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Climate change in asset management

"With the growing risks of assets becoming stranded by responses to climate change, it might seem necessary to ask whether not adjusting your investment strategy is wise, let alone affordable." These words were spoken by a person well-versed in economic diplomacy, with an unmistakably British sense of understatement: last September, Prince Charles was making these declarations on climate change in front of the financial community (including Ban Ki Moon, Leonardo DiCaprio, Al Gore...). This issue is the focal point of regular inquiries within the financial community itself. What risks and assets are we talking about? This issue deserves some in-depth explanation, beyond the media aspects.

November 2015
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The financial sphere is slowly becoming aware of the financial risks arising from the expected negative impact of climate change on the economy. Developed in 2011 by British NGO Carbon Tracker, the concept of “carbon risk” indicates that climate change could call into question business models based on the production of fossil fuels and subsequently cause a poorly anticipated financial depreciation of the companies concerned.

Their analysis (Unburnable Carbon, 2011), supported by the International Energy Agency, aims to demonstrate that the effective exploitation of the proven fossil fuel reserves is incompatible with the “carbon budget” available for keeping global warming within 2°C. To meet this objective, one third of global oil reserves, half of gas reserves and over 80% of coal reserves, must remain untapped. Coal emits more CO2 than any other source of energy. It represents 29% of the global demand in primary energy but emits 46% of global CO2, according to the IEA. Overall, coal emits almost twice as much natural gas for the same provided energy intensity. The NGO concludes that policies and regulatory measures implemented to fight climate change will generate a poorly anticipated depreciation of assets by companies and investors, similar to the explosion of a “carbon bubble”. Subsequent studies extended the scope of this carbon risk by emphasizing the risk of market disaffection for fossil fuels and a replacement by renewable energy, whose competitiveness is increasing while that of unconventional fossil fuels declines (see example: Toil for Oil spills danger for Majors, Kepler-Cheuvreux, September 2014).

In parallel, after a series of extreme weather events, including Hurricane Sandy in New York, insurers are beginning to understand the cost of material damage associated with climate change. These risks weigh naturally on assets such as infrastructure, real estate and forestry and agricultural assets, but also on companies whose supply chains may be interrupted by such events. The Governor of the Bank of England has announced his intention to examine the risk posed by climate change for insurers, both in terms of damage to be covered and in the event of a “bubble” on carbon assets which these institutions have invested in. He also announced that the Financial Stability Board had offered the G20 to create a working group on the reporting of risks related to climate change: top financial regulators are now highly interested in the case. Apart from risks for each investor in the allocation of asset, one must not forget the future impact of climate change on global macroeconomics. A warming scenario of 2°C would already entail, according to the IPCC, an estimated annual global economic loss between 0.2% and 2%, which would alter the overall performance of the asset portfolio. An increasing number of attempts have quantified these financial risks (1) but the interdependence of issues makes this task difficult and generates a wide range of uncertainty.

Finally, investors need to take into account the image risk associated with their management of the climate challenge. The civil society is slowing realizing that the decisions concerning asset allocation made by financial institutions have a significant economic and environmental impact in the real economy, on the long term. Also, the beneficiaries of funds managed by institutional investors, as well as NGOs, are increasingly taking into account the investments made by financial institutions and form their own opinion on the related societal benefits. The fight against climate change, apart the specifically financing of fossil fuels, is the subject of a constantly growing international campaign.

A number of solutions are emerging to meet the challenge of managing both financial and reputational risk on investors.

The dawn of a revolution among investors

Significant institutional investors, such as AP4 (Sweden), FRR (France), BT Pension Scheme (UK), the New York State Common Retirement Fund (USA) or the Local Government Super (Australia) chose to decarbonize all or part of their investment portfolios by explicitly incorporating a carbon criterion in their process of stock selection. Most of the major European asset management companies, including French ones, have seized this opportunity to offer low-carbon products and funds. A first method consists in setting targets to reduce greenhouse gas emissions for all the sectors held in the portfolio, by selecting companies with the lowest emissions in their sector (best-in-class principle). This method allows a significant reduction of the portfolios’ carbon footprint, without excluding an economic sector.

This logic is now made available to passive management i.e. investors with an allocation that replicates a stock index, thanks to the development of “low carbon” indexes by most major index providers (Euronext, MSCI, S&P). These indexes help maintain all sectors within the portfolio while offering a lower carbon footprint than traditional indexes, thanks to the selection or overweight of the least polluting emitters within each sector. For example, the French ERAFP (“Régime de Retraite Additionnelle de la Fonction Publique” – Additional Pension Plan of the Public Service) has adopted a process to reduce by 40% the emissions associated with the investments of an index fund of €750 million compared to its initial benchmark.

