Private investors need to come clean and commit to science-based targets on climate change, says Paul Simpson. Unfortunately, “there is still money out there for the dirty investments in the short term,” he laments, calling on regulators to take action against opaque finance.
Paul Simpson is CEO of CDP, a UK-based organisation formerly known as the Carbon Disclosure Project. CDP supports companies and cities to disclose the environmental impact of major corporations, and aims to make environmental reporting and risk management a business norm. He spoke to EURACTIV’s Frédéric Simon.
- 7,000 listed companies worldwide currently report information on climate change
- Those that fail to act face litigation risk and shareholder pressure
- So-called “fiduciary duty” of investors is evolving
- Investors need to commit to science-based targets on climate change
- Finance sector needs to get rid of “dirty investments”
- Risk of green tech bubble is less serious than risk of climate change
CDP was launched originally to encourage companies to report on their exposure to climate-related risks, such as floods, water scarcity and so on. Why would they want to do this? After all, this is potentially sensitive information, so why would companies reveal their vulnerabilities?
When we started CDP in 2000-2001, the investment community needed to engage on climate change and climate risk. Investors were really not engaged at the time. And those who could see the risk coming said they needed better information.
So at CDP we created a process where, each year, a group of investors asked the companies for disclosure. In 2002, we had 35 institutional investors worth $4.5 trillion of assets under management asking the world’s 500 largest listed companies to disclose.
So the prime reason why the companies initially began to disclose is because their investors were asking them to do so.
What are those risks, essentially?
As a company, you have four categories of risks linked to climate change: risks related to changing policies and regulations, risks related to change in technology, and physical risks like extreme weather events – floods, droughts, etc. And in time, you also have risks related to changing consumer sentiment.
Now, Mark Carney, the governor of the Bank of England, has launched the ‘Task Force on climate-related Financial Disclosures’. They have similar categories of risk which they call transition risks.
But they also have a relatively new category called liability risk. In some sectors, liability could result in law suits.
…like Bayer-Monsanto which recently lost a case on glyphosate in the US?
Yes, exactly. We’ve seen happening in the past with tobacco and asbestos. Today, there is a risk that some companies or some sectors may face liability risks on climate change, particularly if they fail to act and have not been honest about what they know.
I assume the companies that are willing to disclose such information are those which do relatively well, right?
To some extent. Companies like to tell their positive stories, of course. But the purpose of disclosure is that it focuses on specific information. At CDP, we’re asking companies about the risks and opportunities they face, how they manage the issue, who in the company is responsible, what is their job title, their name, and so on.
So it’s structured information which they cannot manipulate…
Exactly, it would be very hard for them to do so. We also ask companies whether they have their information verified or audited. Of the large listed companies, at least 70% now have some form of external verification. A lot of companies and investors don’t consider this a voluntary anymore. It’s becoming a market norm, it feels like we have to do it.
I understand only a small fraction of companies have signed up to the CDP programme. How long before it becomes standard and everyone starts doing it?
I think the glass is more than half full. On a global level, we have now 7,000 listed companies disclosing information on climate change, some 2,000 on water and about 200 on deforestation in their supply chains.
On the climate part, the listed companies represent more than half of the world’s market capitalisation on the top 30 stock exchanges in the world. Which is why I say the glass is more than half full.
Now, there are some companies which either don’t want to disclose or are not yet ready to disclose. But we need full disclosure. And that requires investors to push more companies to disclose.
In the UK, for instance, Aviva told the FTSE 100 companies to disclose on climate change through CDP, otherwise they warned they will vote against the board at the annual general meeting. That is relatively strong pressure, and it needs to happen more, not only with large companies but gradually with medium-sized companies as well.
There is also increasing regulation. In the UK, listed companies must report greenhouse gas emissions from their own operations. It’s been a legal obligation for at least five years in the UK. In the EU, there is the non-financial reporting directive that needs to evolve and become mandatory. And in China, the government is working on Environmental, Social and Governance (ESG) rules that we think will become law by 2020.
So there is increasing investor pressure and in time, regulations should drive this disclosure across every company.
Financial markets are focused on the short term profit of companies and a quick return on investment. They have until now failed to put a price on the environmental, social or governance issues that companies face. Is that likely to change any time soon?
This is a key problem. If you look at the incentives of an investment banker, they need to meet the market benchmark and possibly exceed it in order to get their bonus. So there are fundamental problems in financial markets that drive short-termism.
