Climate change ranks as one of the defining challenges of our time and requires an all-sector response. The global financial markets are already responding, pouring billions of dollars into sustainable finance products and investments to support the world’s transition to a net-zero emissions economy.
At CommBank’s inaugural sustainability conference ‘Financing Australia’s Transition’, institutional investors discussed their approach to investment decisions and where the momentum is as capital is mobilised to fund a more sustainable future.
As climate risks continue to grow synonymous with investment risks in its impact on long-term shareholder value, institutional investors are shifting their focus to more progressive investment opportunities and portfolio transition models aligned with the global decarbonisation movement.
“We’ve arrived at a challenging moment in our global energy system,” said Megan Starr, Global Head of Impact at Carlyle. “As institutional investors, we’re doubling down on renewable energy as fast as we can, but we also need to help traditional energy companies in their transition to net zero.”
Taking an integrated approach to sustainable investments
Environmental, social, and governance (ESG) issues have long been a key consideration for many institutional investors and businesses, rapidly accelerating in both uptake and integration over the past 18 months. The new challenge for investors is transforming present ESG risks into future opportunities that can enhance long-term portfolio sustainability and resilience.
“We know that an orderly transition towards net zero will result in less value destruction than a delayed transition, and both will cost less in the long run than no transition at all. When we think about ESG, we take a whole portfolio approach that will support an orderly transition,” Allison van Lint, Head of Research in Responsible Investments at Cbus Super, told the panel.
Kyung-Ah Park, Managing Director of ESG Investment Management at Temasek, agreed that ESG needs to be integrated across the end-to-end investment process. For Temasek, this includes adopting internal carbon pricing as a lever to accelerate the transition pathway.
“It’s really applying an ESG lens from pre-investment due diligence to post-investment engagement and taking a look at what the material ESG considerations are,” Park said. “Carbon pricing is a cross-cutting consideration but issues can range from product responsibility to cyber security and data privacy.”
Investors also need to weigh up the risk and return trade-off, taking into account the growing impact of climate risk on investments.
Craig Morabito, Global Head of Credit for First Sentier, said: “This is not just about getting the highest return, no matter the risk. We’re starting to see climate risk play out, and companies have a timeline to get to net zero before that pricing is going to be built into investments.”
Engagement over divestment to help drive the transition
Rather than simply divesting their holdings in carbon-intensive businesses, many investors believe institutions can play a more constructive role in supporting companies through their pathway to decarbonisation.
“The world is changing, and the role of private capital is to invest in good businesses and turn them into great businesses – which means making them climate resilient first and foremost,” said Starr. “That’s why we don’t segment investing into binary terms of good assets versus bad assets: we focus on the decarbonisation trajectory of individual companies.”
Van Lint agreed that the emphasis shouldn’t be on reducing overall portfolio emissions through divestment alone. While portfolio reduction targets are important, they are a valuable tool to support overall decarbonisation rather than an end goal in themselves.
“We could cut emissions by 50 per cent overnight by divesting from 20 companies out of thousands that we own, but we need those companies and industries to continue to transition, to be there in the future,” she said. “There’s no point having a net zero portfolio if the world isn’t net zero – that’s why we’d much rather remain invested and engage with companies.”
She also believes sustainability-minded investors will feel comfortable with high carbon stocks – if they have a clear transition plan in place and are successfully moving towards renewable energy. “It’s less about what the current state is, and more what the future will look like and how our portfolios are aligning with that,” said van Lint.
Morabito added, “It’s becoming harder to justify a position in the portfolio with a high carbon footprint. We need to articulate that they’re on a pathway towards net zero, to give clients comfort that they have adequate transition plans that we’re assessing over time.”
Helping companies make a successful transition
Starr said the key to a successful transition was taking the time to help companies use available data and understand their carbon profile, while mapping their journey to decarbonisation.
“We have to start right at the beginning with climate positioning. That means sitting down with companies and working out what their potential scope should be. It takes time to get the foundations right and actually build capacity,” she said.
And companies with a higher carbon footprint will need support from institutional investors at every step of their transition – to ensure they stay on track with their plan as they progress towards net zero.
“We help companies set measurable and relevant objectives for that sector and region. But there must be ongoing engagement, so each company understands the risks and knows what they have to do next to improve their net zero visibility,” Morabito said.
As companies create and implement their transition plans, institutional investors can help them make the most of all available and emerging carbon negative solutions, including new technologies for carbon removal and nature-based carbon credit systems. Investors are also working collectively to drive greater sophistication and standardisation of portfolio metrics and enhance transparency around emissions data.
“With the urgency of the climate issue, both in terms of scale and time horizon, there’s a real need to be hyper-collaborative. By creating strong partnerships between capital markets, policy and technology, we have a very large opportunity to identify the pain points and actually drive innovation in the race to net zero,” said Kyung-Ah Park.