Other investors chose to divest, in a more or less targeted way, from the most carbon-emitting sectors (principle of normative exclusion). Extractive companies exposed to coal are particularly targeted, on the grounds of the necessary reduction of this energy in any energy transition scenario to limit climate change. At the end of May 2015, the Norwegian parliament decided unanimously that the Norwegian sovereign fund, first global investor, will now exclude coal from its portfolio. Other large funds such as CalPERS and CalSTERS also followed the same example. The insurer AXA voluntarily disinvested from coal by disposing over €500 million of assets last May. Some minority investors want to divest from more unconventional fossil fuels (oil sands or shale gas) or withdraw entirely from the production of fossil fuels. The creation of “no fossil” or “no coal” indexes has opened this approach to passive management. These practices are rooted in so-called “ethical” exclusionary practices which aim at aligning the fund’s investment practices with the values or the general interest of its beneficiaries.

Other investors, such as British insurer Aviva, favor an interventionist approach during investment in order to support portfolio companies in the energy transition (principle of shareholder engagement). They engage with corporate management in order to increase transparency regarding companies’ strategic resilience to climate change, notably on the exposure to climate and energy risks. CalSTERS interviewed 44 extractive companies last year to gain such information. Beyond obtaining information that support investment decisions, some managers also require companies to strengthen their inclusion of carbon risk, by setting GHG emission reduction targets, by “decarbonizing” their overall energy mix or by implementing energy efficiency programs.

Shareholder engagement can be driven either bilaterally or collaboratively, by seeking to leverage the message across a larger pool of capital, under the form of a shareholder dialogue. If necessary, this can lead to filing resolutions during general meetings. This case is more common in the US than in continental Europe, where I can mention the Carbon Asset Review initiative developed by CalPERS. If dialog is unsuccessful, it may eventually lead to the withdrawal of the investor from the company’s capital. This process of shareholder dialog, which is spreading more and more, has the merit to encourage a change in corporate practices, for example by integrating an internal carbon price into their decision-making process, particularly in the financial modeling of their investment projects. By penalizing the net value of investment projects that emit most greenhouse gases, this mechanism can deter companies from making these carbon intensive investments and thus contributes in its own way to decarbonizing real economy.

Finally, one of the most direct and significant contributions of an investor in the fight against climate change is to fund businesses and infrastructure and contribute directly to the transition towards an low-carbon and resource-efficient economy.

In France, for example, investment needs related with this transition were estimated at 60 billion euros per year by 2050 according to the Conseil national sur la transition énergétique (French National Council on the Energy Transition). These needs include renewable energy, energy efficiency and public transport. Two kinds of logic enter in the game: first, investing in new, so-called greenfield infrastructure (i.e. built on a vacant lot or greenfield). Their construction is expected to lower greenhouse gas emissions in real economy compared to the previous situation. On the other hand, investors who wish to diversify their exposure to the carbon economy sectors and technologies will aim for equity or refinancing of existing projects, known as brownfield, or companies whose products and services contribute to the energy transition and are environment-friendly. Whatever the nature of the real financed assets, the financial sector has developed various investment vehicles to meet the investors’ constraints in size and liquidity: investment in thematic funds, whether in debt or capital, direct investment in infrastructure, corporate or project green bonds. Those investments will meet the 58 billion euros objective in green financing before 2020 set by ABP, the first Dutch institutional investor, the 500 million pounds that Aviva expects to invest annually in green infrastructure, the second billion that Barclays wants to invest in green bonds.

In November 2015, over 950 investors have taken at least one of these actions on climate change on all or part of their portfolio, a figure that represents an increase of 46% in five months. Most of these commitments are public and can be found on dedicated platforms. Far from excluding one another, these approaches can be combined to maximize their impact. For instance, in May 2015, the Caisse des Dépôts Group has committted to spend 15 billion euros by the end of 2017 in the direct funding of environmental and energy transition, to assess and reduce its carbon footprint and to systematically promote shareholder dialogue on climate change. The Caisse des Dépôts has also clearly stated that if the shareholder commitment did meet expectations in terms of reduction of the carbon footprint of companies, it reserved the right to divest some of them.

A financial institution’s commitment to decarbonization can be assessed based on the estimated carbon footprint of its investment portfolio or fund. The latter allows to quantify the volume of emissions that its capital has contributed to generate. Its evolution is an indication of the decarbonization of the activity of an institution and many investors have set a goal of reducing their carbon footprint. PFZW, the Dutch pension fund of health professionals, a leading European pension funds with over €140 billion of assets has committed in September 2014 to halve the carbon footprint of all of its portfolio in five years. It was followed by ABP, which aims at reducing by 25% the carbon footprint of its equity investments (approximately 5000 equities) during the same period.

Number of investors (institutional investors and management companies) that committed against climate change


The proliferation of initiatives is supported by several dynamic. First of all, access to information is improving, particularly through an increasing standardization of the reporting frameworks of listed companies. In Europe, the reporting of greenhouse gas emissions is based on a largely voluntary approach contained in guides such as the GHG Protocol, the GRI or the CDP. Results are often incomplete or even incomparable. A study among 431 European companies (2) reveals that their average rate of publication of complete data between 2005 and 2009 is 15%. Today, these figures are much higher for leading listed European companies, although access to information is difficult or costly for midcaps and unlisted assets.

Secondly, there is an explosion of these methods of data analysis: multi-criteria analysis of the climate performance, the carbon footprint of an institution or portfolio, carbon sensitivity tests on valuations of assets... However, the relative lack of maturity and of methodological standardization implies that investors, especially stakeholders, should interpret these figures with hindsight. Several decades were necessary to establish standardized financial accounting systems and financial analysis indicators: incorporating climate components is a complex task that should by no means be underestimated!

