Notes: The UNPRI is an independent organisation supported by, but not part of, the UN, that works to promote the incorporation of environmental, social and governance (ESG) factors into investment and ownership decisions by investors worldwide. Using six “Principles for Responsible Investment“, it works with and through an international network of investor signatories, including many of the world’s largest asset owners and managers.
Technical terms are marked with a * and explained in the Glossary
2016 marks the 10th anniversary of the PRI’s foundation, a decade which has seen its signatory list grow from 100 to 1,600, representing assets under management* of over US$62 trillion. During this period the PRI has been at the forefront of a long campaign to build consideration of factors which affect all their stakeholders, not just the financial prospects for shareholders, into the behaviour of companies.
PRI works through a voluntary code to which companies sign up and agree to adhere to the fullest extent possible. As time has gone on, other actors have joined the effort to change company behaviour, especially regarding their policies affecting the environment and climate change. Actions include pressure for companies to disclose their carbon usage or investment, the development of the “stranded assets” argument (demonstrating that continued investment in high-carbon activities is illogical as well as harmful) and shareholder activism where campaigners use ownership of company stock to get motions for behaviour change heard through the governance systems of public companies.
All of these approaches now amount to quite a formidable array of pressure-points on company managements and boards, but until recently it would probably be fair to say that such activism has been mainly concentrated in developed markets. Some 70% of the PRI’s membership at the end of 2015, for example, was in the US and Europe, with 256 members in the US but only 17 in China, including Hong Kong SAR.
Engagement on ESG is growing in developing economies
This situation is, however, now rapidly changing in the Asia Pacific and other regions. The drive towards what China calls the “ecological economy” is itself driven very powerfully by countries waking up to the realities of resource depletion and pollution, but nevertheless this critical new impulse is opening up opportunities for greater engagement on sustainability issues by organisations such as the PRI with companies in developing economies.
“Responsible investment is now a huge theme”
We spoke to Sagarika Chatterjee (who leads PRI’s work on investor action on climate change and green investing), at the end of a year in which the organisation has been heavily involved in the G20’s work on green finance, during a Chinese presidency of the Group. We were especially interested in an “input paper” that the PRI had completed for the G20 Green Finance Forum in Shanghai in September and which summarised the views of 17 organisations, including some of the largest institutional investors in the world, on the opportunities and obstacles they saw in investing in green finance in developing countries. The report was used to frame a discussion among G20 finance ministers and provoke thinking on the key changes that need to be made to establish investment avenues for these asset owners and managers, who control the vast bulk of the world’s investment funds. In December, it will be launched in Mandarin at China Social Investment Forum, as part of a bid to engage local Chinese investors on green finance.
“The report was a great opportunity,” Chatterjee says “because it meant an organisation like us, which is independent of political agendas, could bring investor views direct to finance ministries and outline very straightforwardly the barriers to scaling up low carbon investments and hurdles – but also some of the solutions – that investors see on both the supply and demand sides. We could also use it to highlight the steps that investors have taken themselves to overcome the hurdles.” The immediate outcomes from the G20’s Green Finance Forum included the announcement of a major joint China/UK green bond issuance guaranteed by the People’s Bank of China and the Bank of England, the scaling up of the the Sustainable Banking Network and specifically promoting the work of the PRI.
“That’s not meant to be opportunistic for us, “Chatterjee notes. “We think there is a recognition that by doing so, the G20 will enable PRI to get deeper into these local markets and provide advice to companies and investors on how to identify low-carbon opportunities and incorporate green principles in general investment decisions.” Following 2016’s work on opportunities in green finance, the G20 agenda will now move on to focus on issues of environmental risk assessment and green data availability. The objective of this work, Chatterjee say, will be to develop policy options to promote strong environmental risk management by banks, insurers and investors that will complement the direction of travel coming out of the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures*. “It’s important for investors to understand the risk side as well as the opportunity side, and have the support of policy makers to encourage appropriate management of these.”
