Asset owners align on stewardship approach
The Universities Superannuation Scheme, the Association of British Insurers and Reclaim Finance explain current climate strategy trends among asset owners.
While the details of individual climate strategies still vary significantly from fund to fund, asset owners tend to agree that engagement activities are preferable to outright divestment.
The reasoning, for example, of the Universities Superannuation Scheme (USS) – the UK’s largest private pension fund by assets – is that divestment may mean selling an asset to another investor who is less climate-focused and is therefore not always a useful contribution to the energy transition. This view was echoed among asset owners who attended Net Zero Investor’s recent DC Forum.
“The alternative to stewardship is a binary situation in which the businesses and investors that care about climate change are pitted against those that don't in a separate economy,” says Ben Howarth, chief sustainability officer at the Association of British Insurers. “That would be a bad outcome. For the majority of asset owners, divestment is always a last resort.”
Howarth stresses the importance of collaboration among asset owners in stewardship processes. “It's no good making a fuss at an AGM if other stakeholders aren’t engaged, because ultimately the vote won’t have a meaningful impact,” he says. That’s why the Paris Aligned Investment Initiative and similar schemes are particularly focused on clarifying best practice in stewardship processes.
“Like many other pension funds, we've been engaging with companies that we own for a long period of time” Innes McKeand, head of strategic equities at USS, tells Net Zero Investor. “The engagement strategies of pension funds have often been focused on getting better reporting from companies on areas such as target-setting, carbon emissions, and transition plans. With climate change a clear financial risk, we’re now beginning to demand more real-world outcomes. This is achieved through both direct engagement and collaborations with likeminded investors.”
Ensuring incentive packages for company executives are aligned with climate outcomes is an important part of USS’s engagement strategy because it affects the financial outcomes of those companies. For example, in a recent engagement with Barclays, the pension fund asked why only a very small proportion of executive incentive packages were linked to climate change.
Banks that are major financiers of fossil fuel expansion projects are increasingly on USS’s agenda to engage with, McKeand says. “Whether or not they make sufficient progress, or we end up considering divestment, remains to be seen,” he adds. “Since banks are such an important part of the economy, exerting pressure to achieve better long-term financial outcomes seems to be the right approach for the time being. I don’t think it’s possible to simply divest from banks and expect meaningful change.”
Fossil fuel expansion projects are widely seen as incompatible with the 1.5°C temperature target set by the Paris Agreement.
USS integrates environmental, social and governance (ESG) metrics into investment decision-making processes and is increasingly expecting portfolio managers to take the lead on engagement with companies on these issues, rather than delegating it to the ESG team.
If no progress has been made following ongoing engagement, the portfolio manager may consider divestment, since companies without a clear transition pathway are “unlikely to provide good financial returns” in the long run and therefore represent a risky investment.
Getting the right data, especially on Scope 3 emissions, is also a challenge. This is one of the main reasons why engagement strategies have traditionally focused on getting better disclosures.
Joining an alliance is another key element of any climate strategy. “For asset owners, the most important alliances are the Net Zero Asset Owners Alliance and the Paris Aligned Investment Initiative,” says Howarth. “The majority of major asset owners are now signed up to either one or both.”
The Net Zero Asset Owners Alliance aims to ensure that its members implement a consistent methodology regarding long-term alignment with its targets and tracking and measuring progress. The Paris Aligned Investors Initiative, on the other hand, is more focused on establishing robust stewardship practices, especially for carbon-intensive industries.
“The business plans and individual targets and strategies still vary significantly among asset owners,” Howarth adds. For example, firms developing new saving products and new pension schemes are likely to focus on creating “dark green” funds and marketing them to people with strong green preferences.
Meanwhile, consolidator businesses that deal with back-book pension products and existing savings products do not necessarily require marketing to new customers and are probably less focused on impact investment than transitional activities via stewardship processes.
Most major asset owners have now signed up to alliances and made long term net-zero commitments. However, Reclaim Finance, which tracks financial firms’ climate policies via its Oil and Gas Tracker, is concerned that the methodologies to reach net zero often lack consistency and contain significant loopholes. For example, decarbonisation targets set for carbon-intensive industries often lack absolute terms and include exemptions for certain kinds of assets.
Reclaim Finance is adamant that engagement activities are only effective when combined with stringent investment restrictions (for example, denying new debt to companies) and systematic sanctions if inadequate progress is made.
“Although stewardship activities are a useful lever to push companies to change, they often lack credibility, including among the largest investors,” Lara Cuvelier, sustainable investments campaigner at Reclaim Finance, tells Net Zero Investor. Cuvelier stresses that this problem is not limited to asset owners but is widespread in the whole investment space.
In its analysis of the voting policies and demands made by asset owners to investee companies, Reclaim Finance rarely sees “clear and precise demands” being made to fossil fuel companies. For example, as a general rule, major asset owners hardly ever ask fossil fuel companies to halt expansion plans.
That said, an increasing number of smaller asset owners and asset managers, especially in France, are starting to enforce more stringent exclusion criteria and prohibit investment in companies with fossil fuel expansion projects.
For example, French public sector pension scheme Ircantec, whose policies Reclaim Finance has earmarked as best practice, has committed to divest from all companies with upstream and midstream oil and gas expansion plans by 2024. Ircantec will also divest from all unconventional oil and gas companies by 2024 (unless they commit to having zero exposure to unconventional) and by 2030 for conventional oil and gas companies (unless they are aligned on a 1.5°C pathway).
Reclaim Finance notes that the possible exemption for companies with credible transition plans aligned with a 1.5°C pathway will need to be closely monitored, in particular regarding future oil and gas expansion plans.
“If the investee company is able to demonstrate a credible transition pathway, then the asset owner will typically refrain from divestment,” says Howarth.
Scramble for green assets
If engaging with carbon-intensive companies represents one end of the climate strategy spectrum, then investment in renewable energies and green technologies is the other. USS, for example, has invested approximately £2bn in renewable energy and green technology businesses, such as wind farms, which align with the financial aims of USS.
“We’re doing what we can but there’s often stiff competition,” McKeand says. “Sometimes, we even get outbid by oil companies, which are scrambling for a foothold in the green energy space.”
Most green asset opportunities exist in private markets, since only a tiny proportion of listed companies are actually green. “Over the last ten or 15 years, many businesses, including renewable energy businesses, tend to stay private for longer,” McKeand adds. “Funds such as ourselves are natural owners of such businesses, given they can be expected to provide good long-term returns but require a fair amount of initial growth capital to get them to scale.”
McKeand also notes a trend towards government support for the green energy space. The US’s Inflation Reduction Act, for example, is widely seen as a game changer in terms of stimulus for the green transition. Such incentives can help move renewable energy forward and provide the right sort of “risk-return characteristics” for private investors.