Divestment 2.0: The power is in the eyes of the investor

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Sam Gill from ET Index explores the issue of how to avoid investing in fossil fuels. Sam is Chief Executive Officer at ET Index, a Climate-KIC backed company that has been based between the Imperial Innovations Incubator and Level39 Canary Wharf since its inception in 2014. It is a spin out for the independent not-for-profit research body, the Environmental Investment Organisation.

Investing in carbon intensive companies is acknowledged to be both ethically and financially risky. As Carbon Tracker helpfully highlighted, the risk of a multi-trillion dollar ‘carbon bubble’ in the financial markets is real,and that over four-fifths of current known fossil fuel reserves will need to stay underground to prevent temperature rises going beyond 2C.

As the debate around fossil fuel divestment reveals, shareholders are increasingly demanding a wholesale transformation of the real economy and capital markets to avert catastrophe. But while the moral and financial cases begin to align  this has yet to materialise into large-scale action in the financial sector.

A number of providers are proffering adjusted equity indexes that help investors reduce their exposure to carbon risk. These redefine risk to reflect the value at risk from potential stranded assets in clients’ portfolios based on the probability of future scenarios. They do not, however, harness the power of the financial system to address the new realities of the twenty first century and meet the needs of investors.

Publically tracking the environmental component of an investment could  combines shareholder engagement and divestment action to put pressure on actors in the financial system to credibly address climate change.

What is environmental tracking?

Environmental tracking aims to align investors’ financial interests with real climatic impacts by tying share price to carbon emissions. A chosen benchmark, such as the FTSE 100, can be adjusted, or ‘tilted’ in accordance with the carbon emissions of each company.  For companies, the only way to move up the ranking is to lower their emissions and pressure companies operating within their supply chains to do the same. This gains them a greater weighting in the publically accessible index and therefore a greater share of investment from those tracking the index.

Transformational

Adding supply-chain emissions to the equation makes the mechanism truly transformational, cascading these effects throughout the world economy. As companies face financial pressure to clean up their supply-chains, every company along the value chain must respond by significantly cutting its own emissions. In this way financial incentives can come to serve the most immediate needs of humanity, rather than hampering the continued survival of the human species on this planet. The Environmental Tracking mechanism is designed to address carbon risks at an individual investor level and at the aggregate level, redirecting global capital flows. The transition index, for example, reduces a portfolio’s carbon intensity by over 75 per cent whilst also closely tracking the market.

A win-win solution

From an investor’s point of view the mechanism is a win-win solution; not only does it significantly reduce carbon exposure –offering tilts representing over 25 per cent, 50 per cent and 75 per cent carbon reduction – but closely tracks traditional, non-carbon adjusted, indexes. Crucially it aims to protect investors from ‘carbon price shock’ as, or when, high-carbon companies start to suffer in the transition to a low carbon economy. The mechanism is also built to incentivise the disclosure of emissions data, since companies unwilling to disclose their emissions are ranked as equal to the worst performer in their sector.

Engagement vs divestment

Environmental Tracking stands at the crux of the debate between engagement and divestment, arguably satisfying both needs. Environmental Tracking indexes actively engage with companies by directly influencing company share price, and each index also comes with a fossil free version for investors looking to divest completely from fossil fuel holdings. Carbon tilted indexes, if done right, could significantly reduce carbon emissions, a focus on Scope 3, or supply-chain emissions whilst severely penalising sectors that produce highly carbon-intensive products.

This methodology puts the power into the hands of the investors, giving them the unique opportunity to assess a company’s direct emissions, and make then responsible for the full life-cycle emissions of their products, be it a barrel of oil or an automobile.

Find out more about the Grantham Institute event “Divestment: what are the options?”, discussing what fossil fuel divestment might offer as a tool to combat climate change.

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