Ladies and Gentlemen, I am enormously impressed to find so many of you here this evening prepared to consider the role of investors and, in particular, pension funds, in the move to a sustainable economy. I can only take it as a compliment to four of my Charities which operate in this area unless, of course, you are all here out of curiosity as to what I might say next! Whatever the case, I am particularly grateful to my Charities and the National Association of Pension Funds for helping to organize such an important occasion.
I don’t think you really need me to tell you but I never assume anything as I get older! that we live in increasingly uncertain times and while there are some signs of the green shoots of an economic recovery, that recovery is based upon a return to the Elysian Fields of the “business-asusual” scenario of ever-increasing consumption. Which would be fine, if we had an infinite supply of Nature’s resources to consume, but we don’t. The economic capital required to feed that growth is actually dependent upon diminishing our reserves of natural capital, which is intrinsically unsustainable. And it is for that reason that I think we could do ourselves a lot of favours if we recognized just how urgently we need to understand the systemic relationships between the depletion of key resources freshwater, soils and so on and the volatility of prices in different markets like food and energy. At the moment we are enabling a “perfect storm” to develop, and that generates very considerable economic risks which, in turn, are made more and more acute as the demand for resources goes up and up. And then you add in the enormous, game-changing risk-multiplier call it what you will or try to deny it, but there is still a great elephant in the room that I can only call climate change. And we are rapidly heading for a global temperature that is, to say the least, dangerous. In case you think that is manageable just remember that human kind relies on just 30 crops for about 95% of plant-derived food intake. Yet many of these species are likely to be highly vulnerable to changing temperatures, weather patterns, as well as pests and diseases proliferating as a result of climate change. If you don’t believe me, ask the plant scientists at Kew Botanic Gardens. So preserving wild varieties is likely to be essential to improve current weak genetic diversity in the face of such emerging threats.
But what does all this have to do with you? Well the answer is quite a lot. As the largest class of institutional investor, you have enormous influence over the functioning of our capital markets and, therefore, over corporate behaviour, including how major emerging risks are mitigated. And, as a sector that is defined by your long-term liabilities, you have a need, and arguably a duty, to ensure that those risks are identified and managed.
There is, of course, a possible alternative to the “business-asusual” model which is currently causing so much collateral damage. You might imagine it is a straight choice between improving rates of return or encouraging the companies you invest in to be more environmentally and socially responsible. In fact, can you believe it, there is increasing evidence that those companies that improve the way they tackle the environmental and social challenges they face prove to be the ones better able to deliver long-term returns. So you can have your cake and eat it!
Research at Harvard, the London Business School and Deutsche Bank, amongst many others, has shown that companies which have implemented sustainability policies have out-performed their counterparts. They have also enjoyed lower costs of capital and achieved better risk-adjusted returns. What is more, research published only this week by Business in the Community and Legal and General demonstrates that responsible businesses become more resistant to share price volatility, which I would have thought is an important consideration if you are a pension fund.
I know that we all find that old habits tend to die hard and that no-one really wants to be the first to make a move in a new direction, but is there not a case for making sure your portfolios are resilient in the long-term by adopting sustainability and by that I mean that you should look at the underlying environmental and social credentials of the companies in which you invest as a core driver in your mainstream investment strategies? From what I understand, this would certainly be a contrast to current practice. If there is an eye on sustainability it is, at best, studying matters in a separate and subordinate silo, segregated from daily mainstream fund activities. Working in that corner of the organization is also seen by many to be a somewhat quixotic “lifestyle choice”, rather than a core exercise in portfolio management with serious long term consequences.
Some time ago, through the combined agency of the Cambridge Programme for Sustainability Leadership and my International Sustainability Unit, I did my utmost to encourage a small group of pension funds the P8 to look at these issues and it is clear from what they say that the current interpretation of legal and fiduciary responsibilities is a big deterrent to changing investment practice. But I wonder if that really has to be so?
Interestingly, in 2005, Freshfields produced an influential report which confirmed that environmental, social and governance issues are financially relevant, and should be taken into account. This was a view, of course, also reflected in Professor Kay’s 2012 review of the equity markets. I gather the Law Commission is currently looking to clarify the guidance for pension trustees and investment managers, and David Hertzell, who is leading this work, is in the audience this afternoon and will, I am sure, be happy to discuss this matter later over a stiff drink!
