Through the lens of the natural environment, individuals and businesses have become much more conscious of their carbon footprint. It is imperative, however, that the lens of financial risk supported by the regulator also come into focus, with institutional investors having a significant role to play in combating climate change.
It is clear that climate change has never been more important for investors with financial regulators increasingly reinforcing the message that there is an onus on investors to act. The RBA has joined the choir – deputy governor Dr Guy Debelle has spoken out on the impact of climate change to monetary policy. And, Mercer revealed in our latest climate scenarios report Investing in a Time of Climate Change - The Sequel 2019 that climate change is having a direct impact on investment performance.
In the face of mounting evidence and support that ESG investing is a fiduciary responsibility, why does the multitrillion-dollar finance sector continue to fund fossil fuel consumption as core to business-as-usual investing? APRA’s recent study found that just one-third of regulated entities considered climate change risks as “material” to their business.
Perhaps a lack of clarity on how environmental, social and corporate governance (ESG) factors can be financially material is enabling relaxed attitudes and leaving trustees without regulatory action on what is expected of them on ESG and climate change.
We’ve seen ESG become the subject of increasing scrutiny and regulatory pressure in other markets. Recent changes to the UK’s investment regulations, consistent with the Europe-wide IORP II legislation, take effect in October 2019. Trustees are required to have a Statement of Investment Principles, documenting how they take account of financially material considerations, including ESG factors and, explicitly, climate change.
This has spurred a stepped change in attitudes towards ESG, with our global Responsible Investment business seeing enormous demand from UK-based clients for education and advice on how to invest responsibly over the last few months.
Comparatively, in Australia there is no consistent guidance available to trustees. The PRI’s industry paper called on APRA in 2016 to update the language of its Prudential Practice Guide on investment governance, developed in 2013, which still confuses ESG and ethics. Clarification to superannuation funds that ESG issues – and explicitly climate change – are material to risk and return analysis and therefore should be incorporated alongside other risk and return factors in investment decision-making is an obvious step to take.
Currently, there are significant differences in the ESG practices of Australian funds, which see some keeping up with as well as setting global industry standards, regardless of local regulatory guidance. Others, however, have found themselves open to litigation spurred by member concern, as we’ve seen in the current case against REST. With a suite of environmental issues dominating the news such as droughts, waste management, coal mines, fracking and more, stakeholders from fund members to NGOs will demand answers from funds on where their investments are being allocated.
With APRA and ASIC both reaffirming their position that investors must take strong action on climate change as a significant financial risk, setting aside the associated ethical issues, regulators have a role to play in providing clarity in their best practice guidance.
Jillian Reid, principal, senior responsible investment specialist, Mercer