Besides solving these technical difficulties, the establishment of a climate strategy also implies that each institution carries out an organizational and cultural adjustment. But even if the awareness of the financial materiality of climate change is slowly growing among financial professionals – it still is quite limited. Those institutional investors who are already committed to a responsible investment approach – i.e. integrating environmental, social and good governance issues in their management decisions – are the most proactive drivers. It is no surprise since they were able to benefit from their experience and existing skills within their organizations. On the whole, the actions undertaken by many investors still prove marginal when compared to the 190,000 billion dollars in financial assets at the global level: the investors who signed the Declaration of Montreal manage 8 trillion dollars, a figure expected to strongly increase during the COP21.

The climate commitment: a collective imperative for the entire financial sector

Institutional investors, collecting bodies of savings that place their funds on the markets for their own account or on behalf of their customers (individuals, pension funds, policyholders...), bear a special responsibility regarding their positioning as ordering parties in the financial system. One encouraging sign: the rise of cooperations which will hopefully accelerate the development of skills and adapted financial tools and services. Thus, the Institutional Investors Global on Climate Change (IIGCC) aims to stimulate the development of investment practices, business practices and policy frameworks to face the long-term risks associated with climate change. The Montreal Declaration brings together 100 institutional investors and management companies committing to measure and report the carbon footprint of their equity portfolios by the end of 2015. The Portfolio Decarbonization Coalition (PDC), supported by the United Nations Environment Programme, has the ambition to contribute to decarbonizing $100 billion worth of portfolios by the end of the 2015 Paris Climate Conference.

But if the institutional investors are to show the way forward, the whole chain of financial stakeholders must commit to the operational integration of climate change in their products and behaviors. Banks, for example, need to ensure that their financing activities of projects, corporate credit, but also their advisory activities in the issuance of securities and mergers and acquisitions, assess and take into account the different risks entailed by climate change. BNP Paribas will integrate the climate component in the rating methodology of projects and companies it finances and at a group-wide scale, they will gradually systematize the use of an internal carbon price. Providers of financial advice and analysis also have a crucial role to play, whether through the research activities of brokers or rating agencies. Reactions are quick: who could have imagined, only a few months ago, that Standard & Poor’s would take into account climate risk in its credit risk assessment of countries?

And yet, even the voluntary commitment of many financial players, however many, cannot lead alone to a “decarbonization” of sufficient magnitude. A regulatory and political action is necessary, both within the financial system and in the real economy. At a minimum, investors need to be able to access the relevant technical information. For example, since 2010, the US Securities and Exchange Commission recommends issuers to assess their exposure to climate risk in their annual reporting. One can cast serious doubts on the proactivity of the listed companies in this field, because it is the investors who demanded greater transparency from major oil companies on the sensitivity of their business models to the energy transition. During the 2015 General Assemblies of Shell, BP and Statoil, an international coalition authorized almost unanimously the adoption of resolutions asking these companies for a reporting on the operational management of emissions, the resilience of their portfolios to different scenarios of the International Energy Agency, on R&D in low-carbon energy, as well as lobbying practices. At the present time, the vast majority of non-European fossil fuel companies haven’t made any commitment in this direction.

The transparency issue doesn’t affect only businesses. Public authorities need to quickly allow non-specialist investors to assess the credibility of environmental claims of these presumably “green” financial strategies and investment vehicles. This is exactly the purpose of the Low Carbon Transition label that the French Government wishes to implement for thematic funds. It is also the aim of the Climate Bond Initiative, which develops a frame of reference for issuers and acquirers of green bonds in order to identify the underlying assets which represent an investment in the real economy with a positive effect on climate. This label could end up becoming a certification.

Finally, the visibility of energy and carbon prices/costs is of course necessary for all actors to take long-term decisions. For example, the price floor of carbon set by the UK for electrical generation allows investors as well as client and producing companies to take informed decisions. The visibility of the regulator on the financial system’s sensitivity to climate change is also necessary to guide its own action. As such, it is worth highlighting the G20’s initiative to mandate the Financial Stability Council in order to examine, with public and private stakeholders, how the financial sector takes into account climate change. On these issues, as on others, it is crucial to form an international coalition to avoid the free riding of some actors at the expense of the sustainability of the system.



1. Investing in a Time of Climate Change, Mercer, 2015, The Cost of Inaction: Recognizing the Value at Risk from Climate Change, The Economist Intelligence Unit 2015
2. Liesen, Andrea and Hoepner, Andreas G. F. and Patten, Dennis M. and Figge, Frank, Corporate Disclosure of Greenhouse Gas Emissions in the Context of Stakeholder Pressures: An Empirical Analysis of Reporting Activity and Completeness (July 24, 2004). Forthcoming in Accounting, Auditing & Accountability Journal.

Franck Silvent
Director of Finance, Strategy and Holdings, Caisse des Dépôts Group
Helena Charrier
Responsible Investment Project Director, Caisse des Dépôts Group