PRI’s Nathan Fabian on transition pain points and rethinking investor alliances

2023 has been a turbulent year for investor coalitions on climate change. Networks such as the Net Zero Asset Owner Alliance, the Net Zero Insurance- and Banking Alliance have been instrumental in bringing investors committed to tackling climate change together and improve the effectiveness of shareholder engagement.

But now they are finding themselves increasingly in the firing line of the anti-ESG movement in the US. Meanwhile, some of the world’s largest emitters of fossil fuels have very prominently backtracked on their climate pledges, causing some to question the effectiveness of shareholder engagement on climate.

Amid these new challenges, Nathan Fabian, chief responsible systems officer at the UN Principles for Responsible Investment (UN PRI) made Net Zero Investor headlines earlier this year for stating that GFANZ was in need of “careful repositioning.”

Fabian is not new to these debates. Besides having been at the helm of PRI’s ESG team for more than eight years, he also spent two years as chair of the European Platform on Sustainable Finance and acted as Rapporteur on the EU’s Sustainable Finance Taxonomy.

Net Zero Investor sat down with him to find out why he thinks net zero networks need to change their strategy.

Investor coalitions to tackle climate change have been plagued by exits this year. There seems to be more division than ever. What drives that?

The economic transition on climate is now underway but there are pain points along the way, for sectors, the economy and for investors.

These pain points are where the abatement costs are uncompetitive. We can deal with this either through regulation, technological breakthrough or demand for new markets. But it’s not an easy, smooth transition, there is some cost that has to be absorbed.

We are starting to see that play out in the political debate and in the policy settings. I don’t think we should be surprised by that, we always thought we would get to this stage. In fact, it is necessary to address this challenge. This is just a case of continuing to focus on what is required here, both in terms of investor response and in terms of policy setting.

I don’t see it as division, I see it as a natural tension of what will be quite a big economic adjustment. Most investors who are long-dated or institutions operating in perpetuity understand that.

These pain points are the economic cost of the transition to net zero?

We know there are costs, from transitioning and not transitioning. We are already at a point where the physical impacts of climate change are materialising. This is no longer a “cost-less” discussion. This is a question of how you implement this with the lowest levels of volatility to the economy as you restructure and as you start to deal with the damages of climate change.

Five years ago, we used to say: ‘There will be economic costs to reducing emissions but frankly, right now it is quite clear that there will be costs across the board and we just have to choose which costs we want.

You mentioned earlier that networks like GFANZ will need careful repositioning. What do you mean by that?

GFANZ as you know is really a broad umbrella with many different types of groups playing different roles in the financial system. As we get closer to 1.5 degrees and those trade offs are becoming much clearer, we are going to have to be much clearer on the different roles different financial institutions play. At the moment, the GFANZ message is broad, simple and clear. We are all trying to reach 1.5 degrees.

But science is telling us that we are getting very close to missing that target now. So we are going to need to be much more precise about the different roles for different investors. At PRI, we are very closely involved with the different initiatives and the asset owners have a very different approach to target setting than the managers.

This is quite important and if we don’t distinguish here, that is when people are starting to get concerned about greenwashing.

Going forward, the PRI in its work with the initiatives can encourage greater clarity around the unique positions that different financial actors can take.

Should there also be a stricter minimum requirement for being a member of such networks?

That is the right question. Overall, we are coming to a phase where we will need much greater transparency on how we are using targets, what are the targets for, how are we following them as different types of institutions and how is our portfolio positioned today and what steps are we taking next? That is the right way to deal with concerns about greenwashing.

The members of these alliances are the willing. To honour and maintain trust in these ambitious targets, we need more transparency on performance and the barriers investors face in meeting them.

When it comes to criteria on performance or alignment with goals, we are going to see lots of different types of criteria and that is even more essential as the world approaches 1.5 degrees.

Should there be stricter rules on banks lending to fossil fuel companies or insurers underwriting fossil fuel business whilst being a part of net zero networks?

I don’t think banning financing of pollution solves the problem. It simply doesn’t because somebody else will finance it. Instead, we should be clear on what steps are being taken and why.

If a bank, insurer, or investor has a financial relationship with a polluting asset, they need to explain their assumptions about transition. What they think their contribution to the environmental outcome is and how that relates to their climate pledges.

The Paris Agreement is well below two degrees by the way, or 1.5 degrees and no overshoot. The idea that we could divest the pollution doesn’t really work. Half of the fossil fuel emissions are owned by governments.

