Wall Street in 2020 and change you can’t ignore

Climate Economy

Wall Street in 2020 and change you can’t ignore

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If the passionate activism of Greta Thunberg and the apocalyptic images of Australian brushfires offer dramatic recent — of climate change, it is the consistent yearly encroach of unseasonable warmth in places like the midwestern United States, where I am writing this, that really substantiate its damning course around the globe. Over the last two decades, every successive winter but one has burned through the last temperature record.

The good news is that finally, the growing fear on Main Street has infected Wall Street. There are signs that Environmental and Social Governance (ESG) is finally being transformed from carnival barking to corporate agendas. It may be January, but 2020 will likely stand as the year the hopeful marketers stood aside as the portfolio managers rolled up their sleeves and got to work.

Larry’s $7 trillion climate warning

There has been striking evidence of late that the money managers who move markets are taking a fundamentally new stance toward ecologically sound investing. Two years ago, Blackrock CEO Lawrence Fink triggered a national debate when he wrote to global CEOs about the need to consider both profit and purpose when running a company. Corporate reformers hailed the letter as timely and much needed; BlackRock’s more conservative clients hated it.

This year, he vowed to deliver on his own wager, and specifically targeted climate change as an opportunity rather than a mere cost. After a year of finding itself in the cross-hairs of climate, Fink surprised everyone saying climate change was “reshaping finance,” and had become a “defining factor in companies long-term prospects.”

All the better that Fink took his climate dance public at the annual gathering of the world’s foremost political, economic and social elite in Davos, Switzerland. The Davos crowd went wild as Fink marched from event to event proudly sporting a climate “warming” blue-striped scarf. Even Bill McKibben, a leading pioneer of the climate movement described Fink’s letter as “Seismic… A watershed moment.”

Aware that some of BlackRock’s biggest clients are oil companies and oil potentates, Fink’s acknowledgment of climate risk came with qualifiers: he said that a long transition would be needed to make the jump to a post-carbon economy and that oil companies and natural gas would play a critical role in that transition. He also dismissed a carbon tax as “regressive” and didn’t seem to be certain of his climate science. Still, as the last three years have demonstrated, when the world’s largest fund manager speaks, people listen. Fink’s 2018 letter started a wholesale rethink of the purpose of capitalism. This year’s letter will do the same with climate. And the more their goals are intertwined, the more environmentally sustainable businesses will become.

There have been a host of other encouraging developments to look forward to in 2020:

UN taps Bank of England head to enact climate change initiatives

Mark Carney, the Governor of the Bank of England will be joining United Nations staff on March 16 as its Special Envoy on Climate Action and Finance, replacing Michael Bloomberg, who is running to be the president of the United States.

A long-time proponent of fighting climate change by encouraging action in the financial sector, Carney will work to significantly shift public and private financial markets and to mobilize finance to levels needed to achieve the 1.5-degree Celsius goal of the Paris Agreement.

The work is slated to include building frameworks for financial reporting, risk management, and returns to bring the impacts of climate change into the mainstream decision-making process and to support the transition to a net-zero carbon economy.

The UN is well known too for forcing the issue with investors in establishing the UN Principles for Responsible Investment initiative that seeks to encourage global institutional investors to consider issues such as climate change in the drafting of investment policy.

The UN Secretary-General is said to be counting on Carney to galvanize climate action and transform climate finance as part of a build-up toward the 26th Conference of the Parties (COP) meeting in Glasgow in November. (Carney began his career at Goldman Sachs before joining the Canadian Department of Finance and later serving as the Governor of the Bank of Canada (2008-2013).

In December, Carney spoke frankly about what is at stake. Climate change will affect the value of virtually every financial asset, he warned. Companies and investors need to take action now because when the result of extreme weather events become obvious, it will be too late. Carney said climate change demands a new approach to investing: “Asset managers and asset owners will increasingly have to assess the transition paths of their investments and report their impact on their clients. Our citizens need to be able to see whether their investments are consistent with the path to net-zero.”

Beyond checking the box

Led by Carney and others, there seems to be a consolidating united front being created by global banks, large institutional investors and asset management firms to think about climate change beyond the due diligence review or an ESG marketing label.

Rather than simply “checking the box” as if to say – “Yes we too care about the environment,” managers are increasingly going to be asked more impactful questions such as whether it makes sense to be an activist investor rather than simply screening out of carbon-heavy stocks.

As Carney declared: “The disclosures of climate risk must become comprehensive, climate risk management must be transformed, and investing for a net-zero world must go mainstream.”

As a farewell gesture, one of Carney’s last official acts was to get the Bank of England to undertake the world’s first climate stress test for banks

Goldman says no to arctic oil and coal but sticks to tar sands and fracking

Meanwhile Carney’s previous firm, Goldman Sachs is struggling to find the right balance on carbon investing. It becomes the first major American financial institution to end the financing of new oil drilling or exploration in the Arctic. Joining the ranks of UniCredit, the Royal Bank of Scotland and Barclays, Goldman’s policy will also rule out financing for new thermal coal mines and coal-fired power projects worldwide. However, the bank continues to finance tar sands and fracking.

Institutional investors were not surprised. Over the last two decades pension funds, endowments and foundations have slowly shifted from not only divesting from fossil fuel companies but to begin asking their investment managers about the larger philosophical questions surrounding investing for the social good. Goldman, like BlackRock, is working to balance realism and the desire to embrace a new post-carbon economy.

