Views on improving the integrity of global capital markets
18 November 2021

Don’t Make Climate Promises You Can’t Keep

Posted In: ESG

Company CEOs and governments have rushed to make “net-zero by 2050” promises. This is an admirable goal, but in reality, how many of those CEOs and leaders of government will be in their current positions in 2050? Likely, none. Promises are easy to make, particularly when doing so is a simple act of virtue signalling, with the knowledge that by the time it is clear these promises are empty, they are someone else’s problem.

Few of the companies and governments that have made these net-zero promises have provided details about their path from today to 2050. That, too, will eventually be someone else’s problem.  

Incentivisation is key

People are simple creatures: we do what we are incentivised to do. If we want to tackle a problem, such as climate change, we must tackle incentives. But this is something that the finance industry has struggled to do thus far. It is too busy making promises for which someone else—the next generation—will be responsible.

Some of the promises the finance industry has made include making net-zero pledges as well as ensuring that investors are able to make a tangible difference through “green” funds. These promises have some substance, but plenty of greenwashing and opportunism is evident. Last year, we surveyed nearly 2,500 CFA Institute members, of whom just 40% said that their organisation currently incorporates climate risk into their analysis. We had hoped that a year later this percentage would have improved, but cultures change slowly. Plenty of “global heads of environmental, social, and governance (ESG)” were global heads of something else a year ago—and their CVs are somewhat light on sustainability experience.

I am not looking to criticise the financial industry unfairly. Some might say the financial industry is playing catch-up on climate matters after decades of inaction, but efforts certainly have increased in recent years. Nevertheless, the danger is that catching up may involve making promises on climate to clients, regulators, and future generations that may not be possible to keep.  

Finance must do what it can, but should not promise what it cannot

The 2021 United Nations Climate Change Conference (COP26) recently concluded, and even more climate promises were made by world leaders as well as captains of finance and industry. Unless they can deliver on these promises on a global level, we will be right back in the same position next year, wondering if the next COP can save the world.

Finance certainly should not take a back seat when it comes to sustainability, but we also must be realistic. The role of finance in combatting climate change is essentially the efficient allocation of capital. That is an incentives game. As an industry, we must find the best way to invest capital to engender economic and societal prosperity.

So far, capital allocation has largely ignored the externality of climate change; consciously or unconsciously deciding that in the short term, it was not a problem, and that in the long term, it was someone else’s problem. Although some jurisdictions, such as the EU, have tried to intervene with market-correcting regulations (such as the Sustainable Finance Disclosure Regulation), the deferral of climate action from the finance sector globally can go on no further. Action must be taken now.

The world of finance must do what it can to efficiently allocate capital to tackle climate change, but it should not promise more. Investors need timely, consistent, comparable, and material climate-related data, which we do not yet have at scale. Organisations like the Taskforce on Climate-Related Financial Disclosures, the Value Reporting Foundation, and the International Financial Reporting Standards Foundation calling for a focus on material climate data will help, but investors need to engage with companies to ensure that the data needed are available. This means advocating, consistently and repeatedly, for material climate data.

Ultimately, governments must do the heaviest lifting. They set the incentives for individuals and industries, which together will have the biggest impact on climate change.

A global price on carbon, for example, is one incentive that will change behaviour. Although it will be challenging and politically unpopular for governments and policymakers, investors need to help provide cover for those difficult decisions and, once again, must advocate—consistently and repeatedly—for a price on carbon.

The investment sector also has a key role to play in helping companies standardise sustainability reporting, improve disclosures, and reassess their compensation incentives. A March 2021 study from Equilar showed that only 38 Fortune 100 companies currently disclose compensation metrics tied to ESG goals. Only about 15% of these goals deal with environmental issues and, if an ESG metric is included in pay incentives, it usually makes up only a small portion of total incentive compensation. More meaningful incentives tied to actions on 2050 net-zero promises would be more effective in driving change.

Be a participant in your own rescue

Investors must understand their ESG mutual funds might represent a step in the right direction, but they are not going to save the world. Their actions on the ground as consumers and voters have a much greater impact. If they do not invest in a company that is “bad” for the climate, for example, someone else will. If, however, they opt for alternative choices in the way they live (energy, food, transportation with lower carbon footprints) and change the way they vote (voting for climate action), no new consumer or new voter can replace them. As a result, their choices will have a more fundamental impact in the real world. Investments always only reflect consumer and voter decisions. 

As we look to the future, we must recognise that some segments of society can have a bigger impact on climate than finance. Our industry needs to be careful not to over-promise, but it also must continue to play its (not inconsiderable) role and advocate for change where it can.


A version of the article previously appeared on IPE.com.

 

Photo credit: iStock / Getty Images Plus Kirill_Savenko

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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