From fad to fixture: how investors are waking up to climate risk

By Benjamin Hulac | 01/29/2016 09:17 AM EST

Historically, investors haven’t worried about how climate change or greenhouse gas-cutting laws might affect their ledgers. But as a growing number of money managers, Wall Street traders and regulators agonize over climate change costs, that stance has shifted from apathetic to alert.

From fossil-free investment products to assessing the risks of weather disasters, Wall Street is slowly but steadily embracing climate change.

From fossil-free investment products to assessing the risks of weather disasters, Wall Street is slowly but steadily embracing climate change. Photo courtesy of Flickr.

U.S. EPA’s accusation last fall that Volkswagen AG had cheated on emissions tests sparked a fire sale in global markets. Sellers pushed the company’s stock down 30 percent in just four days.

After New York Attorney General Eric Schneiderman (D) announced that coal company Peabody Energy Corp. had for years deceived investors by downplaying the threat that climate change and climate regulations posed to its business, Peabody shares dropped 10 percent in two days.

And Exxon Mobil Corp. shares dipped when the public learned on Nov. 5 that Schneiderman, probing to determine if Exxon lied about climate risks to its operations, had subpoenaed the oil giant. The same saga played out when news broke Jan. 20 that California Attorney General Kamala Harris (D) is also investigating Exxon for covering up what the company knew about climate change: The stock fell 5 percent in a single session before recovering.


Historically, investors haven’t worried about how climate change or greenhouse gas-cutting laws might affect their ledgers. But as a growing number of money managers, Wall Street traders and regulators agonize over climate change costs, that stance has shifted from apathetic to alert.

"Environmental and social scandals are showing up in stock price crashes," said Verity Chegar, an analyst at BlackRock Inc., which manages $4.6 trillion.

Climate risks, the new financial hazards

Pollution and man-made disasters, like oil spills or toxic leaks, are often low-level corporate issues. For decades, banks and financiers have asked about environmental hazards but framed them in a financial context, Chegar explained.

Still, she said, environmental damage "becomes material to the company after the oil spill."

After the Deepwater Horizon rig exploded April 20, 2010, triggering the worst oil spill in U.S. history, BP PLC swiftly lost half its market value: In two months, the share price plunged from more than £600 to just above £300.

In October, BlackRock said "sustainable investing is not a passing fad." It deemed climate change an inevitable "regulatory risk" and is undergoing a global effort to incorporate environmental risk assessments into its investment strategy.

Deepwater Horizon rig fire
After the Deepwater Horizon rig exploded in 2010, BP PLC lost half its market value. It’s just one of several recent environmental disasters that have caused companies to lose their footing with investors. | Photo courtesy of WikiCommons.

UBS AG, the Swiss bank, in "response to increasing client demand," in 2015 said it would start researching the repercussions of environmental impacts across varies sectors. Citigroup Inc. has integrated climate change in its risk analysis, too.

In her work, Chegar uses an increasingly common technique called environmental, social and governance (ESG) investing — known also as sustainable, sustainable and responsible, or socially responsible investing (SRI) — to scrutinize how non-financial events harm or benefit business.

Chris McKnett, managing director and head of ESG for State Street Global Advisors, the world’s third-largest money manager last year, with $2.4 trillion in assets, said clients are more frequently calling to ask about climate risks. State Street is designing a zero-carbon index to meet those demands. And Hugh Lawson, a head of ESG investing for a Goldman Sachs Group Inc. division, reported the same trend in July 2015.

"Because of investor demand, you’re going to see more and more products like this set up," said Tom Van Dyck, a managing director at Royal Bank of Canada and an SRI expert, in an interview. "More and more people come to us and say pollution is a subsidy."

Proving green investments can be profitable

Investors are beginning to accept that their stock picks can be environmentally and financially successful, Van Dyck said.

FTSE Group, BlackRock and the Natural Resources Defense Council launched a fossil fuel-free index fund in 2014. Dozens of comparable funds have followed.

"From a personal perspective, when I think about climate change, it’s clear that a million things need to happen," said Stuart Braman, founder and CEO of Fossil Free Indexes, a suite of benchmark indices that track the Standard & Poor’s 500 Index but screen out the largest coal, oil and natural gas companies. "There’s a set of economic risks built into our situation right now."

After launching in June 2014, the Fossil Free Indexes US has consistently outperformed or matched the S&P 500.

"Climate change is a unidirectional thing that we’re trying to slow down," Braman said. "I think a growing number of people are listening."

SRI assets grew more than 50 percent, to hit $3.3 trillion, between 2003 and 2012, and reached $6.6 trillion in 2014, according to the Forum for Sustainable and Responsible Investment. In 2012, $1 of every $9 of professionally managed money was invested using sustainable techniques, according to Morgan Stanley. Two years later, that figure had increased to $1 out of every $6.

The Sustainable Stock Exchanges Initiative, a U.N. project that encourages firms to share emissions and environmental data with investors before listing on a financial exchange, has grown from six exchanges overseeing 6,000 listed firms in 2012 to 16 exchanges and more than 18,000 firms in 2014. And last year, shareholders filed a record number of resolutions related to climate change (ClimateWire, May 27, 2015).

"If you’re working on data that’s a year old, you’re significantly out of date," said Tom Starrs, vice president of market strategy and policy at SunPower Corp., during the SRI Conference on Sustainable, Responsible, Impact Investing in Colorado Springs, Colo., in November.

‘The next systemic risk’

Climate change dominated the three-day Colorado Springs symposium, held in the shadow of the Rocky Mountains.

Funds and financial indices to hedge against climate risks were the most-hawked investment vehicle. Panels on electrification, energy use, oil investments, emissions, fossil fuel divestment and climate policies from the White House were plentiful.