Cambridge Associates warns that financial markets are underestimating climate risk

One of the largest investment consulting firms catering to institutions, Cambridge Associates, last month told clients that climate risk is being underestimated by financial markets. They warned that there is a narrowing window for investors to get ahead of the curve as the price of risk related to carbon emissions is set to steepen as the climate impact is increasingly felt. Repricing of risk is set to take place on an unprecedented scale.

“Put simply, we all need to think like scientists now,” officials state in a white paper.

With charts and tables illustrating the challenge, Cambridge stresses that the 20 warmest years on record have occurred in the past 22 years, with the past four years being the hottest. 2019 was on course to be the hottest yet.

Cambridge says rising global carbon emissions will force asset allocation changes geared to dampen the impact of asset price shocks.

“Climate change sciences tell us increased investment risk is now inevitable on a timescale of relevance to most asset owners…. Investors who add this new risk dimension to their asset allocation and manager selection process are likely to be better positioned than those that do not, even if it is not clear how climate change will occur,” says the report.

Cambridge officials add that while there are also opportunities to invest in the transition to a low-carbon economy, the unintended impact of climate change is likely skewed to the downside. “Currently, risks linked to these changes outweigh opportunities, and we believe their potential impact is likely underestimated by financial markets.”

AQR eyes the promise and the challenge of dumping carbon stocks 

For some managers, it has become a question of how far they should go in reaching net-zero. In a recent white paper, Cliff Asness’ firm AQR Capital Management looks at the carbon exposure issue. They say that low-carbon managers will avoid carbon-intense stocks, but the specific stocks they avoid could really differ depending on their investment view.

Back in 2015, Asness was roundly criticized for questioning the validity of climate change at a time when other managers were beginning to discuss the implementation of ESG initiatives.

What AQR does is to tilt its investment portfolio by measuring the portfolio companies’ ratio of carbon emissions in tons to revenue in millions of dollars. It allows them to reduce the carbon intensity by at least 25% versus the cap-weighted benchmark.

While simply dumping carbon stocks looks attractive initially, trying to drastically reduce exposure broadly to carbon emissions becomes onerous, AQR officials say.

Going beyond ESG: CalSTRS takes the lead in climate engagement

It’s been almost 15 years in the making, but 2019 was a big year for climate change investment for the California State Teachers’ Retirement Board in Sacramento.

After supporting several global investor initiatives aimed at lowering carbon exposure, trustees began implementing a low-carbon transition work plan at their October 2019 board meeting.

The goal is to manage the $248 billion retirement system’s climate-related risk and identifying opportunities to invest in climate-related solutions across all asset classes. This is on top of the work the pension has already done in sourcing ESG-related investment strategies within its risk-mitigating strategies portfolio.

“CalSTRS is methodically and prudently examining how to prepare the fund to meet the retirement obligations of our members while also adjusting to a low-carbon future,” said Harry Keiley, the chairman of the CalSTRS investment committee.

The fund has led the Climate Action 100+ Engagement movement among institutional investors. Climate Action 100+ includes more than 370 investor signatories representing more than $35 trillion in assets and engagement with 161 global companies. The ambitious goal is net-zero emissions by 2050.

Through the Climate Action 100+ effort, officials placed pressure on Duke Energy, which ultimately announced an updated climate strategy that would reduce its carbon emissions by half, or more, from 2005 levels by 2030. CalSTRS led the group of investors in assessing the risks at Duke Energy associated with climate change and the application of pressure to change its business strategy and operations accordingly.

The nation’s second-largest pension system has also participated in other combined investor efforts such as Task Force on Climate-related Financial Disclosure and the Sustainability Accounting Standards Board.

More information can be found in the system’s Green Initiative Task Force Report.

Now the hard work begins

At KKR, there is a legendary warning from founder Henry Kravis whenever the private equity giant celebrates a new deal. “Now the hard work begins.” 2020 is shaping up to the year when talk on climate and ESG means that chief executives will no longer be able to avoid the increasingly knotty ethical challenges of balances ESG leadership and profit.

Last year, executives learned some hard lessons that smooth words no longer satisfied their increasingly engaged stakeholders.

Take the of the dilemma faced by JPMorgan Chase & Co. boss Jamie Dimon. Last April he and other bank CEOs tiptoed back to Riyadh, Saudi Arabi a year after the assassination of Washington Post columnist Jamal Khashoggi. Unfortunately, the conference was overshadowed by a government decision to behead of 37 suspected terrorists – some teenagers.

JPMorgan was also one of several banks, including Goldman Sachs, Morgan Stanley, and HSBC, that managed a $12.5 billion bond sale for the state-owned oil giant, Saudi Aramco,

Days later, however, activists cheered when Chase joined a global boycott of posh hotels owned by the Sultan of Brunei after the sultan introduced laws that punish same-sex or extramarital sex by stoning.

Chase’s decision to blackball one royal court, while courting another, took splitting ethical hairs to a new level and shows you how challenging the transition to a post-carbon economy and the adoption of more ambitious ESG standards will be.

As Brooke Masters commented in the Financial Times, CEO’s “cannot ignore social, and environmental concerns, but they also have the duty to make money.”


Written by

Susan Barreto

A financial journalist for more than 20 years, Susan Barreto has edited and wrote for a variety of publications having worked at Crain Communications, Euromoney Institutional Investor and Reuters.