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Climate Risk: From Measuring to Mitigating Greenhouse Gas Emissions

Published January 31, 2018

State Street Global Advisors President and CEO Cyrus Taraporevala addressed attendees at the Investor Summit on Climate Risk at the United Nations headquarters in New York, highlighting the important role asset managers and asset owners play in moving sustainability in the right direction. Watch video of Cyrus speaking at the summit or read his remarks below:  

Thank you to Ceres and the UN Foundation for the opportunity to speak to you today.

I am honored to be among so many distinguished experts. I thought my most valuable contribution to today’s discussion might be to share some front-line stories of the companies we’re invested in and have been engaging with on the issue of climate risk.  I hope these will help illustrate some of the real challenges companies are facing in identifying feasible ways to measure and mitigate climate risk. In full disclosure, I haven’t come with any definitive answers, but I would like to challenge some of our thinking as investors about the most effective ways to work with companies and help them develop strategies for reducing greenhouse gas emissions.

Like all of you in this room, we at State Street are concerned about climate risk because we believe it poses a material financial risk to our investments. We’ve all seen the headlines that 2017 was again one of the hottest years on record. It was also the costliest for the US due to weather-related disasters: hurricanes, wildfires, tornadoes and flooding. More than $300 billion dollars in damages and losses. $300 billion dollars—that’s 50% more than the nominal GDP of a European Union country like Portugal. Apart from the horrible human toll, just think of what that means in value destruction when it comes to supply chains and production losses. And that doesn’t begin to capture the cost of other climate-change-related disasters in other parts of the world.

So Why Do We Care?

We are the third-largest asset management company in the world, and one of the largest index managers, with more than $2.7 trillion in assets under management.1 Globally, we are invested in over 10,000 listed companies. That makes us the quintessential long-term investor, providing quasi-permanent capital to these companies. As long as a company is in the index, we own it—we can’t make the S&P® 500 the S&P 499. So as stewards of our clients’ assets, we have developed an active engagement program with our portfolio companies across a full range of environmental, social and governance issues that might impact long-term returns. Climate-related risks have been a priority issue for a number of years precisely for that reason. We have also made ESG issues, including climate, a research priority for us across our entire investment management platform, with nearly $200 billion in ESG assets under management.

We acknowledge that there is a great deal of uncertainty and debate around the exact financial impact of climate change –  that to us is the textbook definition of risk. It’s important to note that our focus on climate risk is not about imposing a particular set of values on others; it’s about promoting research-driven value in our investments.

What Do We Do?

Because of this mission, we have called on boards to consider climate change as they would any other significant risk to the business and to ensure that the company’s assets and its long-term business strategy are resilient to that change. In addition to publishing specific guidance on the kind of analysis and reporting we would like our portfolio companies to provide around climate risk, we have also used our proxy vote to promote greater transparency around these risks. For example, in 2016 we were the first large investment manager to vote against management in support of certain shareholder proposals calling on oil, gas, and utilities companies to disclose more information on how climate change is affecting their business. We are pleased to see other large investment managers now supporting similar proposals.

What Are the Challenges?

But during more than 240 climate-related engagements with over 168 companies globally in the last few years, we have heard a litany of challenges companies face in identifying and measuring the financial impact of climate risk, let alone implementing strategies to mitigate that risk. Sometimes it’s about not having the appropriate enterprise systems to capture the necessary data. But often it is not understanding how to implement an appropriate mitigation strategy.

Let me give you two examples:

In the first case, Company A is told by its investors it should develop a strategy to help limit the rise in global average temperature to well below the 2 degree Celsius threshold set by the Paris accord. In the case of Company B, it faced a specific goal to reduce its carbon emissions by 20% over five years.

By a show of hands, how many of you think Company A achieved its goal? How many of you think it was Company B?

These are actually live examples from our portfolio. Company A is a US oil and gas company, which had no idea what actions to take to achieve its goal. It didn’t know what a 2 degree warmer world would look like…or how the pace of technology improvement might change the scenarios. Board members were also unsure about what kinds of metrics would best capture the impact of their decisions, and what systems they would need in place to monitor the impact. Company B is a Japanese manufacturer of air conditioners. With a more specific emissions-reduction target, the company was able to invest in research and development that ultimately led to a much more energy-efficient product. They not only reduced their overall carbon emissions significantly, they also ended up with a product that was in much higher demand as consumers around the world look to buy more energy-efficient appliances. Now, personally, I think you could argue the pros and cons of each approach, but I offer these as examples of how companies are responding in different ways with different levels of success.

Let me give one more example of the complexities around this issue. An Australian integrated energy company we’re invested in had already done the kind of climate risk analysis we’re calling for, and decided the long-term future of coal did not look promising. So the company began restructuring its business to transition away from coal toward renewable energy. As part of that process, they announced a plan to shut down their coal-fired power stations. But the Australian government intervened and asked them to abandon their plans, in part to preserve jobs. Clean air or jobs?  Do you want to win on the “E” or the “S” in ESG? Sound familiar?

What Is To Be Done?

So what can we learn from these examples? On the one hand, we support good-faith disclosure projects underway, especially the Task Force on Climate-related Disclosure. This is the investor-led initiative spearheaded by Mark Carney and Michael Bloomberg, which State Street has formally endorsed. But as we are thinking about disclosures and targets, we should ask ourselves what the best path forward is for companies from an implementation perspective. We should probe more deeply with our portfolio companies to understand how and why they arrived at the goals and strategies they have in place and ensure that they have the kinds of measurement and monitoring capabilities they will need to achieve those goals. And we should acknowledge up front that the answer might be different for different companies and sectors.

Second, we should remind ourselves that, while the focus on high-impact sectors like oil, gas, utilities and mining is understandable, we shouldn’t be limiting our engagement efforts to those sectors. For 2018, we will be expanding our stewardship focus on climate risk to sectors such as agriculture, transportation and insurance, since they have obvious connections to climate-related changes. And we will need to look at the entire product lifecycle of these companies, including the carbon intensity of their upstream and downstream operations.

Finally, we need to recognize that focusing solely on reducing the volume of greenhouse gases we are adding to the atmosphere is not going to be enough to stay within the 2 degree limit; we need to actively reduce the carbon gases that have already compromised the environment. The latest “Emissions Gap” report from the United Nations Environment Program suggests that we might have to target even more aggressive reductions in greenhouse gases in order to stay under the 2 degree limit.

But don’t underestimate the game-changers happening even as I speak: India intends to sell only electric vehicles by 2030 and expand solar and wind power exponentially over the next five years. China is launching a national carbon trading program to limit pollution. And Norway’s sovereign wealth fund – one of the world’s largest – has recommended that it divest of its oil, gas and coal investments.

Of course, the other game-changer is all of us in this room. Even if certain governments are moving in the opposite direction, it is incumbent on investors like us, asset owners and asset managers alike, stewards of long-term value, to work with companies to bend the arc of sustainability in the right direction. Think about the global assets under management, which amount to nearly $70 trillion: that is significant capital firepower to put behind the climate challenge. So I say to all of you here today: let us redouble our commitment to work together to steer companies onto a path toward a cleaner, healthier and more sustainable future.  Thank you.

 

1State Street Global Advisors as of December 31, 2017.

 

Disclosures

The views expressed in this material are the views of Cyrus Taraporevala through the period ended 1/31/2018 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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