Views on improving the integrity of global capital markets
16 March 2018

ESG Q&A: Principles for Climate-Conscious Investment

Posted In: ESG, Financial Reporting

Climate change is an issue that will have an immense impact on our lives and the financial world in the coming years. Engagement between issuers and investors on the issue is increasing as investors begin to plan for investing in a world with a lower carbon footprint.

Investors, however, need resources to help them better understand how to make more climate-conscious investment decisions. Luckily, a group based in Oxford is on the case and has developed a simple set of principles to help investors understand the issue of climate change, how climate change can affect the economy, and how to engage in climate-conscious investing.

We spoke with Richard Millar, one of the founders of the Oxford Martin Net Zero Carbon Investment Initiative, to better understand the principles and their purpose.

Tell us a little about the team that put together this report.

Our initiative was set up to bring together up-to-date understanding of both climate science and climate economics. My co-authors Myles Allen and Cameron Hepburn hold professorships working on the physical and economic aspects of climate change respectively, and have been instrumental in developing, over many years, the core academic insights which our principles are based upon. The final member of our team, Sir John Beddington, former chief scientific advisor to the UK government, brought very valuable policy experience to the team, helping to ensure that what we produced was as directly relevant and useful to the policy and business communities as possible.

What was the reason behind producing set of principles? What purpose does it serve?

Our interest in this issue initially grew out of questions such as whether large institutional investors such as universities should divest from fossil fuels. Whilst some such investors may choose to divest entirely, this in itself only serves to transfer ownership of fossil-intensive companies to others who are less likely to be actively concerned with the climate issue. Many investors and institutions are preferring to use their ownership position to actively engage on climate issues with the companies that they own to try and engender real shifts in business practices on the ground. For those such investors, we aimed to create a set of simple, physically based, and implementable principles that are directly connected to what we know is needed to stop global warming: namely, a world with net-zero carbon dioxide emissions. The principles allow investors and companies in all sectors of the economy to focus on what really matters when considering climate-related risks, and assess the compatibility of business plans with internationally agreed climate goals.

Have you had input from issuers and investors?

Yes — in the development of our principles we convened several workshops with investors and companies from the extractive sector and the wider economy. We worked with the G20-mandated Taskforce on Climate-Related Financial Disclosure (TCFD) to help inform their thinking on recommendations for forward-looking disclosures. Interacting with investors significantly shaped our thinking regarding the principles. A clear desire we heard from investors was for simplicity in both implementation and monitoring, which was potentially something that was not captured by more complex disclosure regimes that are beginning to be used. The principles aim to fill this gap.

What role do you see the financial sector playing in combating climate change?

The financial sector will be crucial in determining what level of warming we ultimately stabilize the climate at. Whilst governments are needed to set the mood music, it will largely fall to the private sector to develop and deploy the technologies that are going to bring a net-zero carbon world within reach. The financial sector has a huge role in facilitating the required shift in capital away from emissions-intensive activities and toward net-zero emissions technologies and activities. As much infrastructure has very long lifetimes, it is imperative for the financial sector to engage with these questions today.

Walk us through the principles please.

  1. Commitment to net-zero emissions

Limiting warming to any value, be it to the “well below” 2°C goal of the Paris Agreement or higher levels, requires that we ultimately reduce global net emissions of carbon dioxide (the difference between human sources and human sinks of emissions) into atmosphere to zero. Companies that publically support the goals of the Paris Agreement should back this up with an explicit acknowledgement that this means a commitment to net-zero emissions from their own business activities before the end of the century. 

  1. Profitable net-zero business model

Given this need for net-zero emissions, a key disclosure for assessing long-run climate policy risks is whether a company has a developed and plausible net-zero emissions business model, which might be expected to still be profitable within a net-zero emissions world. As the lifetime of some infrastructure is very long, the planning for a company’s net-zero emissions future will need to start today. 

  1. Quantitative medium-term targets

Commitments to quantitative targets that are indicative of progress toward a stated net-zero business model are essential to make sure that companies can be held accountable on their stated climate-related ambitions. Near-term emissions reductions can often be achieved without progressing toward the net-zero business model; therefore, it is essential that mid-term targets directly connect to the long-term trajectory of the company.

Are there other principles that were on an original list that was later whittled down to these three? Are there other secondary principles that investors should be looking at?

An important additional focus for companies and investors is how they can minimize their cumulative carbon dioxide  emissions between now and their attainment of net-zero emissions. Contributions to climate change are primarily determined by the total cumulative emissions of carbon dioxide, so long-lived infrastructure investments should ideally be made with a view to minimizing the committed cumulative emissions over the lifetime of the assets.

When were the principles released and how long were they being refined before they were released? Do you expect them to change/evolve in the future?

We launched our initiative with a set of draft principles in late 2015, with the final set of principles published in the academic journal Nature Climate Change in January 2018. Over the intervening period, we developed our ideas in response to many conversations with investors and company executives, to make them as relevant to the concerns of investors as possible. As our principles aim to be very directly related to the science fundamentals, we envisage them continuing to be as relevant, and if not more so, as society starts to tackle the challenge of actually achieving deep decarbonisation and net-zero emissions.

Where do you think we are in investors understanding the importance of climate change? Is the understanding among investors where it needs to be?

The signing of the Paris Agreement in late 2015 really marked a step-change in engagement with the climate issue in the financial community. Initiatives such as the TCFD have shown that there is real interest in trying to value climate issues better in financial decision making. Important next steps will be a wider understanding of the scale of the challenge of reaching a net-zero emissions world, which will affect all sectors of the global economy, and moving climate-related issues from being solely an ESG topic to a mainstream concern for the company boards.

What response have you gotten on the principles from investors? Is there a commitment from any investors at this point?

We’ve had a positive response so far. The principles have certainly been challenging both investors and companies to really think about how any given company could satisfy our principles—a substantial challenge for any company today but something that isn’t beyond the reach of some across a number of different sectors. We’ve presented our ideas to representatives from large banks and insurance companies through to central bankers and university endowment managers. Our principles have recently been incorporated into the strategy of the new “Climate Active” fund from Sarasin, a specialist assessment manager with over £14 billion of assets under management.

What is success for these principles 5 to 10 years down the road?

Success would be that the framing of a “profitable net-zero emission business model” becomes one of the standard ways to frame the analysis of climate-related financial risks and opportunities. If investors are thinking about issues regarding a net-zero business model and quantifiable milestones toward this goal, and using sound science to inform their decisions, that would be a success.

Thanks Richard. And if anyone wants to get in touch with Richard, you can reach him at: [email protected].


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Photo Credit: ©Getty Images/Piriya Photography

About the Author(s)
Matt Orsagh, CFA, CIPM

Matt Orsagh, CFA, CIPM, is a senior director of capital markets policy at CFA Institute, where he focuses on corporate governance, ESG, and climate change analysis. He writes and speaks frequently on these topics on behalf of CFA Institute. His paper, Climate Change Analysis in the Investment Process was named “Best ESG Paper” by Savvy Investor in 2021.

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