Presented by four experts in the field of sustainability: Amr Addas, CFA, Stephen Kibsey, CFA, Cary Krosinsky, and Benjamin Yeoh, CFA

The sold-out CFA Society Toronto Sustainable Investing Symposium  on 31 January 2020, at CFA Society Toronto offices was filled with professionals eager to build their ESG (environmental, social, and governance) knowledge, with others attending to find out what all the fuss is about. Listeners gathered to listen to four experts in the field of sustainability: Amr Addas, CFA; Stephen Kibsey, CFA; Cary Krosinsky; and Benjamin Yeoh, CFA. Globally, asset managers and companies are setting ambitious targets for reducing their emissions and introducing plans to promote sustainability. The major Canadian banks have committed $100 billion to $400 billion in sustainable finance and others are following suit. Climate change cannot be solved by governments or companies alone, but must include the participation of the financial industry and capital markets.

ESG and sustainability are broad topics that require more than one day to cover; Amr and Stephen both teach a program dedicated to the topic at Concordia. The four presenters did cover an impressive amount of material, however — the following forms some of the highlights.

What is sustainable investment?

The definition provided at the start of the symposium by Amr Addas and Stephen Kibsey is the perfect place to start in creating a common understanding of the topic: “[Sustainable investing is] an investment approach that integrates long-term ESG criteria into investment and ownership decision-making, with the objective of generating superior risk-adjusted returns.”

Fiduciary duty

The establishment of that definition flowed well into discussion of an often-cited reason to not incorporate ESG: fiduciary duty. The argument is that solely using traditional financial indicators in investment decisions satisfies the legal obligation of acting in the best interest of clients; this, however, is based on an out-dated belief that incorporating ESG factors compromises returns.

Several organizations view the incorporation of ESG factors as part of their fiduciary duty. CFA Institute states “the duty of CFA charterholders [is] to factor in all material information, including material ESG factors into investment analysis, unless contrary to client wishes. […] such factoring is consistent with an investment manager’s fiduciary duty.”  The UNPRI and UNEP Finance Initiative’s view is that “investors that fail to incorporate environmental, social and governance (ESG) issues are failing their fiduciary duties and are increasingly likely to be subject to legal challenge.”  Business Roundtable, an association of U.S. CEOs, obtained the signatures of 181 U.S. CEOs on its 2019 “Statement on the Purpose of a Corporation,” which rejects the shareholder primacy creed and urges companies to consider the environment and workers’ well-being alongside profits. The Commonwealth Initiative on Climate Change is …

“examining the legal basis for directors and trustees to consider, manage, and report on climate change-related risk, and the circumstances in which they may be liable for failing to do so.”

The Data challenge: Working towards standardization

The availability and quality of ESG data has improved, although there remains much to be done in terms of standardization. Most of the available data is self-reported and voluntarily disclosed. Some firms have professed survey fatigue and a lack of resources to answer all the surveys they receive, while others have addressed the issue by including all relevant data on a publicly available website, from which it can be sourced. There is a need for a coherent framework for reporting several data points such as Scope I/II/III emissions (Scope I: direct emissions resulting from company activities; Scope II: indirect emissions generated from use of electricity; and Scope III:  indirect emissions from the supply chain, both up and downstream).

The proprietary nature of ESG data providers’ methodologies, data aggregation, and weighting approaches, which are used in assigning a unique ESG score to each firm, have created some unintended consequences. Firms may have difficulty assessing which issues need addressing to improve their scores. The correlation between data provider ratings is low, with the same firm receiving very different scores per provider. As such, it may be prudent to use multiple providers.

The Sustainability Accounting Standards Board’s (SASB) materiality map is a great resource mapping the material ESG factors to each sector, which is essential for developing a sustainable investment strategy.

The World Economic Forum, SASB, the Task Force on Climate-Related Financial Disclosure (TCFD), and others, have been working towards standardizing data, metrics, materiality, and use of scenario analysis, and towards creating a common language and frameworks. The Network for Greening the Financial System (NGFS), of which the Bank of Canada is a member, views climate change as a financial risk and is working to bridge data gaps and improve the quality, consistency, and reliability of data. NGFS and the Expert Panel on Sustainable Finance both recommend a central data source for this data.

Fossil fuels: Stranded assets, engagement and the transition to a lower carbon economy

The Carbon Tracker Initiative notes that only a fraction of the world’s oil reserves can be safely burned if we are to meet the global temperature targets set out in the Paris Agreement on Climate Change. Global government action to date has been insufficient and the UNPRI Inevitable Policy Report predicts a government response for action is inevitable and talks of “a response by 2025 that will be forceful, abrupt, and disorderly because of the delay.”

If a company has a massive environmental or carbon footprint, there is a risk they will be unable to extract their assets, and resources such as oil and gas in particular, as it will no longer be economically feasible to do so. This risk is coined “the stranded assets risk.” The Spanish energy company Repsol, for example, wrote down <<DONNA: NEED EURO SYMBOL HERE>>€4.8 billion-worth of assets after concluding their extraction would not be profitable, given carbon pricing and environmental policies. These types of write-downs are likely to become more common moving forward.

It is unrealistic to believe that we will end the use of fossil fuels immediately; however, we do need a plan to transition to a lower-carbon environment. That transition has seen, and will continue to see, a reallocation of capital away from fossil fuel companies to those that will drive and thrive in a lower-carbon environment. Some of this reallocation has been in the form of divestment; however, this is insufficient as an investment strategy to manage portfolio risks. It is necessary to go beyond divestment and look to reducing carbon across an entire portfolio using a more effective method, such as engagement. By engaging with companies, investors can advocate for change and see positive results in helping with their transition.

Climate Action 100+, one of the largest investor initiatives in the world and representing nearly US$40 trillion in assets, uses engagement to pressure the world’s largest greenhouse gas (GHG) emitters to take action on climate change and standardize their exposure disclosures. Several firms have committed to GHG reductions and even net zero carbon policies based on this engagement.

Summary

It was clear, after listening to all four speakers, that incorporating ESG factors is not only necessary to understanding the risks and opportunities to which a company is exposed, but has become a consistent and expected course of action in fulfilling one’s fiduciary duty.  There is work to be done in standardizing and improving the reliability of data, but several organizations have embraced these exact goals, ensuring investors have the necessary information to make informed investment decisions. The inevitable policy response, the risk of stranded assets, and the importance of reducing emissions, will see a reallocation of capital to firms positioned to thrive in a low-carbon environment with engagement likely to be a major factor in this transition.