As mechanisms for ensuring a sustainable economy rise on the financial sector’s agenda, the role of asset owners, and the allocation of trillions of capital required in the transition are increasingly under scrutiny. Pension funds and sovereign funds can play a pivotal role steering investments through stewardship activities, scrutinising and benchmarking the targets of their portfolio and effectively holding them to account.
Nevertheless, key barriers persist for public funds in taking this role. The fossil fuel industry continues to be dominant, heavily subsidised and its transition politicised. Incentives and policy to support greener investment are lagging, and supply is not yet meeting demand for green financial products, bonds and infrastructure. Critics argue that current frameworks prioritise financial returns over sustainability, emphasising short-term performance over long-term goals.
There is a need for greater clarity in disclosures and careful consideration of interim targets to ensure effective policy engagement. The International Sustainability Standards Board has made huge strides in this regard, yet current taxonomy, disclosure and green criteria often exclude the dirtier industries and therefore the investments and portfolios that may support their transition.
Transition finance plays a key role in decarbonising high-emitting industries and governments must set policies that incentivise green investment. These include implementing a carbon price, public investment in sustainable projects and infrastructure investment, and supporting with investment risk. Asset owners must navigate challenges such as shareholder rights and government interventions, particularly in sectors like energy where policy shifts can have profound implications for their stakeholders, especially in the short term.
The pressure to generate long-term returns for members is of paramount concern. Modern fiduciary duty entails considering systemic risks and embracing innovative strategies. Traditional regulations often fail to address contemporary challenges such as physical and transition risks adequately.
Changing the conversation
Taking a long-term view, the risk of stranded assets with continued investment into high-carbon assets means divestment is part of a fund’s fiduciary duty, providing this is based on credible and robust processes. Recognising this, forward-thinking asset owners are diversifying portfolios and engaging in sustainable practices. They are acknowledging that sustainability is not a ‘zero-sum game’ and understanding the importance of environmental, social and governance implementation and transition, even if it temporarily affects portfolio performance.
This is a significant shift from the dominant conversation of divesting portfolios, meeting targets due to portfolio change and shifting investments to purely ‘green’, which does not equal emissions reduction. It demonstrates the significance of transition finance in supporting brown industries to become green through active ownership. This may lead to a temporary browning of portfolios and worse disclosures – but it will ultimately lower emissions.
As one speaker commented at OMFIF’s Global Public Investor seminar: ‘We cannot disclose our way to net zero… Brown companies have lots of expertise; we need to capture this and bring them on board to solve challenges.’ Disclosure frameworks and green criteria must therefore be extended to support and integrate brown industries looking to transition towards a sustainable economy.
To ensure risk-adjusted returns on their investments and that the fiduciary duty to their beneficiaries is met, asset owners must consider macro, systemic factors and navigate complex financial landscapes. As climate change increasingly exacerbates financial market volatility, sidestepping sustainability issues is a luxury they cannot afford. Asset owners are increasingly committed to responsible investment principles, encompassing stewardship, collaboration, effective governance and policy advocacy to drive meaningful change while delivering sustainable returns for their members.
Emma McGarthy is Head of the Sustainable Policy Institute, OMFIF.
