The net-zero investing journey passed a milestone this May, having already ticked one third of the way towards 2030 goals and one twelfth of the way to 2050 goals. Roger Urwin, co-founder of the Thinking Ahead Institute, enquires how investors and the real economy are really doing.
Asset owner net-zero progress
On the plus side of the ledger the asset owners, and the asset managers, have come a long way in their net-zero mindsets and skillsets. Net-zero ambition involves writing a completely new investment chapter. And the response of the industry has been to mobilise a lot of new thinking in a short space of time to do so. The amount of effort and innovation applied has been exceptional.
We are seeing the fruits of this in the industry’s deeper understanding of scenarios and alternative pathways with the TCFD process an important catalyst.
And there are credible investment strategies emerging with bigger allocations to climate solutions in combination with deeper engagement with companies, within the industry and in public policy. At the same time, there has been correspondingly and appropriately little appetite for divestment.
Inevitably there have been some setbacks, including recent performance challenges with low-carbon allocations being whip-sawed by the consequences of concerns about energy security. There are no easy answers in how to deal with these performance issues, and greenwashing temptations, which are further complicated by politics – particularly in the US. These issues illustrate the difficult balancing acts ahead for investors in staying true to their beliefs and principles.
Fiduciary duty, with its heavy presumption of financial pre-eminence, hasn’t helped the net-zero challenge. Asset owners face a tough hurdle when it comes to deploying the requisite capital in climate-solution areas, where long time horizons and policy risk are front of mind and which can be roadblocks to faster change.
On the minus side of the ledger, all these new circumstances are introducing clunkiness and disjointedness into governance arrangements, which is feeling the strain under the grip of massive complexity. This has produced a pile-up problem: too much fragmented reporting and not enough joined-up action. We all notice the grind of new technical stuff, onerous regulations, the talking over each other, and the conversations not landing. The governance pathway will involve normalising and standardising our practices, as well as mastering a new language – this will all take time.
So how do we mark the card at this early, but critical point? We can only give a ballpark answer – such is the peasouper fog that we are working in. But it is reasonable to suggest we are doing as well as can be expected in the difficult circumstances and asset owners are building some muscle and savvy for the challenges ahead. But at this check-in point we are nothing like on track for the climate outcomes sought[1]. In the net-zero pathway, let’s be clear, we have a lot of ground to make up.
Net-zero progress in the real economy
To still achieve the 1.5C pathway, in the real-world, we will need a dramatic reengineering of our energy system across multiple technologies and every conceivable geography. Challenges don’t come bigger.
The massive reengineering required has solar and wind key to the mix; hydro, bioenergy and nuclear in the mix; coal, oil, and gas out of the mix; and carbon capture and storage, battery technology and a streamlined decarbonised grid playing a developing role.
But here’s the rub. We haven’t got the capacity to do all these things to the extent we need because of the frictions[2] that are holding us back and need some fixing.
In the energy transition, it’s not that much about costs holding us back. We now have renewables looking attractively priced and we can absorb somewhat the energy-transition costs arising from new capital deployment. What we can’t seem to do is deploy capital at the speed needed; with less than half the rate of deployment required of solar and wind being the most obvious example.
This lack of speed is because of the frictions involved: capital allocation decisions with fiduciary duty issues; benchmark and time-horizon issues; planning and policy bottlenecks; capacity issues for enabling infrastructure; political infighting around priorities; and aligning the incentives to support the transition.
Understanding these quandaries is not helping us fix them because they are too deeply embedded. Can governments get us back on track? There are few signals that they have the convictions and mechanisms to do this. Jean-Claude Juncker, in his EC President role, very honestly said: “I know the policies we need, but they are not ones that will keep us in power.”.
So how do we mark this scorecard? Again, it’s a ballpark answer but we are not doing well and nothing like on track to align with the climate outcomes sought. And there will be dire climatic consequences to mismanaging the Paris agreed global carbon budget.
What next?
We have written previously about the 4321[3] pin-code. The next phase needs to be about all units of power being aligned to the net-zero challenge and reaching agreement on policy levers and wider incentives. For the investment industry, this is using its democratised power to engage broad societal support and applying its corporate muscle to engage with the private sector to reduce the destructive effects of business externalities. And, in tandem, using its soft power on government to make progress on the key policy measures like a price on carbon, clarity on energy priorities and taxation consistencies. It is through this soft power on others where the investment industry’s pin-code multiplier effect can be most effective to catalyse change. This is about the investment industry taking a systems-leadership position to ensure the system can support the future returns needed. You could call it enlightened self-interest.
We can do this. But we are still looking like we are in the starting blocks. We now really need the power of ‘and’ in thinking and action that is systemic and holistic. And stronger leadership that is joined-up, agile and relentless. And recognising the critical ethos that when we’re in it together we’re stronger together. And we are truly in this together.
[1]In the MSCI Net-Zero Tracker for May 2023 Scope 1 emissions for equities in the MSCI ACWI IMI index are estimated at 11.2 Gt CO2e and have gone sideways since 2019. Only 19% of listed companies are aligned to a 1.5°C pathway while 51% of listed companies align with warming equal to or below 2°C.
[2]Focusing too much on the fuel of change (the supporting science, the technology, the costs) we can lose sight of the principal reason for change failure as not addressing the human frictions implied in change: the inertia, effort and emotional cost attached. With net-zero progress this is most seen in process blocks, disincentives and limits in resources.
[3]The 4-3-2-1 pin-code is a reminder of the sources of power in the ecosystem to effect change where roughly four units of power reside with public policy, three with corporations, two with the investment industry and one with civil society. The critical need is for these four sources of power to connect in an effective combination where the product is far more than the sum of the parts. And the investment industry has the biggest reach, over other sectors, to achieve this.
Roger Urwin is co-founder of the Thinking Ahead Institute at WTW, an innovation network of asset owners and asset managers committed to mobilising capital for a sustainable future.
