Wall Street Sees Opportunity in Low-Carbon Investments

By Fatima Maria Ahmad

As climate change leadership takes on a new face, businesses are taking on greater significance and responsibility in leading the way. We see utilities adopting more low- and zero-carbon generation sources, manufacturers investing in electrification and fuel cell technologies, and financial institutions finding ways to satisfy consumer demand for climate-friendly options.

Investors are increasingly interested in financial products that include an evaluation of a company’s performance on matters related to environmental, social, and governance (ESG) issues that take into account considerations of labor practices, human rights, corporate governance, and environmental impacts.

Strong performance on ESG issues may also influence the long-term financial performance of a company. Experience suggests that many companies that perform well on ESG issues offer opportunities for lower volatility and higher long-term financial returns for investors. More broadly, the public’s perception of the role of business in society continues to evolve as both consumers and investors increasingly expect businesses to adopt sustainable practices. Taken together, these trends have led to a growing market for ESG indices – financial products that evaluate companies based on ESG factors.

Though indices – groupings of equities from selected companies – were originally developed to measure the performance of markets, over time they have become popular as a passive investment strategy. With respect to climate change, investors are often interested in products like low-carbon indices, which evaluate factors like a company’s production of fossil fuels, total greenhouse gas emissions (GHG), and GHG intensity. There are many other varieties of ESG indices developed to consider climate change, such as index funds focused on climate-related opportunities that invest in companies developing clean energy technologies. The variety of ESG indices allows different investors to use different financial products to achieve their investment goals.

C2ES organized a recent webinar featuring leading experts on sustainable finance and ESG indices. Those financial industry experts pointed to milestones like the January 2018 announcement from the New York State Common Retirement Fund (NYSCRF) – the third largest pension fund in the U.S. – that it plans to double its investment in the Risk-Aware Low Emission (RALE) equities index from $2 billion to $4 billion. NYSCRF was the first U.S. public pension fund to create a low-carbon index. The RALE strategy aims for a carbon footprint that is 75 percent lower than the Russell 1000 index benchmark. In March 2018, NYSCRF also established a Decarbonization Advisory Panel, signaling a long-term commitment to the issue.

There are a number of policy developments that are driving the growth of this field. For example, in January, the European Commission High Level Expert Group on Sustainable Finance reviewed challenges and opportunities related to the European Union’s sustainable finance policy and issued recommendations for how the financial sector can better support the transition to a lower-carbon economy. The recommendations include clarifying the fiduciary duties of investors with respect to the achievement of a more sustainable financial system and enhancing sustainability-related disclosures by companies and institutional investors.

Certainly, there are challenges facing ESG investors. For example, there are data quality challenges related to the lack of consistent and comparable data. This is a cross-cutting challenge related to many aspects of sustainable finance, including corporate climate reporting as addressed by a C2ES brief, Beyond the Horizon: Corporate Reporting on Climate Change. The G20’s Financial Stability Board created a Task Force on Climate-related Financial Disclosures to provide an industry-led option for more comprehensive and consistent corporate climate reporting, and their recommendations included more standardized disclosure of climate-related metrics and targets. Over time, as more companies provide similar types of data on climate-related metrics and targets, increased standardization is likely to develop.

Another challenge is the uncertainty of whether the growth of ESG indices is leading to GHG emission reductions and investments in low- and zero-carbon technologies over-and-above business as usual, i.e. the question of whether ESG indices create additionality. This is another cross-cutting challenge that also is raised by the announcement of corporate targets for investments in renewable energy.

Despite these research challenges, investor interest is growing, both from public pension funds and national government funds in ESG indices, helping achieve the investment goals needed to transition to a lower-carbon economy. For example, under the United Nations 2030 Sustainable Development Agenda, it is expected that more than $90 trillion of investment is needed to develop low-carbon infrastructure by 2030.

Low-carbon technologies and infrastructure investment opportunities may become more appealing to companies if they are aware of the opportunity to market them to socially responsible investors and institutional investors. As investor interest in ESG indices grows, we can expect to see more climate-friendly investment opportunities and more potential to make them profitable as corporate America moves toward a low-carbon future. The alignment of private capital with long-term emissions reductions goals is already proving a powerful tool.