Active ownership can help combat climate change. Here’s how.
The 26th Conference of Parties (COP26) was expected to deliver significant pledges to limit global warming to 1.5C degrees (Celsius) above pre-industrial levels. Unfortunately, attendees were unable to agree on what this would look like in practice. In the end, COP26 concluded with an agreement to “revisit and strengthen” emission targets at this year’s COP27.
So far in 2022, world leaders have been unable or unwilling to pass legislation to meet previous commitments made at COP meetings. Nonetheless Russell Investments is on a mission to support the low-carbon economic transition and mitigate climate risk in our holdings through our active ownership activities.
Why is 1.5C degrees important?
Climate experts have warned that the rise in global temperatures should be limited to 1.5C degrees to prevent the worst impacts of climate change—including natural disasters, extreme heat, flooding and drought.1 This was agreed to during COP21 in 2015, better known as the Paris Agreement.
The chances of reaching this target are dwindling. We’d need to halve greenhouse gas (GHG) emissions in the next seven years and reach net-zero emissions by 2050.2 If countries enforced current policies, projected warming would likely hit 2.7C degrees.3 Even if governments hit the targets made for 2030 at COP26, warming would still reach 2.4C degrees.
It remains to be seen if countries will adopt and enforce policies to meet their targets. What has become clear is the role that investors play in the global transition to a low-carbon economy.
What does it mean for investors if we don’t limit global warming to 1.5C degrees?
As national governments fail to meet their targets, companies have felt the pressure to pick up the slack and transition their business toward a low-carbon economy regardless of regulations.
Though not formal participants in COP meetings, attendees have included executives from both the commercial and finance sectors. Their importance to COP was reflected by U.S. President Joe Biden as he said, “It’s bankers that are now deciding. You have major corporate America factoring in the price of carbon. It matters.”4
Corporate stakeholders (investors and consumers alike) are demanding companies show their sustainability efforts by measuring and disclosing the key environmental risks from their activities—both to the company as well as from the company.
The impacts of climate change are more likely to be felt in a globalized economy. Investors need to focus on assessing the physical risks companies face in a world where global warming exceeds 1.5C degrees. Consider the following questions:
Are company operations located in a high-risk drought zone where water costs are expected to rise?
Does a company’s production line sit in the path of increasingly powerful hurricanes which could disrupt manufacturing?
Does the company source raw materials from a region that is expected to be significantly harmed by climate change?
At Russell Investments, we incorporate questions like these into our investment process. It’s become clear that the changing climate will impact the entire business cycle.
How does active ownership at Russell Investments support COP27?
As an active owner, we assess the individual activities of high-risk holding companies through corporate engagement. Maintaining a dialogue with companies allows us to evaluate how prepared they are to transition operations to low-carbon methods. Are low-carbon initiatives being integrated into overall company strategy? Who has responsibility for sustainability programs—C-suite? The board? Site specific managers? Does management view these programs as a necessary evil or an opportunity for growth?
Our active ownership program has strategic focus areas for engagement around natural capital and climate change resilience. Within natural capital, we want to ensure companies display an understanding of their environmental resource use and demonstrate responsible environmental management to maintain the long-term usage of resources. This includes natural resources risk management and awareness of biodiversity impacts.
We expect companies to show how they identify, assess and manage climate-related risks in line with having net-zero emissions by 2050 or a 1.5c degree scenario. We do this in two ways:
We promote standardized reporting in line with the Task Force on Climate-related Financial Disclosures (TCFD). This has become a de-facto international reporting standard.
We are a signatory of the Net Zero Asset Mangers initiative. This means we have committed to supporting investing aligned with net-zero emissions by 2050 or sooner.
Our conversations with companies are primarily around transparency and disclosure practices. We can’t assess the risks or the opportunities facing a company without knowledge of the current programs in place and measurement of operational metrics (e.g., energy usage or scope 1 vs. scope 2 emissions).
The promotion of disclosure is most relevant for our small cap and emerging market holdings where the burden of measurement and disclosure is greatest. By engaging with these holdings to overcome these challenges, Russell Investments can help to reduce emissions.
COP26 captured the global imagination and positively influenced public and private stakeholders to commit to action. However, it lacked specificity in how to limit global warming to 1.5C degrees. Let’s see if COP27 manages to achieve its aim to “revisit and restrengthen” climate targets. In the meantime, in the gap left by world leaders, we see investors increasingly assessing the physical and transitional climate risks to companies. At Russell Investments, we actively engage with companies in high-risk industries to ensure they are prepared to meet these challenges.