Risk-sharing in Climate Initiatives can Deliver Sustainable Returns

Working with Government offers significant opportunity for long-term investors like pension fund members

On July 18th, Dublin’s Phoenix Park recorded the highest temperature since its weather station opened in the early 1880s. The catastrophic effects of climate change are becoming more and more apparent as each year passes, and its impact is getting closer to home.

We know that a vast transformation is required. Our economy, and all others globally, must transition to carbon neutrality and dramatically reduce greenhouse gas emissions. There is undoubtedly a vital role for governments to play through their actions and regulatory agendas. However, the public purse will not meet this challenge alone and nor should it have to.

Individual savers, pension schemes and the asset management industry also have a vital role to play. Many Irish investors are starting to take meaningful steps towards more sustainable investment portfolios. Consumer data illustrates a growing preference for sustainable products, services and solutions to lifetime goals, and pensions are no different.

At Irish Life, we have already taken measures to manage the impact of our investment decisions on the environment across our proprietary portfolios, which form part of €40 billion of assets managed in a sustainable way. Listed companies that are climate laggards are being underweighted; climate leaders are overweighted; and all are being analysed and actively pressurised for continued improvement.

Using carbon intensity as a benchmark for a portfolio’s impact on climate change, these portfolios have seen an intensity reduction of more than 25 per cent since 2019.

Ireland’s commitments to support the transition to a sustainable economy amount to €20 billion per year before many significant but unbudgeted costs are factored in. A significant transformation is required in our domestic economy – one that we cannot avoid or defer.

Substantial new investments to support Ireland’s transition to a low-carbon economy are needed to ensure that we can meet our climate change commitments. Critical areas include our transport infrastructure, power generation and energy efficiency; our stock of residential, commercial and office buildings; water, waste, and renewable enterprises; and agriculture and forestry.

In truth, each sector in our economy where carbon and greenhouse gas emissions are present requires dramatic action to address our climate challenges and commitments. These next steps will be difficult, but they are necessary and actually create opportunity to reward invested capital and deliver long-term income streams.

Most Irish investors have a long way to go to participate fully in this new economy and capture the associated returns. However, there are immense investment opportunities for the private sector, given the innovation and technological developments necessary for effective transition.

These investment opportunities include the electrification of our public transport system; infrastructure for charging our vehicles; the conversion to solar-powered home and office accommodation, air conditioning and heating; and the technology to enable long-term energy storage. In Ireland, we are still at early stages in the investment cycle for these essential initiatives.

Technological advances in carbon capture and hydrogen production to manage cost and deliver efficiencies while reducing emissions, have scope for further development and for capital investment opportunities.

On balance, investors must also consider the risk of loss on capital which remains invested in assets and corporates that fail to effect a meaningful transition.

The simplest analogy is often the one that is closest to home – our diesel and petrol cars, our poorly insulated homes, our high-emission farms and businesses will all lose relative value over the next five to 10 years unless we succeed in transitioning to a more sustainable future.

The same is true for our pensions and savings: if we do not take climate transition into account when allocating capital, we are highly likely to suffer losses over the longer term.

The immediate requirement is to speed up the process of identifying and addressing the hurdles for private capital – our pensions and savings – to invest in the transition economy. For example, most of our State’s pension capital is invested in the stocks of public companies listed on global stock markets and in bonds issued by governments and corporates. For the most part, these stocks and bonds can be bought and sold instantly – they are highly liquid.

Most pension funds have a strong desire for highly liquid investments as it allows flexibility to meet obligations (though in reality this flexibility is often not called upon). Thus, illiquidity is a hurdle for pension funds investing in climate-orientated infrastructure. Similarly, risk thresholds, duration and “J-curve” features present hurdles to some private sector investors.

While these issues represent a potential obstacle for private sector investment, it is often a different set of challenges that are of greater concern to the State. The State, for example, has little need for high liquidity and can be very patient about “J-curve” investments. The greater challenge for the State can often be in mobilising resources, crowding-in capital and supporting investments that do not naturally fit on the State’s balance sheet or within the public sector.

It is on these foundations – the shared objective of investing in a more sustainable economy and achieving a complementary balance of our distinct investment criteria – that we can build a durable model for sharing risk and reward. Consequently, it is appropriate now for asset owners, pension schemes and asset managers to work in partnership with Government and develop risk-sharing strategies that support investment and better manage those obstacles.

For example, a structure whereby the State and private pension funds co-invest to support climate-orientated solutions, and which includes measures where the parties assume different elements of the liquidity premium, smoothed returns and/or different tiers of capital is possible, if not essential, to maximise the available capital for Ireland’s transition.

The public and private sectors already operate in an integrated fashion to enhance the coverage and adequacy of retirement savings. An incentivised, progressive taxation system supports our public and private pensions sector. Deeper consideration of the risk-sharing opportunities would enable the domestic pension system to accelerate new economic growth and participate in more sustainable returns and a more sustainable future for all.

This is where the most significant opportunity lies, where long-term investors are most likely to be rewarded and where Ireland can clearly demonstrate international leadership in this mission-critical transformation. Time is not our friend. The impact is getting closer to home.

Patrick Burke is managing director of Irish Life Investment Managers