If you are serious about a safe level of warming, we need pathways to exit high-emitting activities for all of these sectors. If I hold fossil fuel companies in my portfolio, I need to understand the exit trajectory for practices such as burning coal, how the balance sheet is being applied to that and therefore what my expectation of my company is. How are they redeploying the capital of their earnings through the sale of fossil fuels towards these ends?

That is the legitimate role of the financier who has got exposure to a company, and probably the most impactful role that they can have.

Is a ban going to have that same level of leverage on transition? I don’t think it helps the buyer of the financial product, to be honest. And it certainly doesn’t accelerate the transition. We’ve got to be careful of assuming that we can just divest our way out of this problem.

Is this essentially a risk management process that you are proposing?

That is a good way of putting it. Yes, it is risk management, but it is also capital being active in the transition. That is what a responsible investor does. They understand the environmental parameters, they understand what we should meet for a safe outcome and then they should manage their capital accordingly and tell us where they can’t do it.

Are investors today mispricing the potential cost of the transition, with the risk of stranded assets not being fully priced in?

Yes, there is a risk of under-pricing the financial impact on those assets in future. If investors are satisfied for fossil fuel companies to use the super returns of the last five years to further develop higher cost fossil fuel assets, there is clearly a risk of additional stranded value. If investors are not actively engaging in the capital redeployment question now.

In addition to your role at PRI, you have also been chair of the EU Platform on Sustainable Finance, where you have contributed to the EU’s taxonomy for sustainable activities. What role will the taxonomy play in the race to net zero?

The taxonomy is an example of the kind of tools we need to support transparency. It shows us what activity performance is goals aligned. It is an essential enabling tool for transition. We now see over 40 taxonomies around the world being implemented.

This very basic idea of: “how good is good enough” is obviously taking hold. Can we improve it? Yes of course we can. Europe started with a very ambitious and wide framework. There are challenges. For example, data availability across six environmental objectives is low.

We like the market to start working quite quickly on emissions reduction and goal alignment so there’s a bit of a risk that market data availability on say, circular economy is slowing down the goal alignment on the transition. It is worth the European Commission reviewing this is issue on how it can smooth the implementation. The UK government is also reviewing this question of managing some of the market failures around using these tools. So that is one area for improvement..

And then there is the obvious controversy around including nuclear energy and gas..

Again, we need to be precise about what we mean when we are claiming environmental performance or ambition. With gas, there was the idea of harm reduction by switching from coal to gas as worthwhile transition step. But that is where the EU muddied the picture.

It doesn’t mean that switching from coal to gas may not be a useful thing to do in some contexts. It may even be part of a viable transition plan. But it was hard for users of the taxonomy to understand what was being said about gas and that is the problem.

But doesn’t including technologies such as nuclear provide a powerful incentive to invest more in nuclear energy rather than in other, perhaps more sustainable forms of energy generation?

Yes. I think we are in a world now where there are going to be impacts on multiple of our environmental objectives. We have crossed 6 of 9 planetary boundaries. Expecting that an economic activity will not harm environmental objectives is ignoring the science.

Again, this is why clarity is required. If you wanted an energy policy that included nuclear, it would have been far better to say: Yes it is green on emissions but there is a pollution harm and that should be disclosed. There is a risk of not being clear by simply including it in the taxonomy which makes it harder for the market to distinguish.

You have mentioned a few times that we are not on track to meet the targets set in the Paris Agreement. Is 1.5 still salvageable and if not, what needs to happen next?

It is not the PRI’s role to call the science but if we look at what the scientists are telling us, they are saying it is highly likely that we will have some overshoot. But that doesn’t change the role of the 1.5 degree target, it is our best understanding of a safe limit. The IPCC Science and Policy Dialogue is very clear that 2 degrees or more is not safe.

Limiting warming to well below two degrees and as close as possible to 1.5 degrees is still a meaningful idea. That is our understanding of what relative safety is. The 1.5 degree target doesn’t go away, it is just that the pathway is going to change. We know that this will have clear financial implications, damages are going to be higher.

Unfortunately, we are now in a position where we don’t have a choice. Because government action is not meeting the pledges..

Will we see a greater level of policy enforcement?

Let’s look at the inflation reduction act. These are extremely high level, accessible funding for specific activities. This is a type of industry policy. It is not a regulation. It is a different government instrument for the same purpose. Are we going to see governments intervene more on economic development, taxes and subsidies? Yes we are, no question.

Christopher Marchant contributed to this article.