Looking more widely afield from the G20, Chatterjee emphasises how the basic context for green finance in emerging markets – and specifically to support the NDCs – is very favourable. “Responsible investment is now a huge theme, “she says. “Investors want to take this further and into new markets, but they can’t scale it up unless the developing economies address the demand and supply barriers.” Echoing the sentiments of last week’s NDCI.global featured resource, the Finance Guide for Policy Makers, Chatterjee also emphasises how important it is for policy makers to be able to talk to investors on a very practical level. “Countries won’t attract these investments unless they can get down to a nuts and bolts level on the changes that need to be made.”
Hurdles on Demand and Supply Sides
So what are the hurdles? “Firstly,” Chatterjee says, “we can’t emphasise enough how investors need policy certainty, not chopping and changing. That’s a constant in all of this.” Then she breaks the issues down into demand side (investor appetite) and supply side (the financial products or projects that can satisfy this appetite).
On the demand side, Chatterjee naturally picks out the promotion of responsible investment principles in local markets, but also the need for definitions of standards for green finance. This is a really important concern for investors, she says, because whether they are investing for themselves or on behalf of others, they don’t want to be seen as engaging in ‘greenwashing’, that is investing in things which promote themselves as green but in fact very probably aren’t. ‘Clean coal’ bonds might be an example of where a way of definitely putting an investment on one side of the line or the other is needed. “These standards need to be meaningful across countries so that they internationally comparable,” Chatterjee says.
“Fiduciary duty goes much wide than just financial returns”
Other demand side issues she picks out are policy levers and incentives to mobilise investments and changes in investor governance. “For example, there’s work needed on concepts like fiduciary duty*, so local regulators could clarify that investing in climate change solutions is completely consistent with fiduciary duty – that this concept goes much wide than just financial returns”. (Such a progression from the current one-dimensional view is, however, as she readily acknowledges, still far from ingrained in developed market investor thinking also.)
Related to policy developments is capacity building, to start to bring green finance into the mainstream of local capital markets as well as international markets, so those managing, say, local pension funds are aware of the green finance opportunity. “This means we have to build understanding of what ‘green’ means, what opportunities are out there, the record on financial returns, where there are significant misunderstandings about the positive effects that better ESG integration can have. Issuers* feel there’s a lot of education to be done among investors on these issues.”
“The new Energy Transition Law in France is a great example of how regulators can get companies to disclose climate risk”
Finally, Chatterjee cites the need for transparency, for regulators get institutional investors to disclose how they are managing climate risks. “The new Energy Transition Law in France is a great example of that, because it asks about both risk and opportunity, it’s fairly non-prescriptive, and everybody has to do it. These kinds of measures will create the data that investors need on how low-carbon the regular listed companies are that form part of their everyday portfolio. They also recognise that they have to improve their own risk assessment methodologies, especially on transition risk*. Another ‘self-help’ tool is to specifically incorporate green factors in investment agreements they have, such as shareholder agreements.
Institutional development is key on supply side
On the supply side, Chatterjee points mainly to the need for institutional development as the key takeaway from their survey of investors asks they conducted for the G20. “They need to see policy makers encouraging the emergence of liquid markets for quality green assets, and the initial focus should be on listed fixed income products and equities, as that is where investors are right now. Market intermediaries are also really important, she says, “so we need to see more stock exchanges in emerging markets, we need to see the growth of ratings agencies*, sell side research, investment consultants – all these elements of a well-functioning market need to be built up.” The core challenge for investors entering these markets for the first time is risk mitigation, so “we need to see cushions against risk being promoted like credit enhancement*, revenue guarantees like off take agreements, the aggregation of assets to create larger deals that lower the overall cost of finance.”
Chateerjee notes, however, that the NDCs as they currently stand aren’t helping with these agendas. “If you look at them with a portfolio manager’s eye, they aren’t very useful” she says. “There’s a lack of standardisation, not all of them cover how implementation will happen, very few at all speak about the what the financing needs are. We’d like to see the NDCs that are submitted for ratification, or the revised NDCs when that process starts, give an estimate for what is needed on both mitigation and adaptation. How much will be needed from public sources, how much from private, or at least a range. China, for example, has already made this estimate, so it is possible to do it. The China split is something like 15/85 public/private and that provides a context and the massive need for private finance has allowed – or perhaps driven – China to come up with a strategy, starting with green bonds, where they are improving standards and standardisation as ways of drawing the private sector in, responding to kinds of demand I mentioned earlier.”
