Earth Capital's Richard Burrett on How Asset Managers Can Influence the Future of the Corporation
Every business has an impact on societal well-being, either positive such as the production of socially useful goods and services or negative such as pollution. This is particularly true of the investment sector. As intermediaries making decisions on which entities obtain finance and which do not, investors play a unique role in shaping the economy.
There is a growing understanding too of the need for corporate social purpose. Colin Mayer CBE, Professor of Management at the Saïd Business School at the University of Oxford and Fellow of the British Academy, led a programme to look at the future role of business. The Future of the Corporation programme was launched in 2017 and concluded its main phase of activity in 2021. Its extensive research and engagement sought to consider the role of business in society, with new thinking and evidence to elaborate on why purpose is crucial to business success and how policy and practice should support business to be more purposeful. Mayer summed this up in stating that the purpose of business should be: “Producing profitable solutions from the problems of people and planet, and not profiting from creating problems.”(1)
Such awareness is growing in finance and more institutions are stating an intent to conduct business responsibly. Larry Fink of BlackRock has long talked of the need for business to contribute to society or risk losing BlackRock’s support (2) yet this view is strongly contested. Adrian Wooldridge, in an opinion piece in Bloomberg in 2022, argued that Fink is wrong and “Business Doesn’t Need a ‘Social Purpose’ Revolution”(3). Milton Friedman style-thinking that “the business of business is business” remains a dominant market paradigm.Critics of climate action in the U.S. are now arguing that industry climate alliances violate U.S. antitrust laws to undermine the growing industry collaboration around net zero, notably GFANZ and other ESG alliances and frameworks. Legal experts conversely argue that the global companies that form alliances to help them tackle climate change need clear "safe harbour" guidelines from governments to allay fears they could be tripped up by antitrust rules.(4) At the same time climate litigation against governments and corporates for climate action failures continues to increase. It seems that the pathway to conducting business responsibly is built on stony ground.
The British Academy study is not unique in citing the negative role of business in causing ecological damage. United Nations (UN) processes which led to the Paris Agreement on climate change in 2015 and the Kunming-Montreal Global Biodiversity Framework in December 2022 (5) clearly see business as both part of the problem and the solution. Governments, business, and finance are indeed all critical economic actors in laying the foundations for a thriving and sustainable economy.(6) As investors in the business ecosystem, can we not use our influence on putting purpose at the heart of business in
the 21st century?From a climate change perspective, the need for collective action has never been greater. The Intergovernmental Panel on Climate Change (IPCC) 2023: Synthesis report (7) is blunt in what needs to be done. Climate change impacts on people and ecosystems are more widespread and severe than expected, and future risks will escalate rapidly with every fraction of a degree of warming. Adaptation measures can effectively build resilience, but more finance is needed to scale solutions. Some climate impacts are already so severe they cannot be adapted to, leading to losses and damages. The world must rapidly shift away from burning fossil fuels — the number one cause of the climate crisis. We also need urgent, system-wide transformations to secure a net-zero, climate-resilient future. Carbon removal is now essential to limit global temperature rise to 1.5°C.Despite the overwhelming scientific evidence (which is signed off as part of the IPCC process by governments), are critics of climate action seriously arguing that we cannot collaborate to solve a collective emergency? Is central bank action on climate change really wokery as some right-wing commentators in the UK also argue? (8) The politicisation of the debate is both misguided and deeply unhelpful.
According to the IPCC, climate finance for both mitigation and adaptation must increase dramatically this decade. But where is the investment industry right now on this topic? ShareAction, a UK-registered charity, campaigns on the most pressing issues facing the world today. As part of that work, they benchmark investors and define the highest standards for responsible investment. In February 2023 they published their latest benchmarking study, ranking 77 of the world’s largest asset managers’ approaches to responsible investment. (9)
Only four asset managers out of the top 77 globally received an AA or A grade for their approach to responsible investment, while 35% of assessed managers received a D or E grade. Given the audience for Pension Pulse, I take no pleasure in highlighting that the highest-ranked Canadian asset managers are D rated. ShareAction argues that the asset management industry needs to change urgently if it is to demonstrate proactive stewardship that safeguards against key social and environmental risks in the best interests of the investors. Whilst some asset managers demonstrate leadership in particular areas “only a very small number are performing strongly across all the topics” in the survey.
