Are climate targets truly in asset manager’s best interests?

The Glasgow Alliance opened up a whole new debate around fiduciary duty and ESG. But does aiming for Paris go too far?

Fiduciary duty is a tricky thing. Alongside the structure of the corporation, limited liability, and public markets, it is one of the cornerstones of modern capitalism. However, whilst fiduciary duty is enshrined in law around the world, by definition it is a more normative puzzle than these other elements. Just what counts as acting in the best interests of another??

For most of the last century, sticking to the accepted playbook as a director or investment manager was enough. And then along came climate. What has worked in the past is suddenly brought into question by the reality of a disrupted future, and fiduciary duty is no exception, and the normative basis makes it even more sensitive to cultural changes around ESG. So the question now upon us is: What counts as acting in the best interests of another, in light of an existentially uncertain future?

In case the last few paragraphs didn’t make it plain enough, I find this a really tricky question to think about! Fortunately, one of the perks of being a podcast host is that I don’t have to do all of my thinking alone. I feel very lucky to have had Tom Gosling – Executive Fellow at LBS, advisor to the FCA and FRC, and all-around expert on corporate stewardship and ESG on the show.

Tom has done the deep thinking on how climate and fiduciary duty intersect, through an analysis of the Glasgow Financial Alliance for Net Zero (GFANZ). The results are intriguing. As Tom himself wrote, ‘the conclusions [I come to] are uncomfortable for someone who wants to see more action on climate change not less.’ How did we get here?

Glasgow takes asset managers to Paris

The Glasgow Financial Alliance for Net Zero was a product of COP26, and the push by Mark Carney and other major figures to begin turning the great ship of global finance into line with the Paris Agreement. Its central tool for change is the net-zero commitment, and over 550 financial institutions across 50 countries, managing over $100 trillion have signed up to bring their investments in line.?

Tom Gosling’s concern is around the Net Zero Asset Manager’s Initiative in particular, which is a subset of GFANZ bringing together people who manage other people’s money. The issue isn’t with such groupings in principle, which he thinks are important; instead, ‘the bit that I've been challenging is the extent to which the goal of 1.5 degrees with limited or no overshoot has been embedded into those commitments in quite a granular way.’ He believes that this creates real risks for fiduciary duty.

Gosling has laid out his arguments in detail here, here, and here. If you want the punchiest version, then you must listen to the end of our conversation. This is my summary of his key ideas:

1. Clients haven’t explicitly mandated the 5-degree target, and they aren’t (yet) forced by law or regulation. Managers are going beyond their remit.
2. 1.5 degrees can be the right goal for the world – i.e. as social policy – whilst not being in the best interests of the industry’s most wealthy, western clients. Markets should concern themselves with optimising financial concerns, not the political economy.
3. Stewarding money for a target the world will almost certainly miss risks malinvestment and the possible creation of stranded assets.?
4. The overall result is superficial alignment and charges of greenwashing as managers inevitably fail to invest in a way that creates a 1.5-degree world.

In the spirit of Tom’s brilliant engagement with the issue, I want to offer some thoughts of my own.

All markets are political

Firstly, I want to address the distinction between financial and political concerns. Tom is absolutely correct that markets are not the right place to set policy, and they are not designed to optimise for broad, long-term non-financial outcomes. We can’t leave the job of getting to 1.5 degrees (or any climate target for that matter) to money managers, because they aren’t up to the job.?

However, it’s equally unhelpful to make the argument that fiduciary duty frees business from politics and social outcomes altogether. Markets may be able to ‘look through’ events to a degree – Tom gave the example of the remarkable market rebound during Covid in 2021 – but that itself is mediated by a political choice to insulate businesses from financial consequences.

In the case of the Covid rally, it rested upon a rescue package for markets so outrageously generous and iniquitous (bailing out junk bond funds, anyone?) that I can’t see that market recovery as anything other than political. It was also a product of other, more subtle socio-political connections – the absence of strong regulation for oligopolistic tech, the failure of global tax reform, and so on. In other words, markets recovered because we created the political conditions which enabled them to.

Once again the principle of interconnectivity is critical. Returning to GFANZ, to say that wealthy Western investors are completely unaffected by the impacts of climate change on developing economies (for example) is to ignore all the ways, obvious and subtle, that we are bound together. Globalisation cuts both ways: when climate change disrupts supply chains, impoverishes frontier markets which are pencilled in as sources of future growth, and creates mass migration and geopolitical instability, then we will see if politics continues to allow fiduciaries to ignore social realities.

The value of negativity bias

All of which brings me to my second point, which is that fiduciary duty in the case of climate today needs to be understood largely in a negative frame. Critically, it is not (yet) about speculating on the source of future growth and positive returns so much as avoiding future loss. Markets may not be great policy-makers, but they are policy-takers, and the future is going to get a lot spikier in this regard. From carbon taxes to class-action lawsuits, being on the wrong side of the decarbonisation curve will start costing investors in a real way.?

Source: https://tinyurl.com/yxsaznsf

Tom is right that what financial actors can constructively offer is fuel for net-zero innovation. But if we are talking about money managers in markets today, a realist must admit that aligned behaviour is currently much more about divesting than investing. That is simply a reflection of the state of global business: for every dollar at work creating products that actively improve the environment, there are ten (or one hundred?) dollars committed to ecologically destructive activity.?

This has implications for targeting 1.5 degrees. I agree it looks like we’ll miss the mark. However, when we understand it as an issue of divestment and avoiding future losses/sanctions, it doesn’t matter whether you are aiming for 1.5 degrees or 2.3; you still need to be getting out of the worst polluters.

The precise degree of divestment is open for debate. But consider this: more warming only creates more negative outcomes for investors, and these outcomes scale non-linearly and with greater uncertainty for each fraction of a degree. Fiduciary duty is also a question of risk; and the sheer uncertainty and risk of catastrophic loss you accept if you target 2 degrees (or 2.5 degrees, or whatever feels ‘realistic’ today) is orders of magnitude greater than if you aim for 1.5.?

Similarly, the point about risking stranded assets from over-optimistic investment in green technology is an interesting one, and there is certainly something to it. However, I also think it frames a problem ahead of its time. The imbalance between negative and positive opportunities in today’s markets reflects the fact that we are so far behind in the supply of green technologies that the day when investment outstrips demand feels a long way away. Furthermore, there is a binary, non-scaling element to some necessary infrastructure responses, such that even if governments end up acting for a 2 - 2.5 degree world, they will still need to build out a full electric-powered grid as they would have for 1.5 degrees; just later, and at a higher cost.?

Resolving an impossible position

This is a fascinating debate, and I’m glad Tom brought it up. Where we do completely agree is that we shouldn’t be putting asset managers in this position in the first place. They are caught between society and government who are colluding to talk a good game on climate (thus the Paris goal) whilst still being unwilling to take the concrete steps to make it a reality.?

What we really need is for clients (particularly the institutional 500-pound gorillas) to step up and explicitly mandate Paris-aligned investment; and governments to create policy and regulatory frameworks that force action on the markets anyway.?

It is perfectly reasonable for fiduciary duty to consider climate change, and even require managers to align with explicit future scenarios. Using fiduciary duty as a primary tool to get us there, however, is in nobody’s best interests. ?

#climatechange #ESG #fiduciaryduty #ParisAgreement #sustainability #socialresponsibility #environmentalimpact #corporategovernance Tom Gosling