Mark Carney, the governor of the Bank of England, gave a speech on the tragedy of horizons, which sets this out very clearly: climate change is a long-term horizon problem but if we let it build up, we risk locking in systemic risk. And we need to find mechanisms to link these two horizons.
We think disclosure is one of the solutions. But we also need other incentives, like a carbon price, which applies in the EU for some sectors.
In addition, there are long-term investors like pension funds, which by definition are supposed to act on the long-term, investing in the best interest of their beneficiaries. When we’ll retire in thirty or forty years, they can either offer the most amount of money in a 4°C unsafe world or an optimal amount of money in a safe and stable world. Well, I clearly prefer the safe and stable world.
So the fiduciary duty of investors is evolving. You can ultimately argue that long-term investors need to incorporate this information in order to protect their assets. In theory, that is very true but we need to see clearer progress in the way it’s implemented in practice.
The transition to a green economy in Europe will require an estimated €180 billion of additional investment every year until 2030, according to the European Commission. Is the financial sector ready to deliver?
There is no shortage of capital in the world. There are about 250 trillions of invested assets in the world so finding 180 billion a year is not a problem. The problem is getting the right information, through disclosure and the right policies to drive those investments and give relative certainty on the direction of travel.
Take renewable energy incentives. They have been helpful at kick-starting the market but sometimes governments have changed policy quickly and investors were left with political uncertainty. Investors need those kinds of signals to be bolder and say they’re not going to invest in things like coal, or oil sands, and put more money into clean technologies.
The question then becomes what can be considered clean technology. The European Commission has proposed a taxonomy to determine, sector by sector, whether an economic activity is environmentally sustainable or not. Can this be a game-changer for the investment community?
It can be very helpful. The EU action plan on sustainable finance is going in the right direction, we applaud the EU on this. Now, implementation is going to be key.
But it’s quite complex because investors may have portfolios which have a bit of green, brown and black assets. In the UK, a company will be listed green if it derives more than 40% of its revenue from green and clean technology. So a taxonomy will be helpful in determining a standardised approach.
But there will be a debate as to what falls in different areas. Because investors may hold interests in companies that do a range of things.
If you take the automotive sector, some carmakers are investing enormous amounts in low-emission or electric vehicles, which is great. While at the same time, they may still be selling diesel, SUVs, etc. So are these companies green or brown? It’s usually a bit of both.
In the end, there aren’t that many companies that can be considered ‘pure players’ in clean technology: Vestas comes to mind for wind power, Tesla for electric vehicles, and some Chinese companies in the wind and solar business but there aren’t that many.
Once you have to taxonomy in place, the question is how to reward the green and penalise the brown. What are the best ideas there in your view in order to do that?
Companies first need to be disclosing about what’s green and what’s brown. And then really, it’s about providing policy incentives about pricing. The market is getting better at that, but you need the policy incentives. A so-called brown penalising factor might work just as well as a carbon price.
What could a brown penalising factor look like?
As far as I can tell, no one has worked this out yet! One thing governments can do is put this consideration at the top of the investment chain. For example, pension funds could commit to phase out coal. I don’t think that’s controversial in the EU anymore, it’s only a question of when. So you could say pension funds should commit to phase out coal. But should the date be set by policymakers or investors – that’s still up for debate.
And in practice, a carbon price at the source of emissions or a simple tax break for electric vehicles – these are probably better in the real economy to drive purchasing decisions than financial markets.
Do you see a tipping point coming about green finance becoming mainstream across the entire financial services industry?
We do, it depends, whether you consider the whole world or just parts of it. In Europe, absolutely yes, partly driven by the EU action plan and the work that has been going on in already in financial markets.
Do you see that coming in the 2020s or 2030s?
The science of climate and environmental risk tells us it needs to happen quickly, by 2020. I think we have a number of building blocks in place already. And I think at least large institutional investors are on track.
For example, Allianz just announced they will commit to a science-based target to keep their whole portfolio with in a 2°C pathway. And that’s a bold an important commitment. We now have some 500 companies committing to science-based targets and that’s quite game-changing. So, it’s happening.
Now, there is a concern that while large institutional investors commit to sustainable finance and disclosure, there are still some parts of finance which is more opaque – such as hedge funds, private equity, offshore finance, or places like Switzerland, where finance is still pretty opaque. I think that shows there is still money out there for the dirty investments in the short term and that something needs to be done about this.
You were in San Francisco for the Global Climate Action Summit 2018. What are the companies or sectors where the most green innovation is taking place at the moment?
