The 2-degree business plan: How investors can cut climate risk

The 2-degree business plan: How investors can cut climate risk

cracked ice and climate change risk investor pressure
Flickr Phillip Grondin
There's a crack in the foundation of many businesses: A fialure to address mounting climate risks.

The diplomatic success of the COP21 climate talks in Paris was a remarkable milestone. The active engagement of investors was a particularly noteworthy development during the United Nations talks.

Yet we also cannot ignore the sober subtext. As United Nations Secretary General Ban Ki-moon and other prominent officials clearly stated, the Paris Agreement is a starting point, not a turning point.

A recent MIT study underscores a harsh reality we ignore at our peril: Even if countries honor their pledges, current Intended Nationally Determined Contributions (INDCs) point to warming of 3 to 5 degrees Celsius above pre-industrial levels.

And this is happening now. According to an annual assessment of global risks, the World Economic Forum's experts consider climate change a short-term risk, even in 2016.

What this means for investors is that they cannot be satisfied with the incremental climate risk management instruments developed pre-COP21.

If, over the next 10 years, investors rely primarily on tools such as greenhouse gas disclosure, portfolio decarbonization and strategic asset allocation, investors will fail to deliver on what they can do — namely, bridge the gap between what was agreed and what needs to be done to hold planetary warming below 2 degrees Celsius.

As concerned investors gathered in New York for the Ceres/Investor Network on Climate Risk (INCR) summit this week, we must remember that this group has huge influence. A U.N. working paper by Cary Krosinsky estimates total public equity valued at roughly $67 trillion, compared to the World Bank’s estimate of $77.8 billion for World GDP in 2014.

Definitional issues aside (equity value is a stock and GDP is a flow), fiduciary duty exercised at scale could galvanize the private sector at the scale necessary to address climate change.

Today, investor influence generally works against the changes that are needed, as the dismissal of NRG’s forward-looking CEO demonstrates. But it need not be thus.

Business plans post-Paris

The time has come for forceful stewardship. Investors should use shareholder resolutions to require companies to publish 2-degree transition plans. Once the key companies in any sector have done this, so containing first mover disadvantage risks, investors should encourage implementation of these plans at a sectoral level.

Given the limited window of opportunity to avert abrupt, non-linear and irreversible climate damage, this is the only sane risk management decision possible. Investors need to hold corporate leadership in every industry accountable for addressing climate risk through large-scale, coordinated and public shareholder resolutions.

Forceful stewardship — an open and transparent framework to align and coordinate investor action on climate risk across all sectors of the global economy — provides a mechanism to create minimum standards for 2-degree business plans that can be measured and monitored.

Ceres and INCR members are doing great work with many sectors, hydrocarbon companies included, and this has been the case for some decades. But now is the time to acknowledge that incremental remedies for addressing systemic risk will not be a winning strategy.

COP21 also has shown that current public policy options have limited promise, given that a high enough carbon tax isn’t politically tenable for nations that are the largest GHG emitters.

There is no question that holding planetary warming to 2 degrees Celsius requires the active and urgent mobilization of the private sector. We need to move further and faster than the actions we’ve seen from the public sector to date, and institutional investors need to take these responsibilities seriously.

The best hope for mobilizing the private sector to address climate change is for investors to fulfill their fiduciary responsibilities by using their shareholder voting rights to push companies to adopt meaningful transition plans.

Three important developments in 2016 should lead institutional investors to address climate risk in this new way: the many opportunities for corporations to profit and grow sustainably by developing innovative solutions to climate change; the threat of legal action by asset owners if managers fail in their fiduciary duty; and the very real economic (and human) costs of catastrophic climate change.

While this agenda may seem disruptive, the reality is that as intelligent investment professionals, their clients and stakeholders will come to realize there are significant fat tail systemic risks around the corner which demand action now. What seems fantastical today will become the new norm tomorrow.

Forceful stewardship provides a path that optimizes opportunities and reduces risk. Investors, asset owners and all stakeholders will benefit from choosing this path.