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Analysis

Market approach to climate change

by Flavia Micilotta

Market approach to climate change

The 21st UN Climate Change ‘Conference of the Parties’, held in Paris in December 2015, ended with the milestone agreement for countries to reduce their greenhouse gas emissions sufficiently to keep the increase in global temperatures well below 2°C this century.

The agreement established a system for measuring individual countries’ commitments and contribution every five years. A progress assessment is set for 2018.

Although it is too early to determine whether the agreement has been drafted sensibly or whether it will deliver on its commitments, it sets the tone for policies and businesses.

Investors now have a number of options to contribute to the transition to a more sustainable economy. In this context, the best-case scenario is a race to the top for both investors and companies to take part in the fight against climate change.

Policy push

The strongest policy push following the Paris conference came from France, where the government encouraged the financial community to adopt Article 173 of France’s law on energy transition and green growth.

By asking investors to disclose how they factor environmental, social and governance criteria, as well as carbon-related aspects, into their investment policies, the law points the way towards more sustainable patterns of investment.

The Paris agreement also led a number of investors to reconsider their investments in oil. Mark Carney, the governor of the Bank of England, declared in September 2015 that investors faced potentially significant losses as a result of climate change action. Following this, even investors who did not think of themselves as particularly ‘pro-environment’ began to reconsider the viability of investing in oil companies. Now they are pondering the real costs of the carbon bubble.

The European Commission demonstrated an understanding of the various issues of relevance to different stakeholders, as well as strong willingness to support this change.

In the last six months, it has launched two key consultations. These have examined how companies can increase their transparency, following up on the new directive on non-financial reporting, and how investors can improve their standards in respect of long-term and sustainable investments.

Both pieces of the same puzzle, the consultations have sent a strong message about the importance of those ‘intangible’ criteria, most often referred to as economic, social and governance criteria.

Looking to the long term

Embedding these criteria into investment analysis and portfolio construction across a range of asset classes is the underlying principle of sustainable and responsible investment. According to Eurosif’s definition, socially responsible investment ‘is a long-term orientated investment approach which integrates ESG factors in the research, analysis and selection process of securities within an investment portfolio. It combines fundamental analysis and engagement with an evaluation of ESG factors in order to better capture long-term returns for investors, and to benefit society by influencing the behaviour of companies.’

ESG Chart

ESG incorporation 

In ESG incorporation, investment institutions complement traditional quantitative analysis of financial risks and returns with qualitative and quantitative analyses of ESG policies, performance, practices and impacts. 

Asset managers and asset owners can incorporate ESG issues into the investment process in a variety of ways. Some may actively seek to include companies that have stronger ESG policies and practices in their portfolios, or to exclude or avoid companies with poor ESG track records.

Others may incorporate ESG factors to benchmark corporations to peers or to identify ‘best in class’ investment opportunities based on ESG issues. Still other responsible investors integrate ESG factors into the investment process as part of a wider evaluation of risk and return.

Regulators have come a long way in pushing the socially responsible investment industry forward. But much can still be
done to help SRI become a significant factor in the transition to more sustainable economies.

Flavia Micilotta is Executive Director of Eurosif, the European Sustainable Investment Forum.

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