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June 02, 2009

Investors Must Lead Efforts to Reduce Climate Change Risks
    by Robert Kropp

Report by the United Nations Global Compact finds opportunities in a transition to a low-carbon economy to be challenged by the urgency of climate change risks. -- The International Energy Agency (IEA) estimates that in order to achieve a stabilization level of 450ppm CO2 by 2030, investment of $10 trillion will be necessary. But according to a report recently published by the United Nations Global Compact, "such large sums of money are within the long-term capacity of the financial sector, as long as the appropriate public policy incentives are in place."

The report was authored by the Principles for Responsible Investment (PRI).

The report, entitled Investor Leadership on Climate Change, notes that low-carbon investment opportunities are plentiful, so much so that in 2007, $204 billion was invested in various renewable energy projects. With a focus on equity investment, the report speculates that for such long-term institutional investors as pension funds, "the fiduciary case for action on climate change is compelling."

A spokesperson for PRI said, "The UN Global Compact wanted its series of reports on climate change to include one that focused on investors. The PRI author found several examples of best practice that investors can use in developing their own climate change investment strategies."

Warning against the inclination of investors to wait for policies that would create incentives for investment in low-carbon opportunities, the report details a number of problems associated with such an approach. Assumptions on the part of investors that effective policies can be easily accomplished in a diverse geopolitical arena, and that capital markets will act efficiently in addressing climate change, are far from foregone conclusions. Instead, the report finds, investors must take a leadership role in reducing the risks of climate change.

"There are enormous activities in the climate change space," the PRI spokesperson said. Citing a study that failure to address climate change risks effectively could wipe out 20% of gross domestic product (GDP) globally, the spokesperson added, "Investors who believe that climate change risks are not part of their fiduciary duty fail to address the long-term risks to which they subject their investments."

When they are supported by carbon pricing, investments in low-carbon technologies "can deliver the kind of risk-adjusted returns that make them attractive," according to the report. Yet many investors have yet to take advantage of such opportunities. Furthermore, the current financial crisis has reduced the flow of capital at a time when increased investment in low-carbon energy supplies is critical.

However, the report cites a recent survey of 100 institutional managers and asset owners, in which half indicate the intention to increase their investments in renewables. And if carbon prices rise to the level of $180 per ton of CO2 that the IEA estimates to be required by 2030, then investments in low-carbon technologies will become increasingly attractive.

Noting that the "recent financial crisis has thrown a spotlight on how investors make decisions," the report argues that asset owners in particular have a responsibility to insure that on their behalf, asset managers are incorporating climate change risks into the investment process. Among the practical steps that investors can take is to use their influence to encourage companies to improve their climate change disclosures. Investors should also encourage investment research analysts to undertake research on climate change.

As shareowners of the companies that are the largest sources of greenhouse gas (GHG) emissions, investors have a responsibility to guide the companies in which they invest on a course to successful climate change mitigation, according to the report. Shareowners can accomplish this goal by such means as insisting that companies improve their climate change disclosures, adopt strategies that address the risks of climate change, reduce costs through energy efficiency, and refrain from intervening in the adoption of climate change legislation.

The PRI spokesperson said, "Large institutional investors have enormous impact, and those that have large and diversified holdings tend to take an active interest in the health of the economy as a whole."

Because large institutional shareowners have such a significant influence, the report recommends that shareowner resolutions be employed to engage companies in the development of climate change strategies. Investors should also join forces through such initiatives as the PRI and the Investor Network on Climate Risk (INCR) to increase their influence even further.

Arguing that "the investment community cannot afford to assume that international negotiators have the capacity" to enact such mandates as global targets for GHG emissions reductions and expanded carbon markets, the report recommends that the investment community speak with a united voice on matters of climate change legislation whenever possible. Such action is critical in the international sphere, where the importance of successful negotiations on climate change treaties cannot be underestimated.

The report concludes with several recommendations to help investors be successful in their role of supplying much of the capital required for the enactment of a global low-carbon economy. Investors must work with governments to ensure passage of effective climate change legislation, and institutional investors must be ready to respond to such legislation with the effective allocation of capital. Such allocations must take into account long-term carbon price risks in order to serve the interests of institutional investors and their clients and other beneficiaries.

Finally, the report asserts that failure to meet emissions stabilization levels will increase the risk of a dangerous outcome and undermine the ability of long-term investors to deliver adequate returns on their investments. "It is firmly in the interests of investors that they help avoid this outcome," the report concludes, "And devote the resources necessary to rise to the challenge of leadership."

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