Leading sustainable investors have spent two years considering the investment implications of climate change adaptation for the electricity, oil & gas, real estate and water sectors. In this short article they report on their conclusions
By Rory Sullivan, Seb Beloe, David Russell, Frank Curtiss and John Firth
In November 2009, Henderson Global Investors, Insight Investment, RAILPEN Investments and the Universities Superannuation Scheme (USS) published the results of a two-year research project examining the investment implications of climate change adaptation for the electricity, oil & gas, real estate and water sectors.
How are companies responding to climate change?
Changes in weather patterns have major implications for investors and companies.
Our research found clear evidence that this is being recognised by companies, with many starting to take account of climate change in their investment plans.
For example, water companies are assessing issues such as sewer overflows arising from severe rainfall events. Electricity companies with coastal power stations have identified the need to address the safety and operational implications of extreme weather conditions. Many companies are endeavouring to build at least some resilience to changes in weather patterns into their designs for new projects.
Yet, with the notable exception of the water sector, companies’ management systems and processes are much less developed than for climate change mitigation.
Specifically, climate change adaptation is not yet recognised as a strategic issue warranting board-level attention, monitoring of the physical and business effects of climate change remains relatively weak, and reporting on adaptation is highly variable.
Moreover, there appear to be significant weaknesses in companies’ risk assessment processes; incremental changes are under-emphasised (with extreme weather events receiving the most attention), companies are focusing on risks rather than opportunities, and companies are focusing primarily on their fixed assets rather than considering the implications for their business model as a whole (e.g. impacts on supply chains).
While public policy is a key influence on how companies respond to climate change, current regulation seems as likely to stymie effective industry responses as promote them.
There are a number of different factors at play: policy time horizons that are incompatible with adaptation planning time horizons, adaptation not being an important factor for the primary regulator and competing policy priorities between regulatory bodies.
For example, in the UK water industry the current regulatory planning horizon is typically limited to a five year period, thereby limiting the ability of the industry to make investments (for example in habitat restoration that provide more stable base water flows during dry weather) with longer pay-back periods.
While the regulator, Ofwat, is taking steps to remedy this situation through requiring water companies to develop 25 year ‘strategic direction statements’, there is still a perceived bias against projects with longer-term pay-backs.
Investors’ views
Investors have paid relatively little attention to climate change adaptation in their investment processes.
There are various reasons for this. One would be the complexity of analysing these risks.
Another is the relatively short investment time-horizons and the reality that a certain amount of resilience to changing weather patterns is already incorporated into existing infrastructure (i.e. the financial consequences may be less significant than theoretical models suggest).
Finally, there is the fact that companies face a range of risks, of which climate change is just one.
Yet it is clear that companies are starting to build climate change-related risks into their investment decisions and, to an extent, strategic plans.
We, therefore, believe that investors should integrate climate change-related risks and opportunities into their investment decisions.
Investors should ensure that companies have appropriate governance and management systems in place.
These should iinclude robust risk identification and assessment processes, clear strategies for managing and responding to climate change, and clear reporting on the significance of climate change-related risks and opportunities for their business.
Closing comments: The centrality of public policy
The general absence of coherent national adaptation policies is a huge issue for investors.
Why? because it means that companies are less willing to commit capital to infrastructure projects due to the risk that such assets could be left stranded or unable to earn reasonable returns. This is a result of dealing with policy uncertainties.
We believe that well-designed adaptation policy should provide real economy-wide benefits through ensuring the resilience of critical assets, through sending clear signals on where capital can best be deployed, and through ensuring that economic and environmental policy are aligned.
Therefore, we believe that investors should encourage policy makers to:
• Develop clear, long-term policies that enable companies to plan and invest appropriately
• Ensure that unsuitable/risky developments (for example, on flood plains) are either regulated against or are designed with appropriate adaptation measures.
• Ensure that regulators for the same sector work together more coherently, ensuring that adaptation policy is aligned with other areas of public policy.
Rory Sullivan is Head of Responsible Investment, Insight Investment
David Russell is Co-Head of Responsible Investment, Universities Superannuation Scheme
Seb Beloe is Head of SRI Research, Henderson Global Investors
Frank Curtiss is Head of Corporate Governance, RAILPEN Investments.
John Firth is CEO, Acclimatise.
The ‘Managing the Unavoidable’ series of reports can be found at: www.acclimatise.uk.com/resources/investors