Green bond comment December: It's time for a CA100+ for sovereigns

Channels: Green Bonds

Companies: Axa, Aviva, CNP Assurances, FRR, EIOPA, Riksbank

People: Gabriel Bernardino, Greta Thunberg

Bond investors need to start collectively engaging with national governments if the Paris targets are to be met, argues Peter Cripps

The sustainable finance movement is booming. Some $90 trillion of assets have now signed up to the Principles for Responsible Investment (PRI).

The fight against climate change is perhaps the most active area for investor action and commitments.

Last week, for example, Axa, Aviva, CNP Assurances and FRR signed up to the Net-Zero Asset Owner Alliance, in a move that sees them commit to reduce their portfolios' emissions to net-zero by 2050.

While such initiatives are essential if the goals of the Paris Climate Agreement are to be met, it is important to recognise that the financial sector cannot alone solve the problem of climate change.

Apart from signing the Paris Agreement, action from the governments of the world has been sorely lacking. Most, it seems, are failing to decarbonise their economies. They have gone 'missing in action' since signing the Paris Agreement.

Grim and grimmer

Meanwhile, the climate science is grim, and getting grimmer. We are already at 1.1°C of warming and on course for 3.2°C, according to the UNEP Emissions Gap report.

As the PRI's Nathan Fabian warned, 1.5°C is effectively out of the window already.

The best we can hope for, then, is for 2°C, after which warming is thought to be catastrophic.

The PRI has written papers about what it refers to as the Inevitable Policy Response. But there is no real indication that such a response is inevitable. Recent evidence suggests that national governments will continue to take action that is wholly inadequate, as we speed on towards 2°C. They will continue to fiddle while Rome burns.

It is a scandal. Greta Thunberg, and the generation she says she represents, have every right to be up-in-arms. Their political leaders are failing them.

The financial sector, with all of its talk of net-zero, transition strategies and the Task Force on Climate-related Financial Disclosures (TCFD), seems light years ahead of governments.

"The financial sector, with all of its talk of net-zero, transition strategies and the Task Force on Climate-related Financial Disclosures (TCFD), seems light years ahead of government."

One asset manager complained to me that the financial sector is, effectively, being asked to do politicians' dirty work for them. "They think we are going to solve this problem for them," he complained.

Yet all the bold commitments of the financial sector will count for nought if they are not met with brave and radical action from governments.

To really change the system requires governments to rewrite the rule book by bringing in sweeping policy measures to change the economic fundamentals. A big fat price on carbon would be the most obvious way to do this. But there are numerous other tools at their disposal.

As Gabriel Bernardino, chair of the European Insurance and Occupational Pensions Authority (EIOPA), told our Insurance and Climate Risk conference this week, the financial sector "is not the silver bullet to solve climate change".

"Without member states, without politicians to decide on a carbon tax that will align with prices and foster transition, generating new projects and aligning the economy, the financial sector can only do so much," he added. "There's a lot to do, the industry needs a lot of aid and instruments to help with the transition but we also need to put pressure on political leaders to take action."

In short, the financial sector is a critical player in the transition to a low carbon economy. But the only players that can really change the rules of the game and bring in laws to make the goals of the Paris Agreement a reality are governments. There is a limit to how far the sustainable finance movement can go without a proper set of policies to underpin the transformation of the economy.

Investors are currently being asked to pre-empt policy. The TCFD is a case in point. It is asking investors to disclose the risks and opportunities that their business faces as a result of climate change.
This is particularly problematic when it comes to transition risks, which arise from either policy/regulation or technological developments.

How are investors supposed to understand the policy risks when there is a disconnect between the goals of the Paris Agreement and the policies that impact the real economy?

What can investors do?

If investors really are keen to tackle climate change, they might be better off spending more of their energies influencing policymakers, rather than shifting their own investments, or trying to engage with companies.

If there is a strong policy signal, such as a meaningful carbon price, this will change corporate and public behaviour by changing the economic fundamentals of doing business.

And changing the real economy will in turn solve investors' problems for them. Their holdings will be forced by law or by economics to change their behaviour, meaning there is less need for investors to engage or to divest.

So, investors need to think how can they use their enormous financial clout to bring about such change.

There has been some action already. For example, the Institutional Investors Group on Climate Change has helped put together a statement to governments on climate change signed by investors with $35 trillion of assets. It warned that current actions are falling short of meeting the Paris Agreement.

But institutional investors must get better at throwing their weight around with governments.

One model they can look to for inspiration is the Climate Action (CA) 100+. One of the more powerful sustainable finance initiatives, it sees 367 investors with combined assets of $34 trillion club together to engage collectively with the 100 biggest corporate emitters of greenhouse gases in the world and some other companies deemed to be strategically important.

While only a few years old, the initiative can already claim some significant scalps. For example, oil and gas supermajor Royal Dutch Shell committed to a range of industry-leading climate commitments, including emissions reduction targets that include Scope 3 emissions, and commodities giant Glencore agreed to cap its coal production at current levels, of about 145 million tonnes per year.

Without strong government action to underlie their demands, this initiative has a tough job. However, if there were strong policies to incentivise corporates to change their behaviour, the CA100+ would be pushing at an open door.

Investor initiatives such as the CA100+ will have limited success while there remains an economic incentive for companies to operate in ways that contribute to climate change.

Investors, if they are serious about the climate, now need to start focusing on governments and what they are doing to meet the Paris goals. What are their strategies to transition their economies to a low-carbon world.

Imagine if the biggest investors in the world clubbed together to engage with countries in the way that they are currently doing for the biggest polluting corporates. Surely, they could have some impact?

Their best hope of a meaningful dialogue with governments may be as buyers of sovereign bonds. To an extent, this is already happening through the CA100+, because many of its targets are 'state-owned entities'.
Engaging with countries' governments is, apparently, not easy but such a platform could facilitate dialogue.

The problem with this proposal is the question of: 'What is the sanction for governments that won't engage?' For listed companies targeted by the CA100+, investors have the threat of voting against management at an AGM.

Investors cannot easily divest from sovereign bonds. Many insurers are required by legislation to buy domestic government bonds. One insurer told me that they don't even integrate environmental, social and governance (ESG) factors into sovereign bonds because there is no point – they feel they have to buy them regardless.

Another investor told me that the idea of ceasing to buy US Treasuries was ludicrous.

However, some investors, particularly in Europe, do exclude US Treasuries because of climate and other ESG-related reasons.

And the Swedish central bank, Riksbank, made a very strong statement to the market when it announced that it would not buy some Australian and Canadian local government bonds because of climate risks.

One asset manager points out that investors lack the resources to engage with governments in this way. But they should start to build them, as the World Bank has done with its Sovereign ESG Data Portal, and working collaboratively would make this easier.

Green bonds could help to provide some of the answers. Several investors have reported that the process of issuing a green sovereign bond has opened a useful and constructive dialogue between investors and government departments.

If government officials are prepared to discuss the use of proceeds for green bonds, then why not their climate strategies?

Bond investors may not be able or willing to threaten the nuclear option of divestment, but they should still be raising these issues, and reporting them to the wider public to raise awareness.

No one is suggesting that this process will be easy. But, if successful, it could prove to be one of the more impactful initiatives in the sustainable finance sector.

Peter Cripps is the editor of Environmental Finance.