Assessment of national government action tells a similar story. If we look specifically at climate action, there have been a lot of commitments made. Indeed, some progress has been achieved but nowhere near enough. The analysis of Climate Action Tracker (CAT) is revealing. Climate Action Tracker is an independent scientific project that tracks government climate action and measures it against the globally agreed aims. It is a collaboration of two organisations, Climate Analytics and New Climate Institute, and has been providing this independent analysis to policymakers since 2009. (10)
The UK government has talked a good story around climate action and can point to many successes, including the Climate Change Act of 2008, updated in 2015, with the purpose of pursuing the transition to a low carbon, climate resilient and environmentally sustainable economy. The latest CAT rating on the UK (December 2022) is “almost sufficient” overall based on modelled pathways, policies, actions, and targets relative to 1.5°C. The UK Government was nonetheless successfully sued in 2022 by ClientEarth over its inadequate Net Zero strategy. (11) The High Court found that the net zero strategy, which sets out plans to decarbonise the economy, doesn’t meet the Government’s obligations under the Climate Change Act to produce detailed climate policies, that show how the UK’s legally binding carbon budgets will be met.
The story on the “other side of the pond” shows room for improvement too. CAT currently assesses Canada’s overall performance as “Highly Insufficient”. The USA is rated as “Insufficient” at year-end 2022 although the passing of the Inflation Reduction Act in 2022 may yet prove consequential in directing new federal spending toward reducing carbon emissions and promoting wider clean tech investment in the U.S.
So, given this background, how should asset owners and managers act around climate change and the wider sustainable investment agenda? I would argue that large institutional investors should act in their own business interests. As Universal Owners with diversified portfolios, they own a representative share of the entire economy, and their interests align with the public at large. Their portfolios are exposed to risks from corporate externalities. There is a clear business case for action.
Central banks increasingly see issues like climate change and biodiversity loss as threats to markets and financial stability. The Network of Central Banks and Supervisors for Greening the Financial System (NGFS), representing 135 members over 29 countries, published a paper in March 2022 acknowledging that nature-related risks could have significant macroeconomic and financial implications. (12) Moreover, they argue that nature-related financial risks should, together with climate change, be considered by central banks and supervisors for the fulfillment of their mandates. Given the evolving materiality of these issues, how can they be ignored by the wider financial community? Would that not potentially breach fiduciary duty?
As an investor in growth equity investing across UK and Europe, we see huge potential investment in the development and deployment of clean sustainable technology. According to the Energy Transitions Commission, around $3.5 trillion a year of capital investment will be needed on average between now and 2050 to build a net zero global economy, up from $1 trillion per annum today. (13)
This represents a massive opportunity. They acknowledge too the need for sectoral approaches across energy, transportation, industry, and the built environment, combined with carbon dioxide removals, in meeting global climate objectives. (14)
As an investor in the energy, food, and water sectors we have long recognised that socio-ecological pressures pose a significant set of issues for the investment sector. The energy-food-water nexus will drive huge demand but face significant transitions to meet the demands of a growing population within scientifically understood ecological limits. This impacts our approach. We would argue that wider sustainability drivers should inform innovation in these sectors. That includes thinking through issues at a systems level to address multiple problems. The net zero transition must be a consideration in all investment decisions made.Furthermore, beyond the choice of investments themselves, there is a real requirement for active ownership in helping investees to address the evolving material issues we face. There is sound research to suggest that collaboration among active investors is instrumental in increasing the success rate of environmental and social engagements. After successful engagements, particularly on environmental and social issues, there is also evidence that companies experience improved accounting performance and governance. (15)
Aligning such engagement around the transition to credible science-based targets makes sense too. Over 2,400 companies now have climate targets validated as science-based by the Science Based Targets Initiative (SBTI). (16) Given the concerns about green-washing and spurious claims of sustainability, investors need to ensure that investee disclosure is credible as well as being future-fit. Understanding the legitimacy gap if any between stated and lived strategy is critical.
