DivestInvest for Organizations

6 steps to help you follow through on your committment to DivestInvest.

6 steps to help you follow through on your committment to DivestInvest.

1. Review Investment Beliefs

  • Review, and where necessary, update your investment beliefs to establish a shared understanding of the investment risks and opportunities associated with climate change.

The beliefs should set out your view on the risks associated with climate change and the energy transition, especially those posed by fossil fuel extraction companies, and the opportunities offered by climate solutions. They could articulate how DivestInvest enables the portfolio to address these risks and opportunities.

All organizations have a fiduciary duty to assess and report on the financial risks of climate change. Legal experts now argue that charitable organizations must align their investments with their mission, and DivestInvest.

Questions to consider:
  1. What values and beliefs are important to our organization?
  2. What values and beliefs are important to our beneficiaries and other close stakeholders?
  3. What do we know, believe and agree on about the investment risks and opportunities associated with climate change?
  4. If you are a charity, to what extent do investments in fossil fuels conflict with our charitable objectives?

2. Establish exclusion and inclusion criteria

  • Establish criteria for screening companies that are easy to understand and empowers managers to deliver your mandate.

The scope of exclusions

The DivestInvest pledge asks investors to exclude, at a minimum, the 200 largest fossil fuel companies by reserves. Some go further and seek to exclude more companies that they identify as particularly vulnerable to a collapse in the fossil fuel supply chain of prospecting, extracting, refining, equipment, and services.  Others prefer to exclude fewer companies, often basing their decisions on the proportion of revenues derived from fossil fuels. Recently, some companies, such as AP7 and the UK Methodist Church have decided to exclude companies they feel are “not compliant with the Paris Climate Agreement.

What route you choose will depend on your values and rationale for divestment, as clarified in Step 1. Consider easily communicable policies that will resonate with diverse stakeholders.

Case Study: Exclusions

  1. The Wallace Global Fund: “Avoid investment in companies that play key roles in the exploration, production, and retailing of fossil fuels, especially coal.”
  2. RS Group: “Divest from all exposures to coal, oil and gas exploration and production companies.”
  3. Copenhagen: “Divest all companies earning 5% of revenue from coal, oil, and gas prospecting, extraction, refining, and equipment and services.”

What to include

Getting the right exposure to climate solutions, though “positive screening” for example, is as important as what is excluded. Investible climate solutions now exist across every asset class of a typical portfolio and in every market. Examples include companies and projects delivering resource efficiency, sustainable energy generation, storage, and transmission, low carbon transport, buildings and sustainable agriculture and forestry.

One approach is to prioritise “environmental leaders” where after screening out fossil fuel extraction companies, investors pick securities which perform best in their sector for ESG, or equivalent metrics. The criteria for ESG evaluations can differ greatly between fund managers, so be sure to understand the underlying assumptions of any metrics.

 

3. Review investment policies

  • Amend your policies to reflect your approach to DivestInvest.

As a starting point, you should amend your investment policy to reflect the new exclusion and inclusion criteria. A more detailed policy may refer to risk management, return targets and outline any potential constraints on the strategy. Investors may also want to update their instructions for asset managers.

Case Study: Investment Policy

The Church of Sweden, with € 900 million, has produced a comprehensive investment policy with clear guidance for asset managers on climate change and DivestInvest. The full policy can be found here. An extract is reproduced below:

The Church of Sweden perceives climate change as a serious threat and therefore has a restrictive view as regards investments in companies that are active in the extraction of fossil energy sources. Managers of the Church of Sweden’s assets are expected to instead invest in companies that contribute to resolving the climate issue in a constructive manner.

Sectors that require special screening

…Today, the world is dependent upon fossil energy, but at the same time needs to convert to a more sustainable energy supply. We believe that it is easier for an energy supply company to use more renewable energy sources to produce heat and electricity than it is for oil and coal companies to shift to deploy renewable energy sources. To date, we are not aware of any oil or coal companies that pursue development towards the production of sustainable energy sources and display sufficiently high standards in regard to the environment and human rights. However, there are a number of such energy companies. For this reason, we make a distinction between extraction companies and energy companies in the climate adjustment.