“Investors need to think ‘Yes, this country has a plan, there are some real opportunities here for me”
Chatterjee hopes that the momentum seen in China’s approach to developing its financing strategy will feed through to other countries. “I really hope we’ll see an impetus in this direction out there as other countries revise their NDCs post-ratification of Paris, so investors think ‘Yes, this country has a plan, there are some real opportunities here for me to invest in, this country is really talking to me about some bankable projects’. The NDCs allow the development of that kind of conversation and for countries therefore to be more strategic about the alignment of their sustainable development plans with the needs of the local and international capital markets, and so come up with the investments that a regular, mainstream investor can invest in.”
As an immediate example this kind of investor engagement, Chatterjee noted an imminent roadshow to be staged in London on December 8th by the Green Infrastructure Investor Coalition (of which PRI was a co-founder). The event will showcase forthcoming green bond issuances from a wide range of Brazilian companies and banks, part of the $152 billion in financing needed by Brazil to meet its Paris commitments. The roadshow [brochure: PDF] is still open for registration.
As to 2017 priorities, PRI is to become a ‘knowledge partner’ of a new OECD-led Institute of Green Finance, which will focus on ways to scale up actual green assets under management, especially green infrastructure, including through the development of risk mitigation. It will also be working with the Chinese Asset Management Association on green capacity building for local investors.
“This is a great example of widening the net on promoting responsible investment principles,” Chatterjee says. “The Association wants to test if what foreign investors are doing on green and low carbon investment through strategic moves could be applied in the Chinese market by Chinese investors. For example, the insurer Allianz has allocated 4 billion euros to investments in renewables and phasing out coal. Another insurer, AXA, has allocated 3 billion to green bonds. The AB pension funds in Scandinavia have allocated 29 billion euros to investments in a ‘clean world’. Can those kind of big, strategic moves be replicated by large Chinese institutional investors? Could this approach this be picked up by other countries?”
Directional straws in the wind
Chatterjee sees two further “straws in the wind” of how investors are starting to align behind climate finance. The first is a new African Investor Network launched at COP 22 to promote climate finance in Africa. This is supported by PRI signatory Caisse des Depots of France, the Morrocan Caisse de Depot et de Gestion Group, the African Caisses des Depots and the Nigerian National Pension Commission. Chatterjee notes that the network will make a 2020 commitment to integrate climate change into funding decisions, to use carbon footprinting, to support African investment programmes and to join the PRI. 19 African Capital Markets Authorities and Exchanges, accounting for 26 African countries, have signed and endorsed a Marrakech Pledge for Fostering Green Capital Markets in Africa.
The second indicator of this direction of travel is more nascent but also potentially significant. “At the moment”, Chatterjee say, “there are few forums for institutional investors to discuss green investments with governments, and investors tell us that many such investments are unsuitable or impractical for them to make. That’s why we are supporting a new UN Global Compact initiative for business and investors to consider how they can support country climate change plans, focusing on 7 countries. This will get going in 2017 and one of the specific aims will be to support implementation of the NDCs and SDGs.”
Sagarika joined the PRI in 2013. She leads its work on investor action on climate change and green investing.
Prior to the PRI, Sagarika worked for over ten years’ at F&C Asset Management (a founder signatory to the PRI), focusing on engagement with companies and incorporating ESG factors into investment practices. She has served as Vice-Chair of UKSIF and trustee of environmental research charity Earthwatch. She started her career at Kingfisher plc in a commercial role, sourcing timber for B&Q.
Sagarika serves in a personal capacity on the investment committee of the Joseph Rowntree Foundation, an independent organisation working to inspire social change. She has an MSc in Development Studies from University of London, a Management Studies Diploma from the University of Oxford and a BA in Social and Political Sciences from the University of Cambridge.