Earlier this month the UK became the first country in the world to declare a ‘climate emergency’. While there is no legal definition for what this means, and it imposes no obligations on the government, it recognises the need to put climate change at the centre of political discussions.
The move follows growing recognition of the severity of the potential impacts if the world warms beyond 1.5 degrees Celsius. As Dr Jason Hickel, an anthropologist and author, explained to the MSCI Global Investing Conference in London this week, the effects would be far-reaching.
“This is not just about our world getting a bit hotter,” says Hickel. “It’s about multiple dimensions of ecological breakdown that pose a severe threat to us.”
These include the potential that hundreds of millions of people could face water stress, and that crop yields could halve. Mass human displacement would also dramatically increase the potential for conflict and threats to the political system.
The required transformation
The special report produced by the Intergovernmental Panel on Climate Change (IPCC) in October last year reached the conclusion that in order to avoid breaching the 1.5 degree Celsius level, global carbon emissions must be halved within the next decade and reduced to zero by 2050.
“This requires nothing less than a total reversal of the present direction of our civilisation,” Hickel argues.
That may sound dramatic, but there is a growing consensus that this is one of the most significant challenges humanity has ever faced. It is unequivocally a threat to global civilisation.
“The good news is that, technically, it is possible to achieve this kind of trajectory,” says Hickel. “But it is going to require mass mobilisation on the level of a World War II-style industrial transformation in order to accomplish it.”
No such mobilisation is possible without the involvement of the financial sector, since it plays such a critical role in the allocation of capital.
“All the tenets of economic dogma are being challenged,” argues Henry Fernandez, chairman and CEO of MSCI.
“We have to change the paradigm of capitalism.”
The risk, otherwise, Fernandez suggests, is that capitalism itself will collapse: “We have to redirect the paradigm for the sustainability of the economic system that has served us well.”
Who moved my retirement savings?
The investment industry is not unaware that there is a challenge. Considering environmental, social and governance (ESG) risks has become standard for most asset managers, and there are nearly 2 000 signatories to the United Nations Principles for Responsible Investing. Together, these signatories represent assets under management of around $90 trillion.
However, a sense of urgency is still lacking across most of the industry.
“The time scale has moved up tremendously,” says the global head of research at MSCI’s ESG research group, Linda-Eling Lee. “A few years ago we were talking about the climate disaster that our children or grandchildren were inheriting. Now we are talking about 2040, which is when I was thinking I would be riding off into the sunset on my retirement savings, only those savings might not be there.”
The industry’s own future is at stake. If it is unable to protect the money of its clients, then what, after all, is its purpose?
Being able to protect capital, however, requires a significant re-imagining of how investment decisions are taken. Specifically, the investment industry needs to reconsider what risk is and how it is conceived.
Many asset managers do already consider how environmental risks might translate into measurable financial risks. The reality, however, is that the risks posed by climate change are potentially far greater than anything that can be financially modelled.
A new paradigm
This is unquestionably a challenge for an industry that relies on numbers. How does it address something that it can’t quantify?
“This is about making choices in the absence of great information, in the absence of great benchmarks, factors and back-tests,” says Urban Angehrn, group chief investment officer at Zurich Insurance. “It’s too new and too uncertain.”
However, not considering the risks because you can’t quantify them cannot be a sustainable strategy.
“Saying the data is not yet there, it’s not perfect, there’s no point in doing anything now – [that] is an active decision,” says Anna Hyrske, the head of responsible investments at Ilmarinen. “The outcome of that is that you’re losing out. The market has moved.”
Ultimately, taking investment decisions in line with the need to transform the current industrial order is about protecting the economic system that is necessary to protect clients’ capital. These cannot be separated from each other.
Catherine Howarth, chief executive of ShareAction, puts it this way: “For fiduciary investors, I think we need to add this lens that says that when I act on behalf of someone whose long term retirement assets I am responsible for looking after, I am going to invest in companies that will make them a great return, but I am going to take upon myself some responsibility to not contribute to anything that would undermine the long term well-being and interests of these beneficiaries.”
“We can’t quantify it yet,” she says. “But we can quite clearly see what those areas are.”