Navigating this noisy and contested space is not easy. It is made more difficult when powerful groupings with legacy vested interests or political ideologues threaten a balanced discourse on what is needed. There is a loss of trust around the sustainability claims of big business. We live in a “show me” not a “trust me” world. This is leading to growth in demands for ESG reporting and the development of taxonomies and green certification criteria. Not all of this is helpful, not all is systemic in its thinking. Much of the work to date is politically and socially constructed.
So, what can investors do in response? We would argue that the starting point is an objective, evidence-based analysis of the changing operating context for business and recognition of the evolving financial materiality of issues like climate change and biodiversity loss. Step two is having a clear social purpose. This should be core to the investment strategy. Investments are not made in a financial bubble. They have environmental and social consequences, and we need to acknowledge that and reflect that in our strategies. Thirdly investors should be using their stewardship and engagement with investees to manage this evolving risk profile and become resilient and future fit. This should include encouraging larger companies to set science-based targets and to use their position to advocate for greater action at sectoral and international levels. This is ultimately in all our financial (and other) interests.
_________
(1) https://www.thebritishacademy.ac.uk/programmes/future-of-the-corporation/
(2) https://www.nytimes.com/2018/01/15/business/dealbook/blackrock-laurence-fink-letter.html
(5) https://www.unep.org/resources/kunming-montreal-global-biodiversity-framework
(6) https://www.cisl.cam.ac.uk/resources/cisl-frameworks/rewiring-the-economy
(7) https://www.un.org/en/climatechange/reports
(8) https://www.telegraph.co.uk/news/2023/01/11/bank-england-paying-price-wokery/
(9) https://shareaction.org/reports/point-of-no-returns-2023-part-i-ranking-and-general-findings
(10) https://climateactiontracker.org/about/
(11) https://www.clientearth.org/latest/latest-updates/news/clientearth-are-suing-the-uk-government-over-its-net-zero-strategy/
(12) https://www.ngfs.net/en/communique-de-presse/ngfs-acknowledges-nature-related-risks-could-have-significant-macroeconomic-and-financial(13) https://www.energy-transitions.org/publications/financing-the-transition-etc/
(14) https://www.energy-transitions.org/publications/mind-the-gap-cdr/
(15) The Review of Financial Studies, Volume 28, Issue 12, December 2015, Pages 3225–3268,
https://doi.org/10.1093/rfs/hhv044
Let me begin by thanking Richard Burrett, Chief Sustainability Officer at Earth Capital, for writing such a thoughtful comment packed with excellent insights.
I also want to thank Elise Hockley, COO & Head of Investor Relations at Earth Capital for sending me this comment.
It's rare that I accept guest comments but when they are well done and thought provoking and add meaningful insights to my audience, I gladly accept them.
Unlike other funds, Earth Capital has been investing in sustainability for a long time and is a leading UK growth equity impact investor.
I've personally met Richard and Gordon Power who co-founded Earth Capital here in Montreal and was impressed with their understanding of these complex issues long before ESG became a popular tag line.
Now, let me get to Richard's paper.
What is the role of the corporation in a world that is highly interconnected where the environment and social issues cross transnational borders?
Do corporations have a social purpose, should they have one or focus solely on profits and the hell with everything else?
I would argue that corporations are first and foremost profit seeking organizations but they are beholden to shareholders and most of all to the consumers who buy their products.