Two Miami firefighters were worried about how global warming would harm them. Big Oil is the next Big Tobacco, primed for public outrage, government investigations, racketeering charges and court hearings, one firefighter told ClimateWire. He feared that negativity could sap fossil fuel holdings. The other, alarmed about a potential real estate crash, brought on by sea-level rise, more violent hurricanes and storm damage in South Florida, sold his home. He rents inland now.

"After the financial crisis, investors should surely be looking for the next systemic risk," said Ian Simm, CEO of Impax Asset Management Group PLC, alluding to climate change in a speech before a packed ballroom.

A group of economic analysts at the Carbon Tracker Initiative in London, an economic and climate think tank, hit on what they think could be that next systemic risk.

Carbon Tracker concluded in a November 2015 report that existing and planned coal, oil and gas infrastructure investments represent a $2 trillion risk to the global economy. That’s the size of Russia’s economy.

To hold global warming to no more than 2 degrees Celsius above preindustrial temperatures, $2.2 trillion worth of projects must be halted, according to the group.

Oil companies resist ‘stranded assets’ as banks start believing

With vehicle electrification and falling renewable energy costs, "We’re right in the middle of an irreversible transformation in the energy sector," said Mark Campanale, Carbon Tracker’s founder and executive director.

Campanale and his colleague Jeremy Leggett said fossil fuel companies almost universally reject the notion their assets could be "stranded" — that is, rendered unusable by countries’ climate regulations, competitive energy sources or both.

"There’s so much more drama within this in the narrative arc," said Leggett, Carbon Tracker’s chairman. The transition from a fossil energy-fueled global economy "is going to go faster than the majority of us believe … than ordinary people can conceptualize," Leggett said.

Oil companies fight the idea other fuels will supplant petroleum and lower demand for their products, he continued. "They do not recognize mass electrification," he said.

In a seminal speech at Lloyd’s of London in September 2015, the Bank of England’s governor, Mark Carney, recognized "stranded asset" risk and pledged to study the matter (ClimateWire, Sept. 30, 2015).

"The challenges currently posed by climate change pale in significance with what might come," Carney said. "The combination of the weight of scientific evidence and the dynamics of the financial system suggest that, in the fullness of time, climate change will threaten financial resilience and longer-term prosperity."

France’s central banker, François Villeroy de Galhau, said last month that market regulators ought to "remain vigilant about" and "possibly monitor the economic consequences of climate change."

Where’s the SEC on climate?

Goldman Sachs already lists climate change effects, like drought, flooding and extreme storms, as a threat to property values. As properties lose value, the thinking goes, mortgage holders could find it harder to pay their loans. Dozens of banks describe natural disasters, compounded by climate change, among their most dire concerns.

And JPMorgan Chase & Co. shareholders, in a proposal last year, said the bank’s membership in with the U.S. Chamber of Commerce, which lobbies against greenhouse gas regulations, posed a reputational concern to the firm due to that association.

However, the top American financial watchdog has been criticized for inadequately examining the economic threats of climate change.

The U.S. Securities and Exchange Commission requires public firms to share material information — anything that could reasonably affect one’s decision to buy, hold or sell a security — with stockholders and the public.

But ESG factors like climate change haven’t traditionally been considered material factors, and most companies share vague information that doesn’t help investors when they disclose ESG-related developments to the SEC. (The SEC issued its most prominent policy specific to climate change in 2010; it is an "interpretative guidance" document, not a hard-nosed rule.)

The Department of Labor charted a different course.

In October 2015, it issued a bulletin calling ESG factors "proper components" of fiduciary analysis. The department even said "it might be a good idea to incorporate ESG into the investing process" because such factors affect a company’s finances.

Mark Ohringer, general counsel for Jones Lang LaSalle Inc., the multinational real estate company, frets about JLL’s exposure to "headline risk" from glaring news coverage and litigation over potential lurking scandals. "We don’t believe ESG sacrifices performance," but rather that it can enhance profit, he said.

‘Every sector is touched by climate risk’

And Lauren Compere, managing director at Boston Common Asset Management LLC, an investment house in that city, said banks like Barclays PLC, PNC Financial Services Group Inc. and J.P. Morgan have long been interested in ESG risks.

"We’ve actually been talking to them for many years about sector-specific guidance," she said by phone. "There are real financial and reputational risks."

The decline of Appalachian mining has already forced thousands out of work and lost investors millions of dollars. "What would that mean for investors five years from now?" Compere asked. "It’s much broader than just the oil and gas sector. Every sector is touched by climate risk."

ESG-managed money, $6.6 trillion according to the most recent totals, remains a sliver of investment capital worldwide. As of 2014, the global stock market was $67 trillion, based on World Bank data, and global debt is estimated to be worth between $75 trillion to more than $100 trillion.

A report TIAA-CREF published in 2014 found "no statistical difference in SRI index" performance than broader benchmarks, while an Oxford University metastudy — a study of many studies — concluded that 88 percent of "research shows that sold ESG practices result in better operational performance" for companies.

To some, the sustainable or impact investing brand is idiosyncratic or even hypocritical.

The investors who attended the SRI Conference contend they can put their money to good use and turn a profit — a goal some decry as patronizing do-goodery that sacrifices profit for charity.

"We’re still misunderstood," said Amy Domini, the founder and CEO of Domini Social Investments LLC, and a pioneer in SRI finance. "We’re still considered to be doing something good so you can have a clean conscience."

As a stockbroker in the 1980s, the period in which many say responsible investing took root, Domini realized clients weren’t comfortable owning shares of weapons or tobacco companies. Ten years later, she and two partners debuted the Domini 400 Social Index, a grouping of large U.S. companies that prioritized social and environmental welfare.

"This is not feel-good investing," she said. "This is about having an impact on the world out there."