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Capital markets need an Extinction Rebellion

Extinction Rebellion running out of time from Alamy 230x150
By Jon Hay
16 Apr 2019

Sustainable finance is bubbling with exciting new initiatives. But making people feel good is not enough. Activity needs to produce results, and so far there is more noise than movement. The tone is far too sedate — it needs some hard core activism to break the torpor.

News on sustainable finance is everywhere. GlobalCapital could keep five journalists busy writing about it if we chose.

In the past week, Standard & Poor’s has launched an ESG Evaluation — a rating issuers can buy to certify their environmental, social and governance characteristics. Moody’s on Monday bought a majority stake in Vigeo Eiris, the ESG rating agency.

On the same day, the Bank of England set out guidelines on how banks and insurance companies should step up their management of climate change risks.

Last Friday, writing in the International Capital Market Association’s journal, the president of France’s financial regulator called for green bonds’ use of proceeds to be enshrined in the prospectus.

Meanwhile, the average world temperature has risen by 0.25C in the past decade. If all human emissions ceased now, global warming would probably still get faster, as a hotter climate means more greenhouse gases are released from the ocean and tundra.

As it is, we are making the world’s CO2 blanket thicker — and at an accelerating rate. Global carbon emissions have climbed 17% in the past decade.

Finance on the case

Should we be reassured that financial markets are riding to the rescue?

Unfortunately not. All the effort devoted to sustainable finance may have made a difference at the margin, but it would be hard to prove.

Renewable technologies have more than doubled as a share of global power generation since 2010, but largely because governments have set targets and provided subsidies. Costs have come down to the point where renewables are often competitive with conventional power, but renewables are still only projected to reach 22.5% of generation in 2020, according to GlobalData. And that includes biofuels, which involve heavy carbon emissions.

Meanwhile, dollars are still pouring into making the climate hotter. The International Energy Agency reports that the share of fossil fuels in energy supply investment actually rose slightly, to 59%, in 2017.

If you buy a FTSE100 tracker fund, 16.9p in every pound will go to oil and gas companies — more than five years ago.

All the biggest banks — including many of those most proud of their sustainability credentials — are desperate to work for Saudi Aramco.

The result is that an energy transition is happening — but much too gradually to stop climate change speeding up.

When the UN-backed Principles for Responsible Investment organisation says $82tr of assets are now managed according to responsible principles, one is bound to ask: what does ‘responsible’ mean?

Comfort zone

Three things are critically wrong with sustainable finance as it has been practised so far. First, it is woefully unambitious. The vast majority of ‘responsible’ money is invested in developed markets, in listed securities, usually blue chip stocks or investment grade bonds — in other words, in the status quo.

Investors might try and lean a bit towards stocks with better ESG ratings, and that probably encourages companies to try and improve those scores. But although this might have helped produce some improvements in issues companies find it easier to change, such as women’s representation on boards, it shows no sign of triggering a wholesale decarbonisation of industry.

The comments by the French regulator on green bonds are an example. Green bonds’ contribution to fighting climate change is very gentle, because the entities financed have ready access to capital and gain minimal funding cost advantage from issuing green debt.

But even so, the AMF is devoting effort to nitpicking about whether the promise to invest proceeds greenly is legally enshrined, or merely a promise in honour. This is wholly insignificant.

Down the data mine

Second, there is an obsession with information. Investors clamour that they need more and better data. The moves by Standard & Poor’s and Moody’s into ESG ratings are meant to feed that thirst, particularly because many investors complain the existing ESG rating providers contradict each other.

The Bank of England’s Sarah Breeden said this week “we need more data, greater disclosure, better analytical toolkits, advanced scenario analysis and new risk management techniques to help identify the hidden dangers on our journey”.

Really? What about the dangers in plain sight? It is surely not difficult to tell an oil well from a wind farm.

The endless demands for more information look like a way for financial players to avoid the main, and very obvious issue — they are invested in the wrong things.

Small talk

Finally, the sustainable finance movement is far too polite. The problems facing the world are so severe that radical action is needed. Yet the sustainable finance debate has the urgency of a vicar’s tea party.

This failing is universal, but the Bank of England is a prime example. Its mandate is to protect the financial system. Since the 1980s it has been clear environmental risks are existential. Why is it only in 2019 that the Bank has estimated the total of stranded assets at $20tr?

It will now make banks and insurance companies think more carefully about their climate risks, using scenarios of how global warming might play out. But it is still treading carefully, not wanting to be “prescriptive”.

Enough is enough

In the political sphere, ordinary citizens are getting tired of the snail-like pace at which governments are dealing with climate change.

The school boycotters, inspired by Sweden’s Greta Thunberg, and the Extinction Rebellion movement now blockading some of London’s streets and bridges are not satisfied that their governments have signed the Paris Agreement. They know this is much too little, much too late.

Some commentators carp that the kids should be at school or the demonstrators are blocking traffic. Try telling someone from Paradise, California, burnt to the ground in November, that climate change is not important enough to cause a traffic jam for.

Protests may not do much on their own. But they can change the conversation. Global debates can move very suddenly when people make a fuss — look at #metoo or the Blue Planet II TV programmes about ocean plastic.

The equivalent in capital markets is the movement to divest from fossil fuels. Many of the great and good in responsible investing scoff at divestment, saying they prefer to “engage” with companies. But if divestment is so ineffective, why do companies threatened with it hate it so much?

It is time for mainstream investors and banks to realise they are not doing enough. If they are actually going to steer the economy, rather than passively riding it with the odd nudge in the right direction, they have got to summon some courage, stop waiting for perfect information and start jabbing the horse with their heels.

The Bank of England has got one thing right: it is not enough for each firm to have an energy transition plan. The sum of all the plans has got to add up to a credible shift of the whole economy. Metrics exist already, such as Science-Based Targets, to work out which companies are on the right path — but markets are not paying attention.

At the moment, the Extinction Rebellion protesters, with their demand for zero emissions by 2025, look like the responsible actors — the vast majority of bankers and investors do not.

By Jon Hay
16 Apr 2019