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By Chuck Leddy
| March 19, 2018
The never-ending debate about the effects of climate change took a sharp turn last June. That’s when President Trump pulled the U.S. out of the Paris Climate Agreement. The decision to remove the world’s second largest polluter from a plan aimed at reducing global warming stumped scientists and infuriated activists.
But rather than sit and stew, educators, business professionals, and climate experts around the country began taking action to find effective ways for the U.S. to reduce its rather sizable impact on the global environment. And some of the brightest ideas are coming from an unlikely place: the world of finance.
“I spend a lot of time along Atlantic Avenue [in Boston],” says Keith Black of Chartered Alternative Investment Analysts Association, a global organization offering a specialized credential in alternative investments that was started in 2002 by a small group of professors at the Isenberg School of Management at UMass Amherst. “Seeing where I walked a few weeks ago now under water in the middle of winter is not a good thing. People living along the coasts are most vulnerable. But if you’re forward looking, and know the potential financial risks, you can plan now.”
Banking on sustainability
Climate change, and its role in things like rising sea levels, has become an enormous financial issue, in addition to an environmental one. And its risks reach far beyond insurance companies concerned about rising sea levels along the New England coastline.
When you talk to experts in what’s called “sustainable finance” about the role investors could play in reducing the global CO2 emissions, you’re bound to hear varying opinions. Some experts focus on corporate balance sheets and economics, while others look at emerging investor activism and what it means that Europe is ahead of the U.S. in regulations.
Sanjay Nawalkha and Theresa Gusman co-taught a Sustainable Finance course at Isenberg. Yet each of them emphasizes a different aspect of managing financial risks associated with climate change.
Nawalkha argues for a profound change in mindsets—economically and philosophically—while Gusman calls for more corporate reporting and enhanced transparency on carbon footprints, providing investors with hard data to make informed decisions.
More open books. More open minds.
Professor Gusman is all about numbers.
She defines “sustainable finance” as “any form of financial service that integrates environmental, social, and governance criteria into business or investment decisions for the lasting benefit of clients and society.”
Gusman says she champions “investor-centered solutions like reporting on climate change and reporting on environmental, social, and governance issues in general.” Companies that report on their carbon footprints and proactively seek to reduce them are more profitable and thus more attractive to investors, she says. “Companies that have good reporting and good results on sustainability issues tend to financially outperform the companies that don’t.” A 2014 analysis of companies in the S&P 500 found that those which built sustainability into their core missions showed almost a 20 percent better return on investment than those that did not.
In addition, Gusman sees more demand by investors, especially institutional investors (e.g., large pension funds), for increased corporate transparency and sustainable business practices: “More investors [and investment managers] are incorporating environmental, social, and governance issues into their investment processes.” Companies that don’t report their climate change impact “are simply going to get left behind by investors,” she says.
Professor Nawalkha would like for society to be more mindful of the impact of big business on our planet. He says what’s driving financial risks around climate change has more to do with the excesses of capitalism than with a lack of transparency in corporate reporting.
“We may be coming to a point of no return [on climate change] if countries go selfishly in their own directions,” he says. Nawalkha points out that many companies exploit the environment for their own financial gain, but then expect other companies to “act responsibly.”
Meanwhile, our weather becomes more extreme, our sea levels rise, and more people and property are put at risk by increasingly extreme conditions. “Our hearts need to be changed,” he says. “It may take a total disaster, a climate catastrophe, to do it.”
ExxonMobil’s activist investors
In 2017, activist shareholders of one of the world’s biggest companies, ExxonMobil, organized a proxy vote to force the oil and gas giant to disclose how its activities impacted climate change. “Exxon put up billboards and lobbied every big investor,” says Gusman, “but 62 percent of all the Exxon shareholders voted for an increase in disclosure on climate change”
Today, Exxon shareholders can get information related to the company’s impact on climate change, transparency that Gusman says “will ultimately impact the stock price,” and place public and investor pressure on Exxon to adopt more sustainable practices.
Keith Black explains this with an analogy. Right now, he says, there are stricter climate change regulations in Europe than the U.S. But he said if U.S. investors have a choice between putting their money with one coal plant making no effort to reducing emissions and a second coal plant at least making an effort, even though neither of them is environmentally friendly today, only one of them is preparing for the day when stricter regulations come—making it a safer investment.
“Some people ask, should we sell every coal company in our portfolio,” Black said. “They advocate for completely getting out of those sectors. Others advocate for investing in the cleanest, nicest ones in those sectors. It gives some reward to the managers in those companies.”
Nawalkha says ultimately it will take one of two scenarios to create the biggest change.
“Either we need inspiring leadership or more devastating climate events will finally wake us up,” he says. “It’s sad that humans often wake up with a hard landing through chaotic events, instead of a soft landing through inspiration, knowledge, and cooperation.”
Just as businesses use reporting standards to measure growth and profitability, Gusman sees the need for global reporting standards on environmental impact.
She supports standards now being created by the Sustainability Accounting Standards Board. “They will be finalizing their standards shortly,” she says, “and they go industry by industry and look at the environmental, social, and governance issues that are particular to each industry.” As these standards emerge, and more companies adopt them, more information on climate change will become available to inform investors who want to consider this issue in their financial decisions.
That transparency on sustainable practices, and a long-term view on climate change, are going to help both smart businesses and investors. “The reason investors and corporations are reorienting their focus toward the long-term is simple: performance,” she said.
A series from Harvard Business Review last year found that companies with long-term focus outperformed competitors by 81 percent in economic profit growth, 58 percent in market capitalization growth, and 132 percent in job creation.
But Nawalkha fears time is running out for the big changes that are necessary and worries that no matter how much analytical forecasting is done, it may one day become impossible to put a value on the impact of climate change. “We could reach a point where there isn’t any meaningful cost analysis anymore,” he says. “How do you meaningfully analyze the lives lost to natural disasters that were a result of climate change?”
As the Harvard series noted, big change requires bold decisions at the very top of the chain of command, including a new CEO.
“In most cases you’re going to need a new leader,” the series said. “And the board of directors really has to buy into it, because not only are you changing your strategy, you’re changing your numbers.”
Stockholders have to accept smaller profits as a tradeoff for future investments. And that requires patience. “And then everyone—the board, the investors, the lab technicians, the salespeople—will watch you to see if you’re serious,” the series said. “It will take a lot of fortitude and determination.”
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