Mission zero

Should company directors have a plan that goes beyond just decarbonising their own company? Should they also be working towards a zero-emissions future for the broader Australian economy? Stephen Dunne FAICD, chair of the Investor Group on Climate Change (IGCC), believes they should.

Directors and companies need to recognise that global warming is a systemic risk to the economy, just as investment managers are increasingly doing, warns Stephen Dunne, chair of the Investor Group on Climate Change (IGCC), and director and chair of the investment committee at the $70b industry superannuation fund Cbus.

Dunne outlines what is expected of investee company directors by the IGCC, which represents fund managers taking care of investments for 7.5 million Australians and New Zealanders.

“They need to be actually trying to understand what risks climate change poses to their business and also what opportunities it presents,” he says.

Dunne says directors need to develop and understand the scenarios that could potentially play out — ranging from an orderly transition to a low-emissions economy, to a disorderly transition, and even a 3°C-plus global warming outcome. Each scenario impacts the risks and opportunities that might arise.

The IGCC expects companies to set medium- and long-term carbon transition targets. “All directors need to be thinking about how climate change is impacting their business, not just those that are high emitters,” says Dunne.

Winning the climate wars

Dunne has long been concerned about the effects of climate change on investments. He was one of the founders of the IGCC when he was managing director at AMP Capital Investors in the early 2000s.

He and his colleagues were engaging with the Commonwealth Scientific and Industrial Research Organisation (CSIRO) to gain an understanding of long-term investment issues that were facing the fund managers. Climate change risk was bubbling away as a significant issue even then.

“It really was around just continuing to develop our understanding and looking for opportunities to actually help the decarbonisation,” he says. “But it’s been a very rocky and difficult ride.”

Dunne is referring to the “climate wars”, which he says saw Australia split on climate change. One camp believed climate wasn’t a financial risk and that taking action would wreck the economy. The other camp believed it was a huge financial risk and that not taking action would wreck the economy.

“The lack of understanding with regard to this issue was very strong,” says Dunne. “The fact that it was very prevalent made it incredibly difficult to have a conversation.”

While, for the most part, investment managers recognise climate change is a huge issue, they are challenged by time frames. They are generally measured by three-year returns, if not their six- or 12-month performance. The risk that a fund manager is terminated for underperformance made it more difficult to factor climate change into portfolio decisions.

This was, in part, the genesis of the IGCC — to bring investment managers together to deal with these risks.

Practical plans for investors

The IGCC has two broad aims — to advocate for policy, and to work with its investor members to set targets for the decarbonisation of their portfolios and help them play a role in the decarbonisation of the economy.

On policy, the group has long argued investors can and should play a very key role in the transition to a zero-carbon economy and should be dealt into the conversation.

The IGCC has published a series of Investor Climate Action Plans (ICAPs), which provide investors with clear expectations for issuing and implementing comprehensive climate action plans, including steps investors can take to support the goal of a net-zero emissions economy by 2050 or sooner. It summarises the key climate actions investors can take right now in four areas — investment, corporate engagement, policy advocacy and investor disclosure.

Different asset classes have varying timelines based on the degree of complexity. Listed equities are relatively straightforward. Property is similarly straightforward in terms of operational emissions, but many buildings contain a lot of embedded carbon. Infrastructure is more difficult because it often also involves Scope 2 and 3 emissions. Debt is also complex because of issues around how investors engage with companies they’re providing debt to.

Finally, sovereign debt is the most difficult because it raises questions about how investors can transition to a low-carbon sovereign debt portfolio.

The IGCC also helps investors engage with companies through Climate Action 100+, the world’s largest investor engagement initiative on climate change. It helps investors collaborate on seeking commitments from the world’s largest emitters to implement a strong governance framework on climate change; take action to reduce greenhouse gas emissions across the value chain; and provide enhanced corporate disclosure.

Change yourselves, then the world

Dunne believes that, like investment funds, companies have two responsibilities: to devise a plan to manage the risks to their own business model and to contribute more broadly to the decarbonisation of the entire economy.

In a paper published in 2021, A Changing Climate: What investors expect of company directors on climate risk, the IGCC states it wants companies to have coherent climate change strategies that are integrated into the company’s strategy, including capital expenditure. Companies should articulate the underlying climate change-related assumptions that lie behind their strategy and capital expenditure decisions.

They should also undertake robust climate change scenario analysis and disclose capital investments, or assumptions, consistent with the Paris Agreement objective of aiming to limit global warming to 1.5°C.

“This is a fundamental risk to all businesses and so it needs to be sitting front and centre in terms of strategy for the risk committee. It’s not just something that sits off to one side,” says Dunne.

Even compared with three or four years ago, he says there has been a significant rise in directors’ engagement on climate change.

The IGCC also wants to see boards becoming more climate change competent, and to see what they are doing to bring climate skills onto the board. While directors don’t need to be experts, they should be able to contribute to the conversation.

In addition, the climate investor group wants information on what incentives companies are putting into the remuneration structures to encourage management to focus and deliver on climate change and transition targets. In particular, it is looking for assurances that remuneration structures aren’t working against those targets by focusing too much on the short term, for instance.

Ambitious goals

The IGCC supports the federal government’s target of a 43 per cent emissions cut by 2030 — although it would prefer a more ambitious target — and it would like to see a 75 per cent reduction target for 2035.

It would also like to see a price on carbon and argues the Safeguard Mechanism — which requires Australia’s largest greenhouse gas emitters to keep their net emissions below an emissions limit — only goes some of the way there. “We’ve advocated the value of actually having a rigorous carbon pricing mechanism that allows a better allocation of capital and a better pricing of the cost of carbon into investment decisions,” says Dunne.

The Labor government has so far recognised that investors should have a seat at the table to help design policies that enable the flow of funds into the transition of the economy to becoming more sustainable and climate change-conscious.

The IGCC connects members to share knowledge about how they can decarbonise their own investment portfolios. However, it also expects them to work towards decarbonising the economy as a whole, which Dunne says reflects a deeper understanding of the risk that global warming poses to the whole economy.

“It is a systemic risk,” he says. “This risk affects every part of the economy and therefore has an impact on essentially your whole portfolio, be it you’re investing in property, be it investing in infrastructure or in the listed markets domestic and internationally.

“From that perspective, you can’t divest completely from this risk. Therefore, you must play your role in actually helping the economy to transition to a low-carbon position, so that systemic risk is somewhat reduced.”

Slow and steady

Dunne can point to progress. Around 85 per cent of large super funds have long-term net- zero targets and a significant portion of them have 2030 targets. Over 70 per cent of the IGCC membership base says climate change represents a risk to the portfolio and it should be being actively managed.

In this, the asset owner and the asset manager are in alignment about the need to address climate risk and the transition.

IGCC research shows that many Australian companies have been slow to start action on climate change, which Dunne puts down to the absence of federal government climate policy over the past decade. It hasn’t provided companies with the certainty to make long- term investments in decarbonisation.

However, that is changing. Dunne believes that with the right policy settings and a government committed to helping create and be part of that roadmap, Australia has got a great opportunity.

“This is in terms of having a significant pool of capital that’s looking to actually invest in this transition and has 20-plus year horizons,” says Dunne.