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Ideas Farm: Turning up the heat

As the race to net zero accelerates, investors should demand more transparency from companies on their climate change risks
Ideas Farm: Turning up the heat
  • The energy transition will likely see a global reallocation of capital
  • But for investors to make informed decisions, they need to know how exposed companies are to climate change

“Every government, company, and shareholder must confront climate change,” said the head of BlackRock, Larry Fink, in his annual letter to chief executives last year. “In the near future – and sooner than most anticipate – there will be a significant reallocation of capital.”

Indeed, we are already seeing money pour into environmental, social and governance (ESG) funds and companies at the forefront of the energy transition. These flows are not just motivated by the desire to ‘do good’ or seek out growth opportunities, but also to mitigate risk. As the race to net zero gathers momentum, investors are growing increasingly concerned about the threat that climate change poses to their portfolios. Companies that fail to align themselves with a decarbonised future could be caught out by the energy transition and leave investors holding onto stranded assets. As Mr Fink says: “Climate risk is investment risk”.

Royal Dutch Shell (RDSB) is currently facing a landmark legal case in The Hague through which activists are seeking to force it to cut its carbon emissions by 45 per cent by 2030 versus 2019 levels. The company’s current plan is to reduce its net carbon footprint by 30 per cent by 2035. Whereas legal action against fossil fuel companies has typically focused on their behaviour in the past, this could set a precedent that dictates their future. Climate litigation could become another financial risk.  

It’s not just energy companies but those who finance them as well. HSBC (HSBA) is currently Europe’s second-largest fossil fuel financier, and while it has pledged to reduce financed emissions from its customers to net zero by 2050, some shareholders are unimpressed by the lack of detail. Ahead of its annual general meeting, 15 institutional investors have filed a climate resolution calling on the bank to publish a concrete plan for reducing its exposure to fossil fuel assets.

Understanding companies’ exposure to climate change can help investors shift their capital towards the highest risk-adjusted returns. But, right now, transparency on this issue is generally poor. “The lack of information leaves companies and investors vulnerable to major losses,” says businessman Mike Bloomberg, who chairs the global Task Force on Climate-related Financial Disclosures (TCFD). “Financial markets are still operating largely in the dark when it comes to climate change, which is one of the biggest risks facing the global economy”.

There has been some movement on this front. Chancellor Rishi Sunak announced last year that by 2025, publicly-listed UK companies will have to disclose their climate change risks in line with guidance from the TCFD. With Joe Biden promising greater action on climate change, the Securities and Exchange Commission (SEC) could also follow suit across the pond.

But calling on companies to report their risks is very different from demanding they take action. This area is rife with hypocrisy and BlackRock is one of the top offenders. For all Mr Fink’s rhetoric, the asset manager voted against the majority of climate-related shareholder proposals filed with S&P 500 companies last year and, in addition, a recent report from Reclaim Finance and Urgewald suggests that a year after pledging to exit investments in thermal coal, it still has $85bn-worth of assets invested in coal companies such as Glencore (GLEN).

Still, all hope is not lost. The Investor Forum – which represents shareholders with £695bn invested in UK equities – has thrown its weight behind the ‘say on climate’ initiative that is being spearheaded by billionaire hedge fund manager Sir Chris Hohn. It is pushing for the UK government to give shareholders a vote on companies’ climate transition action plans, akin to how the 2013 Directors’ Remuneration Reforms enabled a ‘say on pay’. Although as a non-binding vote, it remains to be seen just how effective such engagement would be.

It is easy to become disheartened or cynical, but while progress is slow – perhaps painfully so – we are moving in the right direction. The net zero transition will only accelerate, and investors and companies would do well to ensure that they move with, and not against, the tide.