Most of the super industry is now actively assessing in some way what their response to climate change risk should be. The focus on climate risks by funds has escalated in the last couple of years driven by an increase in members contacting them on issues such as climate risk, greater clarity on legal obligations and APRA asking trustees about their approach to climate risk during supervisory visits.
Superfunds as large scale, long-term investors who hold diversified portfolios are in an ideal position to ensure that corporates don’t have financial losses from mismanagement of risks to their business, especially under-considered risks such as climate change. This in essence is their role as stewards.
As funds grow and increase in sophistication and experience, they are starting to exercise their stewardship muscles either directly with corporates, through their fund managers or via research and engagement experts. There are often two motivations behind this engagement – the assessment of the systemic risk borne within portfolios (including stranded asset risk) caused by climate change, and an increasing concern about the general quality of life provided to fund members as they retire.
The timing of this new focus has been driven by an increased focus on the meaning of fiduciary duty, including:
- Work conducted by the UN-backed Principles for Responsible Investment (PRI), which was launched in 2006 and today its signatories represent US$70 trillion of assets under management.
- The Task Force on Climate-related Financial Disclosures (TCFD), which launched its recommendations in June 2017, providing guidance to companies and investors alike on how to disclosure financially-relevant risks related to climate change.
- Legal opinion published in Australia by Noel Hutley SC including a 2016 memo, where he writes “it is likely to be only a matter of time before we see litigation against a director who has failed to perceive, disclose or take steps in relation to a foreseeable climate-related risk that can be demonstrated to have caused harm to a company”.
- APRA‘s Geoff Summerhayes February 2017 speech “Australia’s new horizon: Climate change challenges and prudential risk”, the first public speech by an APRA official which addressed climate risk. It is clear this is well and truly on APRA’s agenda.
There has also been a significant increase in community activism targeting corporates. For example, a recent campaign in Australia by the group Market Forces against Medibank saw the health insurer announce in November 2017 that it would dump fossil fuel stocks from its portfolio, acknowledging the impact greenhouse emissions had on human health.
We have also seen a growing number of divestments on high emission industries made by investors such as super funds, university endowment funds and even sovereign wealth funds (the Norwegian central bank, which runs the country’s sovereign wealth fund, late last year advised the government to approve the divestment of all oil stocks).
Finally we have also seen an increase in shareholder resolutions which focus on company management and disclosures of climate change risks, such as those seen last year at Exxon, Santos, Origin Energy and BHP.
This all adds up to the fact that climate change risk is no longer a fringe issue. It is seen as a key factor in the ongoing health and success of a company, as well as a factor in a corporate’s social licence to operate. Increasingly it is also seen as an opportunity by some investors, including those seeking alpha. Strategies to leverage into the opportunities include developing a better understanding of which stocks are capitalising on a changing climate, investing in emerging technologies and buying financial instruments (green bonds, for example).
That climate change is no longer a side issue among investors is no surprise when you consider the effect on earnings already being experienced from physical impacts of climate change. Indeed, these physical impacts are affecting ‘business as usual’, including operational disruptions, supply chain risks, asset impairments and other costs to businesses.
These impacts are affecting a broad range of sectors, and predictions for more extreme weather events as climate change deepens are only increasing. For example, Tatts Group has experienced revenue losses associated with horse race cancellations due to bad weather; Myer has suffered losses as a changing climate has impacted winter apparel sales; and Rio Tinto lost production worth more than $1.2bn due to an intense La Niña event impacting the Pilbara during the 2016/17 wet season.
While impacts to business are occurring here and now, more and more we are seeing companies adapt to the changing climate. Examples include:
- Aurizon—Australia’s largest rail freight operator—has been adapting to increasing severity and frequency of extreme weather events. Tropical Cyclone Debbie prompted new processes and infrastructure design to support quick recovery from extreme weather events. For example, by more strategically placing inventory stockpiles with materials to rebuild any damaged tracks quickly, and by rebuilding slopes affected by major land slips with a flatter gradient, high strength rock and armoured with concrete.
- Brisbane Airport, in anticipation of sea level rises and storm surges from extreme weather, has built its new runway 1.5m above the minimum regulatory requirements. It has also built channels to reduce tidal flooding, and a seawall.
- National Australia Bank has been utilising work from Dairy Australia and the University of Melbourne to pilot climate risk analytics software in the dairy industry, with the aim of managing credit risk and loan defaults. The software assists NAB to predict the ability of Dairy Farms to stay in business and to get a better sense of a business’s credit-worthiness when considering further loans.
There is still much room for improvement and there’s a lot of scope for upskilling both in the way climate disclosures are produced and the way they are assessed—by companies and investors alike—so climate risks can be better managed across the whole financial system.
Scenario analysis in particular does not go far enough, quality of disclosure is patchy and very little is done on physical risks. This means that many readers aren’t able to adequately assess disclosures.
The key to getting the right outcomes is through proactive and outcomes-based company-investor engagement meetings. We need to move our focus from emissions intensity to transition and pay more attention to action taken to adapt. As disclosure improves, so too will quality and impact of engagement. Creating better members outcomes and a better environment for future generations.