Climate Change Integration in the Investment Process

To kick off the webinar, Matthew Orsagh, senior director of Capital Markets Policy at CFA Institute, gave a brief presentation regarding climate change and how it can be integrated into the investment process. For centuries, greenhouse gases (GHGs) have played a major role in warming the planet and making it habitable. Without GHGs, the average temperature on Earth would be -18°C, compared with the actual average temperature of 15°. The past few decades, however, have witnessed a dramatic increase in average temperatures because of rising GHG concentrations. To put things into perspective, according to the National Oceanic and Atmospheric Administration (NOAA), between 1880 and 2020, the seven warmest years have been recorded since 2014, while the 10 warmest years over the same period have been recorded since 2005.

Investors need to focus on two types of climate-related risks: physical and transition risks. Physical risks involve economic losses that result from anthropogenic effects of climate change and extreme weather events, such as hurricanes, floods, and droughts. In contrast, transition risks include the financial impact on businesses that produce or rely on fossil fuel assets, such as coal, oil, and gas, which will lose their value because of policy measures and market trends to transition to a low-carbon economy.

Different approaches, such as carbon tax and cap-and-trade, can help reduce emissions, but these initiatives cover only 20% of the global emissions. We need a global carbon market to assess the real price of carbon. Once such a market exists, investors will be in a better position to determine the impact of climate-related risks on companies’ business. It is also important to use standard metrics and framework, such as the EU taxonomy, across the market to inform investors about the impact of their investments. Additionally, we should engage more with companies regarding climate-related risks and educate our profession. This growing awareness can motivate investors to put pressure on regulators to demand for better transparency and quality metrics, helping us make informed decisions in the future.

The presentation was followed by a panel discussion that included Matthew Orsagh and Mary Leung from CFA Institute, as well as industry practitioners, including Hardik Shah, ESG practice lead at GMO LLC, and Kanol Pal, senior advisor on Responsible Investments at BNP Paribas Wealth Management.

Following is a summary of the key points that emerged during the discussion.

The Asia Pacific region has generally lagged its European counterparts in terms of ESG disclosures. Over the past few years, however, the exchanges and regulators have introduced new regulations to disclose sustainability performance, helping investors to engage more with companies on issues such as decarbonisation and human rights. For instance, regulators increasingly have been using a “comply-or-explain” approach that requires companies to either comply with regulations or explain publicly why they do not. This allows the market to decide whether the set of standards is appropriate for the companies in question. That said, it remains difficult to apply the EU taxonomy — a framework to help investors assess sustainable economic activities — because of its strict criteria that can be applied only as the markets develop over the period.

It is difficult to consume and make sense of the plethora of information available. One way to address this problem is to focus on only those ESG issues that are material to a company, rather than focusing on traditional ESG scores. This approach allows investors to evaluate only those risks that are financially important to a company. Industry groups, such as the Sustainability Accounting Standards Board (SASB), have made great strides in mapping material issues to a given industry. Nevertheless, investors should not analyse ESG information in isolation. It is still important to focus on financial information to evaluate whether a sustainable company is overvalued.

Another important point that was raised during the discussion is whether the convergence of ESG standards is realistic. It also is important to realise that industry groups, such as SASB, the Global Reporting Initiative, and the Task Force on Climate-Related Financial Disclosures (TCFD), provide complementary tools. For instance, TCFD focuses on climate-related disclosures, whereas SASB primarily addresses the needs of investors. Hence, it is incumbent upon the stakeholders to understand which tool is more relevant. But the institutions do understand the complexity surrounding sustainability disclosures. As a result, five such organisations have started working together to develop a comprehensive corporate reporting solution.

In the past, investors generally considered governance to be the most important aspect among the three ESG factors, whereas environment and social issues were limited to values-based investing. This is no longer the case, however, as investors have realised the importance of economic value and moral values that environment and social factors present for long-term investors. This easily can be seen in the latest ESG disclosure requirements as the world is striving towards a sustainable future.

The webinar concluded with a subject on how climate change will affect future jobs. The next generation needs to acknowledge the fact that climate-related risks are here to stay, opening doors to various opportunities across different industries. To that extent, the technology sector will see huge investments in renewable energy for managing energy-intensive data centres, whereas coal, oil, and gas industries may encounter issues in terms of future job opportunities.