Ladies and Gentlemen, it is to be assumed that we have all learnt important lessons from the recent financial crisis, perhaps not least the inherent dangers in markets mispricing risks. But I am afraid there is increasing evidence that this is happening again. For instance, The Grantham Institute at the London School of Economics, along with Carbon Tracker, point out the danger of valuing fossil fuel companies as if all their reserves will actually be sold and burned. If we are to keep within the two degree global temperature rise agreed by global leaders to avoid “dangerous” climate change, only twenty per cent of total current fossil fuel reserves could be burnt by 2050, even with carbon capture and storage technology. This, surely, must, at least, lead us to question the wisdom of the estimated six trillion dollars allocated to developing fossil fuels over the next decade. That is a colossal investment generating literally world-changing environmental and human costs that, as a soon-to-be grandfather, I find utterly terrifying...
You will also know far better than I do about the attendant danger and implications of such assets becoming stranded if the world is, indeed, successfully forced to use less fossil fuels. H.S.B.C. has estimated that equity valuations of fossil fuel companies could be reduced by up to sixty per cent, which certainly suggests to me that we are either going to lock ourselves into a global temperature rise of as much as six degrees, rather than the two that is considered as the real danger threshold, or risk significant financial losses to our economy through these stranded assets. If you think about those two options, I would have thought that the economic, political and security consequences of a global increase in temperature of over three or four degrees, let alone six, will completely dwarf the discounted equity valuation that we will need to help us avoid that outcome. The bottom line is very simple. We need, as a matter of grave urgency, to realign our thinking so that we build economies that are resilient to the structural changes caused by resources being depleted and by climate change.
So, I wonder if there is, therefore, also value in you actively seeking out investments and financial structures that actually minimize the risks we are facing? You may already know of the work being undertaken by the Climate Bonds initiative, an investor-focused NGO working to put the debt capital markets behind climate change solutions, and other initiatives seeking to introduce so-called “Green Bonds” which provide financial and environmental returns. And I hope that my International Sustainability Unit will help next year to launch a “Blue Bond” to finance sustainable fisheries. Private sector financing will also be crucial to meet the estimated $100 billion a year of climate finance required, per year, by 2020 an opportunity, you would think, for pension funds to invest in a more resilient economy...
As Patron of the Cambridge Programme for Sustainability Leadership, and the originator of a business leaders’ sustainability programme over the past nineteen years, I have followed with particular interest their recent work with a dozen asset owners and managers to explore the link between the influence of owners around the management of social and environmental issues and the performance of the underlying companies. Meanwhile, my Accounting for Sustainability Project, which encouraged many of you to come here this evening, is working with companies and their investors so as to help businesses articulate the value of sustainability in a way that enables investors to factor these into their strategies. Very recently, my I.S.U. extended this dialogue by bringing together investors, multilateral agencies, governments and N.G.O.’s to identify, and then make every effort to mitigate, the social, environmental and, therefore, financial risks when investing in agricultural land which, as you know, is an area of increasing interest to long-term investors.
The fact remains that this and other work leaves us no better at predicting the future, but it may make us more capable of surviving it. What I can certainly promise you is that “business-as-usual” will become increasingly difficult to sustain; and the longer we obstinately persist with it, the more impossibly expensive risks we generate. It is my experience that it is all too easy for financial institutions and companies to come up with every argument under the sun why something innovative shouldn’t be done. But so often the innovative and imaginative step turns out to make more money and be more sustainable in the long run for everyone. Surely, we have reached that point when the sheer human ingenuity and brainpower at your combined disposal could be used to make that innovative and imaginative leap that the world needs so badly?
So, what has to happen to achieve investment strategies that can effectively manage the changes unfolding around us? Perhaps I could suggest three easy steps you might like to consider taking? Firstly, might you widen the scope of existing risk analysis in order to capture some of the systemic links between risks? Secondly, following on from that, could you reflect these links in your valuation methodologies and the way you allocate capital? And thirdly, and perhaps critically, could you require asset managers to integrate environmental and social issues into the mainstream of their operation, and then measure their performance accordingly and, incidentally, also explore new classes of asset that are more suitable in a sustainable economy?
Ladies and Gentlemen, your sector plays a very significant role indeed in how our economic system works, both now and into the future. So it really does fall to you, I am afraid, to help shape, adapt or re-orientate a system largely devised in a very different nineteenth century context so it is actually fit for purpose and effective in what is fast becoming an exceedingly challenging twenty-first century.