California passed a new law to reach zero-carbon electricity and a net-zero economy by 2045. While in the EU, the discussion is about reaching net-zero emissions by 2050. So California is leading the way.
In terms of the sectors, there is a big buzz around electro-mobility at least for passenger transport. There were big commitments made in San Francisco on the charging infrastructure because the more infrastructure there is, the more people feel confident about buying an electric vehicle.
Renewables continue to be exciting, the cost curves continue to go down for wind and solar. And whoever wins the race to create the best batteries – that is also attracting a lot of attention. Tesla have a big investment with Panasonic and are making the Tesla wall. And then, there is the whole supply chain of those batteries, whether made from Lithium which the most common at the moment, or whether made from substitutes that may offer better performance.
And then, there is the debate on data and technology. Some say data is the new oil, which is debateable. But what we do see is that technology companies that use artificial intelligence and satellite information have a much better understanding of what is happening in terms of emissions and the environment.
We are increasingly seeing a coming together of data disclosed by companies and cities, for example the work Google are doing on satellite technology and remote sensing of what’s happening in cities on air quality and temperature. And that is now all coming together to create much better environmental information.
Do you see a risk that an asset bubble starts building up around green tech in the coming years?
I started my career as an investment analyst so I’m well-placed to say there is always a risk of getting bubbles in markets. Because investment decisions are based on the analysis of the fundamentals of a company’s position but also on perceptions about risk and future growth opportunities. We saw that with the tech bubble.
You can argue that in any growth environment, there is always a bit of a bubble. But when it comes to new green asset classes, on the contrary, some investors may be a little bit too cautious.”
Of course if regulation was to force a big shift in green investment, then it could cause a bit of a bubble. But I think the real challenge at the moment is to get many of the exciting technologies and investment companies in places where they are well run and where investors feel comfortable putting their capital into them.
In a report – “Too late, too sudden ” – the European Systemic Risk Board, an EU advisory body set up during the 2008 financial crisis, warned about the risks of moving too late and abruptly towards a low-carbon economy. Do you see a risk as well that the green transition goes too quickly?
In think the biggest risk is to fail reducing emissions quickly enough. The Bank of England issued a report in September saying the window for a managed transition on climate change was shortening.
From the latest IPCC report, it’s becoming clear that limiting global warming to 1.5°C will be very hard to achieve. In order to stay below the so-called “safe level” of well-below 2°C of warming, we need to move much more quickly in order to get there.
If we don’t, then we’re building up systemic risk similar to what happened during the financial crisis. And that is fundamentally the biggest risk.
Now, can financial markets change quickly enough to avoid emissions getting too high? Or are they rushing? I think it’s good for capital markets to know where they’re going. And the Paris Agreement provides a reasonably clear pathway in terms of what needs to happen – emissions need to peak by 2020 and halve every decade thereafter in order to reach near-zero by 2050.
Now, can we steer a pathway that is quick but not too fast? I think the bigger issue is that if we wait much longer, then we will be a bit too late.
A decade ago, with the collapse of Lehman Brothers, financial markets were seen as part of the problem. With the emergence of sustainable finance, are they now the new heroes?
Ultimately, they are both. The value of financial markets is what they do with capital and where the investments go.
I don’t think we have learned all the lessons of the 2008 crisis. If you look at debt levels in the world, they’re extremely high again, and building up risk in the system. But, financial capital is the lifeblood of the economy. And if we need to transform the economy from high to low carbon, then financial capital is going to be absolutely key to driving that process.
However, capital markets on their own cannot pull the trick, even if some say accountants will save the world. The challenge of creating a truly low-carbon economy is that everyone needs to be involved and we need change in a whole range of places.
What are your expectations from the Climate Finance Leadership Initiative that was recently launched in New York by Michael Bloomberg? What can be its contribution?
From what I understand, the initiative is about private capital – institutional and private investors coming together with governments like France and Germany, and some of the big philanthropists like Bloomberg, the European Climate Foundation, Hewlett and others to make the point that they have a lot of capital around to invest. And that they want to commit more of that capital to low-carbon and environmentally-friendly investments.
Also, in the Paris Agreement, there was a commitment from governments to put 100 billion dollars every year into climate-friendly investments. The current position of the White House is not particularly helpful in that respect.
So I think it’s extremely helpful that others are coming together and forming coalitions to make sure capital goes to the right places in order to reduce emissions and also to build resilience and adaptation in the countries that really need it.