Climate Change as a Topic for Impact Investing

Abstract

ISS-Ethix’ contribution to Responsible Investment Banking (Springer)

Background: Investors’ awareness of climate change has been hastened by the increasing financial and economic impacts of climate change and the growing acknowledgement of most carbon-intensive assets becoming stranded. The call for climate action has also been accelerated by governments and civil society actors interested in and concerned about the environmental consequences of large investors’ climate impact (http://www.carbontracker.org/report/carbon-asset-risk-from-rhetoric-to-action/). The 21st Conference of Parties (COP21) (The international climate conference of all countries in December 2015 in Paris.) ended with the world committing to curb global warming at 2 °C. All these together imply a radical transformation of the world’s economy and therefore investor thinking. Some investments will be at risk while others will benefit.

Purpose: The proposed article argues that investors with a focus on climate change can not only quantify their investment impact but also increase the probability of achieving superior investment returns.

Focus: The following article applies a wide definition of impact investing. It follows an underlying theory of change that suggests that the financial industry can transform the real economy. Impact investing is therefore not only defined as investments in assets that yield a positive, desirable outcome for societal challenges, but also a means to send signals into the market through investment decisions or direct engagement with investees. Furthermore, the article builds the case for the importance of understanding investment impact in the area of climate change, arguing that it can lead to better investment returns by avoiding downside risk and harvesting upside opportunities.

Examples presented: Investors face different dimensions and levels of climate change-related risk. These risks are conceptually divided into asset level risk (e.g., physical risk, risk related to carbon pricing mechanisms, regulatory and litigation effects) and investor level risk (e.g., risk related to Stranded Assets (http://www.ey.com/AU/en/Services/Specialty-Services/Climate-Change-and-Sustainability-Services/EY-lets-talk-sustainability-issue-4-stranded-assets-from-fact-to-fiction) and a “Carbon Bubble (http://www.greenbiz.com/article/carbon-cause-next-financial-crisis-fossil-fuel-stranded-assets)”, financial regulation or reputational risk). Understanding the climate impact of investments, however, can also yield investment opportunities. These opportunities include the financial outperformance of leaders or disruptors (https://www.sicm.com/docs/CDP_SICM_VF_page.pdf) as well as the rise of new—climate-focused or climate-friendly—asset classes such as clean tech or green bonds (http://www.mercer.com/services/investments/investment-opportunities/responsible-investment/investing-in-a-time-of-climate-change-report-2015.html).

Key takeaways: Following governments’ commitment to work towards a global low-carbon economy at COP21, and an increasing societal focus on the topic, understanding the impact of climate change regulation is vital for investors. They need to proactively embrace measurements and strategies to address climate change and related legislation both as a risk and as an opportunity.

Some topics covered in this article have been discussed in the report Fossil Free Indexes/South Pole Group: The Carbon Underground 2016: Managing the Climate Risks of Fossil Fuel Companies in Investment Portfolios (July 2016) and CSSP/South Pole Group: Top 100 Study Carbon (September 2016).