A Quick Guide to Sustainable Finance: Innovation through Risk Mitigation
“It is vitally important for investors to understand the risks that climate change may pose to the businesses they have invested in—and the opportunities in transitioning to a low-carbon economy.”
– Anne Simpson, Investment Director, Sustainability at CalPERS
As we enter a new year, we must reflect on today’s reality: the planet is warming at unprecedented rates, largely due to a carbon-intensive economy. This is just as much a sociological and environmental problem as it is a financial problem. The risks that arise from unmitigated climate change will affect governments, institutional investors, and individuals alike. The Paris Agreement—the world’s first global climate agreement—aims to actively engage in limiting temperatures from increasing 1.5°C above pre-industrial levels.
Why do you, as a parent, a grandparent, a student, a friend, a human, care that America helps reach this goal? In addition to a myriad of equally-important altruistic reasons, Sustainable Directions breaks down a few fiscal consequences by analyzing risk and opportunity.
New York City today
New York City if global temperatures rise 2°C
New York City if global temperatures rise 4°C
“Oceans are taking in 90% of the heat of global warming—it is expected that a child born today will see the ocean rise between 1 and 4 feet in his or her lifetime. In the U.S., 5 million people live within 4 feet of the local high tide level.” – NASA
How could this affect you today? For example, Florida is home to six of the 10 most vulnerable American cities to extreme weather. In Miami-Dade County, housing prices dropped by 7.6% in high-risk flood zones in 2016. By comparison, annual home sales increased by 2.6% nationally.
Farming and agriculture not only puts food on our tables, it is also a significant contributor to our economy. Crops, livestock, and seafood produce $300 billion each year—and when all food services and agriculture-related industries are combined, agriculture contributes $750 billion to our GDP.
Globally, America produces almost 25% of all global grains, including wheat, corn, and rice. Extreme weather events and elevated carbon dioxide levels have adverse effects on these yields. Over the next five to 25 years, the yields of corn, wheat, and other crops in the U.S. Midwest and South are expected to drop by at least 10%.
California produced more than one-third of U.S. vegetables and two-thirds of U.S. fruits and nuts in 2013. Yet, today more than 50% of the state is in a severe drought, according to the U.S. Drought Monitor.
Click here to learn how drought, inland flooding, extreme heat, wildfires, and more will affect your state.
In 2016, the U.S. saw a total of 91 natural disasters, the second-most on record—globally there were 750. What were the three costliest disasters of 2016?
- Japan’s pair of earthquakes in Kyushu: $31 billion
- China’s floods in June and July: $20 billion
- The U.S. and Caribbean’s Hurricane Matthew: $10.2 billion
In total, natural disasters cost the world $175 billion last year, of which only $50 billion was insured. That means insurance companies had to pay $50 billion in natural disaster payouts, according to Munich Re. This not only doubles the amount paid out in 2015, but more importantly, provides a real example of how costly a world of natural disasters could be for the insurance business.
Through these photographs, we can visually understand the detrimental impact natural disasters have on developing nations. Failing, inadequate infrastructure means that a reasonably weaker disaster will have outstanding consequences when compared to a disaster of equal magnitude hitting a developed nation.
Did you know that in 2012 around 7 million people died—that's one in eight deaths—due to air pollution? Both outdoor and indoor air pollution contribute to this, leading to heart disease, asthma, lung cancer, and more. The New York Times compiled stories depicting Beijing’s daily struggle with pollution, from a family checking air pollution levels before determining their weekend activities, to school children kept from outdoor recess due to a poor Air Quality Index rating, to highway closures due to fossil fuel smog.
Now that we have seen some of the outstanding consequences of climate change—and why it is an immediate and pressing problem—we turn to the opportunities that arise.
How can we achieve an 80% reduction in carbon dioxide emissions by 2050?
The Risky Business Project began under the leadership of Michael Bloomberg (former NYC mayor), Henry Paulson (former U.S. Secretary of the Treasury), and Tom Steyer (former hedge fund manager). It collects quantitative data and analyses the present and future effects of climate change on the U.S. economy.
Through its models, it found that the total increase of capital investments needed to cut carbon emissions by 80% would be:
- $220 billion per year between 2020 to 2030
- $410 billion per year between 2030 and 2040
- $360 billion per year between 2040 and 2050
Such capital investments would reduce fuel costs and create savings of:
- $70 billion per year between 2020 and 2030
- $370 billion per year between 2030 to 2040
- $700 billion per year between 2040 to 2050
In the near future, where would the largest additional investments lie?
- Vehicles of all types: $75 billion per year
- Power generation: $55 billion per year
- Advanced biofuels: $45 billion per year
- Energy efficiency measures: $16 billion per year
Breakthrough Energy Coalition, a partnership committed to investing in new energy technologies including Bill Gates and George Soros, demonstrates the Landscape of Innovation. The "grand challenges" are in electricity, transportation, agriculture, manufacturing, and buildings.
