carbon emissions is the single most important thing that an asset owner can do to respond to the threat of climate change.

Having set a target, asset owners – like the corporate sector – will be focused on finding ways to meet their target consistent with delivering to their beneficiaries.

The way in which each asset owner meets its carbon target will depend on the individual characteristics of the portfolio and beneficiary needs.

On the eve of COP21 we are proposing a very simple formula:

1. Set a measurable target to reduce portfolio carbon over a 10 year period. It doesn’t matter how small the initial commitment is, it is important to start the journey as this will drive a culture of accountability and innovation.
2. Look for investment opportunities on the upside, across all your asset classes. Climate change is much more than an unmitigated black hole of downside risk. Low-carbon infrastructure, green real estate, energy efficiency and retrofits, green bonds, timberland, and best-in-class listed equities are only a few of the opportunities available.
3. Support innovation by encouraging a contest of ideas. Like corporations that have embraced carbon reduction, both small and big steps are important. There is no monopoly on good ideas.
4. Also support investment product and solution innovation. The traditional stress on lengthy track records militates against some innovative new solutions. Climate change as an investment phenomenon is simply both too new and too urgent to expect or wait for long track records.
5. Commit to sharing progress. We are advocating an approach that is broader than simply disclosure. By sharing progress - including lessons from what went right and what went wrong - we help others on their own journey.


I would like to finish by reflecting on what the asset owner of the future will look like.

A core principle behind the way that Inflection Point Capital invest is what we call Strategically Aware Investing.

In a nutshell, we believe that investment success involves finding better-managed, more agile and forward-looking companies, with more sustainable competitive advantages, at attractive valuations.

We believe that a series of powerful secular global megatrends, combined with the accelerating velocity of change in global markets, is creating an entirely new set of ‘non-traditional’ risk/return drivers and competitive imperatives for companies. Companies that aren’t innovative and agile in the face of this change will be left behind. And the same goes for institutional investors.
Whilst we have built our own investment model based on this philosophy, a separate question is what does SAI look like for an asset owner?

How does an asset owner need to structure themselves so they are equipped to understand and respond to megatrends that are creating a complex and volatile world?
We are likely to see asset owners develop new skills in order to respond to the demands of a volatile and changing market, radical information transparency, and the increasingly taxing demands from an informed and connected membership and other stakeholders. And this is not to mention governments, which will increasingly look at asset owners to solve social, environmental and economic challenges as their own budgets shrink.

We may even see a new department emerging within asset owning organizations that might be separate from – but linked to — the responsible investment team which is currently responsible for ESG integration, proxy voting and corporate engagement.

An asset owner’s Strategically Aware Investing team might be responsible for:

  • Understanding the linkages between megatrends, future public policy, and the institutional investment landscape
  • Developing analytics that provide the capacity to anticipate changes and adapt portfolios accordingly
  • Connecting an asset owner’s investment and communications teams more tightly to facilitate member engagement on investment issues
  • Finding new investments that will deliver returns and be less volatile in a time of change.

One thing is certain: given the pace and magnitude of the changes swirling around institutional investors today, resilience, adaptability, innovation, and vision have never been at such a premium. Your stakeholders will only get more demanding, not less.

To conclude, it is perhaps fitting to be delivering this speech in New Zealand on the eve of COP21. Pacific Islands such as Fiji and Kiribati are notable not just because it is where the New Year comes first, it is also where the impacts of climate change will be felt first.

Nowhere in the world has as much interest as this region in addressing climate change.

Now is the time to act to ensure that we don’t have to deal with a humanitarian crisis that results from a failure to keep climate change within 2 degrees.

I would like to close with a quote from the CEO of ENEL, one of Europe’s largest energy utilities:

“There is a huge tide flowing. You can decide in which direction to swim, but the flow is not in your control, and neither is the direction. “I would urge you all to start — or keep — swimming in the direction of a low-carbon future.

Thank you so much for your time.

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