4. Update your risk register

  • Update your risk register with an analysis of the cumulative and variable risks to existing asset classes in the portfolio under several climate scenarios.

DivestInvest, by its nature, seeks to reduce financial risks associated with climate change. These risks should be identified and included in your risk register for reporting and analysis purposes.

The UK’s Prudential Regulation Authority identified three types of climate-related financial risks:

  1. Physical: risks that could arise from climate and weather-related events, such as floods and storms, which can damage property or disrupt trade.
  2. Transition: risks that could arise from the process of adjusting to a lower-carbon economy, such as changes in policy, technology, or investor sentiment.
  3. Liability: risks that could arise from parties who have suffered loss or damage.

Other useful resources on climate related risk include the Task Force on Climate Related Disclosure; Mercer and CIEL, Trillion-Dollar Transformation; and EY, Climate Change: The Investment Perspective

5. Review your benchmark

  • Assess the suitability of the benchmarks you are using to evaluate fund managers and guide investment decisions. Decide how rigidly you want to follow them and whether alternative benchmarks may be more suitable.

Investors will often use a benchmark to evaluate an investment strategy. Standard market capitalization benchmarks, such as MSCI ACWI or FTSE All-Share, represent global or national equity markets and define a market’s risk, referred to as the market ‘beta’. Asset owners may adopt an index as a policy benchmark for their asset allocations. Investors also use indexes as performance benchmarks to monitor their external asset manager, and as the basis for passive investment products such as mutual funds and Exchange Traded Funds.

The finance community is becoming increasingly vocal around the potential systemic risk embedded in some benchmarks. If investors wish to change their exposure to particular risks, benchmarks can be created to address this situation. Index providers including MSCI, FTSE Russell, S&P Dow Jones, Fossil Free Indexes and others, are now publishing new benchmarks to gauge the size, optionality and returns of a low carbon economy while including no or low fossil fuel exposure.

Case Study: Applying new benchmarks

In July 2017, Swiss Re announced they had moved their entire $130 billion investment portfolio to track ESG benchmarks.

“New benchmarks are not only used for performance measurement but also for the definition of the investment universe. Any benchmark-eligible investment needs to have a minimum ESG rating. Based on that, the investment universe shrinks to around half of the parent index for the equity benchmark and to around three quarters for the corporate credit benchmark. For buy and hold portfolios, ESG benchmarks define the eligible investment universe. For actively managed portfolios, portfolio managers are given some additional but limited investment flexibility. They are allowed to invest a small percentage in off-benchmark investments with additional ESG rating restrictions based on their own ESG assessment. The approach to select and monitor external investment managers is an additional component to ensure consistent integration of ESG factors. Our external managers are required to adhere to responsible investing criteria and are monitored accordingly. Relevant assessment criteria are governance and policies, the level of integration in the investment process of the external manager and reporting.”

6. Select suitable fund managers and consultants

  • Select fund managers and consultants who will deliver your mandate

Investors may come across fund managers who won’t offer DivestInvest strategies or who will only do so at inflated cost. Investors can challenge this. All fund managers should work to the mandate set by the client and described in the investment documents discussed above.  Ensure you find a manager who gives you confidence about understanding the risks and opportunities presented from a fast-changing energy transition.

When selecting such a consultant show them this guide and ask if they have relevant expertise and experience . If not, consider another investment consultant. Asset owners who have started to DivestInvest have reported that the quality and experience can vary substantially between teams in the same consultancy.

Many organizations who have committed to DivestInvest are happy to share their experience.

It is not uncommon for asset owners to have multiple consultants. They may have a fund manager who then outsources “climate aware” investment advice to specialist firms.

Questions for fund managers and advisers:

  1. What services do you provide to support organizations wishing to implement a DivestInvest or decarbonisation strategy?
  2. Are they sufficiently resourced to deliver your mandate?
  3. What are the skills and experience of responsible team members in this area?
  4. How do you incorporate climate risk into your investment process?
  5. How do you assess and report on DivestInvest?
  6. Do you have a policy to disclose your assets?

 

 

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