This creates room for creativity as governments, institutional investors, and individuals navigate a world constrained by resource scarcity, rising temperatures, population growth, immigration influx, and large-scale poverty. Only by creating sound public and private partnerships, focused on sustainable investments and policy, will long-lasting solutions prevail. Yet, the underlying crux of the issue is money and the flow of capital.
What is sustainable investing?
Sustainable investing is an investment approach that takes Environmental, Social, and Governance (ESG) factors into account throughout the entire investment process. The purpose is to provide a well-rounded perspective to investing, combining financial performance data with ESG metrics to dictate how a company is mitigating future climate risk.
There are several strategies for implementing sustainable investing in portfolio construction and management. The December 2016 World Resources Institute’s Working Paper, Navigating the Sustainable Investment Landscape, describes the five most common terms:
U.S. SIF Foundation's 2016 Report on US Sustainable, Responsible and Impact Investing Trends found that $8.72 trillion assets are currently managed under sustainable investment criteria in America—out of the combined $40.3 trillion assets under professional management. This includes a set of ESG-focused mutual funds and ETFs available to the public, offered through firms like Calvert, PAX World, TIAA, State Street, BlackRock, and Trillium. Increasing ESG research is also becoming available, including the Morningstar Sustainability Rating for funds, Bloomberg Professional Service’s ESG data and research on companies, MSCI ESG Research, Sustainalytics, and Trucost.
Since 2014, sustainable investing has increased by 33%. Policy and regulation has helped catalyze this industry, such as:
- Interpretive Bulletin on Fiduciary Duty, 2015: The Department of Labor released IB 2015-01 to provide guidance on ESG factors for fiduciaries under the Employee Retirement Income Security Act (ERISA). It “acknowledge[s] that environmental, social and governance factors may have a direct relationship to the economic and financial value of an investment, and when they do, these factors are proper components of the fiduciary’s analysis.” Fiduciary duty is core to investment practices, and as such, the IB provides significant authority.
- Financial Stability Board—Task Force on Climate-related Financial Disclosures, December 2016: The Task Force released recommendations on climate-related disclosures. By analyzing what financial markets need to measure and analyze regarding climate change risks, the groups aims to help investors’ needs.
- Interpretive Guidance on Climate Related Disclosure, 2010: The Securities and Exchange Commission with Federal securities laws require “certain disclosures by public companies for the benefit of investors.” In 2010, the SEC “voted to provide public companies with interpretive guidance on existing SEC disclosure requirements as they apply to business or legal developments relating to the issue of climate change.” Nonetheless, mandatory ESG disclosure has not yet been incorporated in America, unlike the European Union.
- Concept Release, April 2016: SEC Commissioner Kara Stein issued a concept release for public input on amending disclosure requirements for Regulation S-K, a law describing public companies' reporting requirements.
- The Paris Agreement at the United Nations Framework Convention on Climate Change: This agreement includes “making financial flows consistent with a pathway toward low greenhouse gas emissions and climate-resilient development.”
- The U.N. Sustainable Development Goals: As part of the 2030 Agenda for Sustainable Development, 193 countries adopted goals aimed at mobilizing efforts to eliminate poverty, tackle climate change, conserve the environment, and reduce inequity.
- The Climate Action Plan: A set of policies and initiatives aimed at cutting carbon pollution.
- The Clean Power Plan: A national policy to limit power plant pollution with the goal of reducing greenhouse gas emissions to 32% of 2005 levels by 2030.
- Green Bond Principles: A set of principles for green bond transparency and disclosure, allowing investors to measure the environmental impact of the security.
Climate change is a universal risk, both to your family and to your portfolio. Sustainable finance has begun to address these challenges, but monumental hurdles remain. This includes reassessing the framework by which firms run. It means amending the Generally Accepted Accounting Principles (“GAAP”) to include an accounting standard through which issues like emissions credits, renewable energy certificates, and allowances can be addressed. It means assessing, where needed, climate risk and the potential of stranded assets in valuation. It means overturning non-free market forces currently hindering the emergence of a low-carbon economy—such as global subsidies to the fossil fuel industry (which reached $5.3 trillion in 2015). It means comprehensive reporting transparency across the entire supply chain.
Change will not happen overnight, but an informed public who demands environmental and social progress will help mobilize financial institutions, corporations, and governments. “As the people of Kiribati struggle to survive, their story offers a glimpse into the future for many nations on a rapidly changing planet,” says Audrey Choi, CEO of Morgan Stanley’s Institute for Sustainable Investing. “It is a clear and present danger. And it should be an enormous wake-up call to us that climate change is not a theoretical issue—this is existential.”