Research - JULY 25, 2017

Climate change — the heat is on

by Richard Fleming

A press release from Mercer about its latest European Asset Allocation Report starts by citing NASA’s statement that April 2017 was the second hottest April in 137 years, and cautions that so far only 5 percent of European pension schemes have considered the financial impact of climate change. We do believe in global warming and climate change, don’t we? Unlike some.

If that — the second-hottest April bit — doesn’t worry you, it should. Records began in 1880, and the hottest April on record was in April 2016. There’s a pattern emerging here. It’s noteworthy, too, that the Arctic icepack is smaller and thinner than ever this year.
Mercer’s 15th European Asset Allocation Report covers 1,241 European pension schemes across 13 countries with aggregate assets of €1.1 trillion. Only 5 percent have considered the investment risk posed by climate change, the report found. Mercer has called for more urgency from the industry to address the issue. As well as investment strategy information, the report tracks the drivers behind environmental, social and corporate governance (ESG) integration and two key areas within responsible investment: investor stewardship and active ownership rights, and the investment risks and opportunities posed by climate change.

According to Phil Edwards, Mercer’s global director of strategic research, “the report findings highlight the need for the industry as a whole to do more [on climate change]; it’s ironic that the pace of response to this enormous issue is best described as glacial, outside a small group of leading funds.

“The Paris Agreement, which came into force in November 2016, has set an ambitious target to keep global warming well below 2˚C above pre-industrial levels, with a stretch target of +1.5˚C,” Edwards says. “It provided a strong signal as to the long-term direction of climate-related policy; investors must therefore consider the potential financial impacts of climate change on their portfolios. Inactivity by pension schemes brings risks from stranded assets and physical climate risks, as well as reputational concerns. A proactive approach can open up investment opportunities in the green fields of the low carbon economy.”

In 2015, ahead of the global climate negotiations in Paris that we thought were concluded successfully but that may yet unravel, Mercer published Investing in a Time of Climate Change, a report outlining four plausible climate change scenarios (considering warming levels by the end of the century from +2˚C to +4˚C) and the impact that each scenario could have on investment returns. That report found that the biggest impacts were under a +2˚C scenario and crucially that long-term investors could position their portfolios for such a scenario without seeing materially reduced expected returns.

There has been a gradual increase in the number of European pension schemes factoring ESG issues into their investment process, the latest asset allocation report found. Financial materiality was the main driver behind this trend, cited by 28 percent of respondents in 2017 compared to 20 percent in 2016. This was followed by reputational risk, cited by 20 percent in 2017 compared to 16 percent in 2016. The report also found that around 20 percent of asset owners integrate ESG risks into their investment beliefs and policy, with 22 percent of those surveyed having a standalone responsible investment policy. So ESG is gaining traction.

According to Kate Brett, a senior responsible investment specialist at Mercer, “the increase in asset owners citing financial materiality as the driver behind considering ESG risks is a positive development for the market — asset owners simply cannot afford to dismiss ESG risks as non-financial. Regulators are increasingly clear that asset owners should be considering all risks that may be financially material, including ESG-related risks and longer-term risks such as climate change — proactive consideration of these issues is absolutely consistent with fiduciary duty,” says Brett. “The forthcoming recommendations of the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures are likely to help drive further focus on climate risk management by asset owners.”

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