Why investors have fiduciary duty for the environment

ShutterstockKhakimullin Aleksandr

The following article is an excerpt from our State of Green Business (SOGB) 2017 report. Published by GreenBiz in partnership with Trucost, it provides a global view of the year's trends in sustainable business. The report is free to download here.

The sustainable investing tide will rise ever higher in 2017 as more investors incorporate sustainability criteria into equity shareholder issues and consider sustainability criteria as part of corporate lending and credit risk. The net effect for corporations? Greater scrutiny and use of environmental disclosure data, as investors aim to uncover quantifiable links among environmental performance, risk and company value.

Corporate disclosure of environmental data continued to grow in 2016. This is unlikely to relent in 2017, given the added pressure created by the Paris Agreement on climate change. Four in five (81 percent) S&P 500 companies issued sustainability reports, and companies not disclosing are clearly in the minority. Last year also saw a spike in stock exchange disclosure requirements: 38 exchanges around the world require some form of ESG disclosure from companies as a condition for listing.

The Forum for Sustainable and Responsible Investment 2016 annual investor survey tallied a 33 percent increase in one year in assets under management that incorporate environmental, social and governance (ESG) factors, to $7.7 trillion in the United States. That’s a remarkable rise, considering that fiduciary duty and sustainability have been uneasy bedfellows, particularly in the U.S.

Businesses and investors are increasingly aware of climate-related risks, whether it is the physical impacts (water scarcity or rising sea level) or policy risks if a carbon- or water-intensive asset becomes subject to policies or regulations that would make the asset less valuable, or "stranded." New research by the United Nations Principles for Responsible Investing found that fiduciary duty is not an obstacle to asset owner action on these risks, and affirmed that sustainability is an important factor in the long-term success of a business. The year ahead may bring additional clarity from the U.S. Securities and Exchange Commission, whose 2016 public consultation on corporate disclosure considered the need for improved disclosure of sustainability factors in SEC filings.

As the value of assets incorporating ESG considerations grew, so, too, did the number of investors measuring carbon risk and divesting from highly intensive carbon-emitting activities, such as fossil fuels derived energy generation.

Large institutional asset owners — mostly pension funds and endowments — were some of the first investors to take steps to protect their portfolios from stranded asset scenarios or the physical risks from climate change. The Asset Owner Disclosure Project (AODP), which works to protect retirement savings from the risks posed by climate change, recorded a 63 percent increase in low-carbon investments last year, globally now at $138 billion. While leadership historically has been from the European Union and Australia, giants such as the $301 billion California Public Employees Retirement, $192 billion California State Teachers Retirement System and the $184 billion New York Common Retirement fund were recognized for their efforts to measure portfolio risks, engage with assets either directly or through proxy voting and invest in low carbon activities — efforts which will no doubt continue.

Despite progress, however some asset owners have yet to get started. For example, according to AODP (PDF), the 4.8 million U.S. civil service retirees who will draw their pensions from the federal government’s $439 trillion Thrift Savings Plan may be disappointed to learn that no such actions have been taken to manage climate risks and protect retirement investments.

This should change as a wider range of investors become aware that ESG issues are not just an equity shareholder issue but also a credit risk for corporate lending.

Asset managers with big shoes are stepping in to join asset owners in evaluating carbon risks. BlackRock, the world’s largest asset manager with almost $5 trillion in assets, issued a report (PDF) last fall recommending investors include climate risks in their decisions. "Investors can no longer ignore climate change," it said. "Some may question the science behind it, but all are faced with a swelling tide of climate-related regulations and technological disruption."

BlackRock is not alone. According to a survey by Morgan Stanley’s Institute for Sustainable Investing and Bloomberg, nearly two-thirds of asset management professionals say they are using sustainable investing strategies to achieve competitive market-rate financial returns. For the retail investor, Morningstar launched a sustainability rating system that enables individuals to evaluate the ESG factors of their 401K investment choices.

Perhaps the biggest trend for 2017 is that ESG factors will be considered in corporate lending and credit risk analysis. ESG factors can affect borrowers’ cash flows and the potential to default on a debt, and therefore are important in considering creditworthiness.

For example, a drought can limit production (reducing revenue) or cause a spike in electricity prices (increasing costs), with significant implications to the bottom line. China’s banks are exposed to costs of $1.6 trillion as a result of the environmental damage caused by industries they finance, according to research published at the People’s Bank of China Green Finance Committee’s annual conference in Beijing in 2016. Recognizing the importance of these ESG factors, Dagong Global Credit Ratings Group, Golden Credit Rating International, Liberum Ratings, Moody’s Corporation, RAM Ratings, Scope Ratings and S&P Global Ratings signed a statement in May to enhance systematic and transparent assessments on ESG in corporate credit ratings.

Further insights are expected from the Natural Capital Declaration’s 2017 launch of a project with nine international financial institutions to pilot scenario modeling to stress-test corporate lending portfolios for environmental risk, and in particular the economic resilience of major industries to the risk of extreme droughts. The participating financial institutions represent more than $10 trillion in assets. Real money.

Players to watch

U.N. Principles of Responsible Investing — works with investors to incorporate ESG factors into decisions and provides thought leadership on key topics, including guidance on fiduciary responsibility.

Sustainability Accounting Standards Board (SASB)developing sustainability accounting standards to help public corporations disclose material, decision-useful information to investors on ESG issues.  

S&P Global a signatory to the U.N. PRI’s 2016 Statement on credit ratings, look for the company in 2017 to launch a Green Bond evaluation tool to quantify impacts and an ESG Evaluation for corporate issuers.

Task Force on Climate-Related Financial Disclosuresthis industry-led task force’s new recommendations call for investors to report on climate-related financial impacts, including scenario and stress testing of business models and investment portfolios.

U.S. Securities and Exchange Commission (PDF)watch for the commission’s response to its request for public comment on its disclosure effectiveness rule, which includes sustainability related issues.