Under the Paris Agreement, all nations are requested to limit global temperature rises to well below 2 degrees Celsius (ideally 1.5) to avoid ‘dangerous’ climate change. This means reducing greenhouse gas emissions by 50% by 2050 – or achieve net zero carbon emissions by that date.
So far, only a handful of countries have submitted new 2030 targets and current indications suggest these will be insufficient.
In the absence of government leadership, attention has shifted onto the investment community to throw some of its sizable weight and influence to help drive this agenda forward.
One of the larger cohorts within this community is obviously the pensions industry, which represents more than $33 trillion in assets. Whilst we are increasingly finding greater engagement from pensions on environmental, social, and governance (ESG) issues like climate change, but this is not without its challenges.
Pension funds and fixed income
Many pension funds are beginning to get a better grasp of incorporating ESG considerations into their investment practices, requiring external managers to demonstrate competence, exercise stewardship and evidence action on climate.
It is important to note here that ESG integration is more developed within the equity universe, and pick-up has been slower in fixed income. Traditionally pension funds have been heavy investors in fixed income with this asset class often accounting for the core investment of their overall portfolio.
The shift to include fixed income in the fight against climate change we believe is logical for many reasons. The absolute size of the debt market trumps equity so in our opinion to make an impact, you need to think beyond equities.
Also, the majority of fossil fuel ‘reserves’ are owned by sovereigns or state-owned companies where debt financing is greater than equity (in some cases issuing only debt).
One area that appears to be gaining momentum is to ‘deny the debt’. In essence, not providing capital funding in the first place to companies or sovereigns deemed to be fundamentally ‘failing’ on climate change.
The other, newer angle, which is being picked up is the thinking that the impact will be greater if efforts are focused on primary markets as opposed to secondary ones, be this in equity or fixed income markets.
By targeting new bond issuance and bank lending in fixed income markets (i.e. primary capital), you as investors may potentially affect supply/demand dynamics more directly. You can not only potentially impact an issuer’s access to capital, you could possibly drive up their cost of capital if you feel they are not tackling climate change enough.
Looking ahead – being active is key
All these approaches may have a role to play in the climate fight. But clearly given the scale and urgency of the climate issue, and the lack of international governmental leadership, in our view we can expect to see more on the ‘deny the debt’ concept especially from asset owners, like pension funds that have set ambitious net zero climate goals.
This may be part of a broader emphasis on the role of the fixed income market, where lenders and bondholders play a unique and critical role. The challenge will be whether they will seize the opportunity to act as enablers of the low carbon transition or be a barrier to it. Either way taking an active approach will be key.