In a world where social media platforms dominate and influence billions, corporations cannot ignore what their shareholders and clients demand, or they risk obsolescence.
Where it becomes tricky is how do large global investors navigate all this and deal with competing interests?
Well, from a pension perspective, pension plan managers have a fiduciary responsibility to meet their future liabilities taking into account all risks, including the risk of climate change.
Some global pension funds have divested out of fossil fuels, most haven't and the reason is simple, fossil fuels still dominate the world we live in and will continue to do so for the next 100 years.
I would encourage anyone who takes issue with that statement to read Vaclav Smil's book on how the world really works to really inform yourself properly.
Now, for the most part, Canada's large pension investment managers prefer engagement rather than divestment, and the reason is simple, they see massive opportunities in the transition economy and want a seat at the table.
They also feel passing the risk onto a fund that doesn't care about ESG is abdicating their fiduciary responsibility for being good stewards of long term capital.
When it comes to responsible investing, Canada's large investment managers have a stellar international reputation so I was a bit surprised when I read this above:
According to the IPCC, climate finance for both mitigation and adaptation must increase dramatically this decade. But where is the investment industry right now on this topic? ShareAction, a UK-registered charity, campaigns on the most pressing issues facing the world today. As part of that work, they benchmark investors and define the highest standards for responsible investment. In February 2023 they published their latest benchmarking study, ranking 77 of the world’s largest asset managers’ approaches to responsible investment. (9)
Only four asset managers out of the top 77 globally received an AA or A grade for their approach to responsible investment, while 35% of assessed managers received a D or E grade. Given the audience for Pension Pulse, I take no pleasure in highlighting that the highest-ranked Canadian asset managers are D rated. ShareAction argues that the asset management industry needs to change urgently if it is to demonstrate proactive stewardship that safeguards against key social and environmental risks in the best interests of the investors. Whilst some asset managers demonstrate leadership in particular areas “only a very small number are performing strongly across all the topics” in the survey.
I would urge you to read ShareAction's Point of No Returns 2023: Part I – Ranking and General Findings as it ranks 77 of the world’s largest asset managers’ approaches to responsible investment.
There you will see the top ten asset managers are all European:
And Richard is right, the the
highest-ranked Canadian asset managers are D rated:
But note that none of Canada's large Maple Eight pension investment managers took part in this survey and by looking at it, it's geared more to asset managers, not global pension and sovereign wealth funds.
Still, I agree with Richard that there is a hell of a lot of work left by all asset managers to put more pressure on companies -- public and private -- to set science-based targets and to use their position to advocate for greater action at sectoral and international levels.
Let me be blunt, we need better data, more consensus on what that data is and we need to force companies to be transparent about it.
In my opinion, it should be be part of the law and regulators need to step up to the plate to enforce it.
In terms of long-term risks, we need to be able to measure what Richard calls "the evolving financial materiality of issues like climate change and biodiversity loss."
That should be the starting point of responsible and sustainable investing but we also need to be very realistic on how this is evolving, how the transition economy will be "non-linear", to borrow a phrase CPP Investments CEO John Graham has stated many times.
Lastly, politicizing climate change from the Left or the Right isn't useful, it will set us back years as we try to navigate an increasingly complex landscape.
Quite frankly, I'm not very impressed with politicians on either side of the pond, many are lightweights and do not understand or appreciate the complexity of what is involved, so they turn to asinine and political popular viewpoints.
I don't blame them, after all, politicians are there to get reelected, but now more than ever we need real leadership on important topics and we need to implement common sense policies that do not demonize the fossil fuel industry but instead look at how we can invest our way to a better, cleaner and more just future.
I better end it on that note because I'm beginning to sound like a politician!
Once again, I thank Richard Burrett for his very insightful guest comment.
Below, an excerpt from an interview between Andrew Moloney (SoftIron) and Richard Burret (Earth Capital). Here they discuss how achieving net zero emissions is playing an increasing role in IT infrastructure decision-making.
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