Biodiversity, Externatlities and Universal Ownership


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Neil McIndoe, Head of Environmental Finance - Trucost Plc - United Kingdom

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  • Transparency of financial risks in sub prime mortgage securities was low – and so is carbon risk
  • The example above shows that International Power reported 3 different numbers in 2005... we managed to get to the right one by speaking to their company secretary and talking through the numbers.
  • And in this case I won’t name names.... But just to illustrate the point, this company ‘mis-palced’ 70 million tonnes of carbon – more than 10% of the UK’s entire carbon emissions – but allocating to them to scope 2 instead of scope 3.Interestingly this is also the amount of carbon that the UK government committed to cut to meet its 2020 target.In this case, the company is not planning to revise their disclosure to the CDP... And since the CDP do not include data validation in their process, this error will not be corrected until next year.
  • If you think find managers in general are doing this..... Mercer reportEnvironment agency have been measuring the environmental performance of their asset managers for the past four years.At annual meetings, Howard Pearce holds his asset managers to account for the environmental efficiency of their portfolios.Environmental performance has improved year on year.This performance chart was used in the EA report about how they are meeting the UNPRI criteria.LPFA case study: Transalta removed from portfolioComparison between Transalta and Scottish and Southern:Transalta produces almost the same amount of electricity of Scottish and Southern but:Twice as much CO2 emittedTurnover one seventh of Scottish and Southern
  • Biodiversity, Externatlities and Universal Ownership

    1. 1. About Trucost<br /><ul><li>A globally recognised environmental research company with 10 years experience
    2. 2. 45+ staff including 17 research analysts
    3. 3. Clients include UBS, Deutsche Bank, Merrill Lynch, Fortis Investments, GLG Partners, Department for Environment (UK), Virgin Money, Credit Agricole Asset Management, BNP CortolConsors, Euronext NYSE, Henderson Global Investors, Hermes
    4. 4. Authors of the UK Government’s Guidelines on Environmental reporting for companies
    5. 5. Quantitative research approach to environmental performance measurement
    6. 6. Proprietary input/output model calculates emissions in absence of adequate corporate disclosure -Methodology supported by Academic Advisory Panel
    7. 7. World’s largest global database of environmental disclosures</li></ul>0<br />
    8. 8. Universal Owner Project: <br />Addressing externalities through <br />collaborative shareholder engagement<br />
    9. 9. P2<br />The Project<br />Addressing externalities through collaborative shareholder engagement<br />The aims of the project are as follows:<br />Identify and prioritize the most economically harmful environmental externalities related to corporate activity that, if addressed, could have a positive impact on the economy (regionally or globally), the capital markets and ultimately on investor returns.<br />Identify key areas of focus and actions that investors can take such as collaborative shareholder engagement.<br />
    10. 10. P3<br />What are Environmental Externalities?<br />Externalities: A consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative. <br />E.g. Manufacturing that causes air pollution imposes costs on the whole society<br />
    11. 11. P4<br />Drivers of Environmental Externalities<br />Environmental impacts, including resource use, pollution and waste generation from business activities, contribute to the degradation or unsustainable use of two-thirds of ecosystems <br />Economic growth and an increase in the global population from 6.8 billion in 2009 to 9.2 billion in 2050 will add growing pressures to finite resources over coming decades, many of which are being used unsustainably<br />The global economy overall will become increasingly vulnerable to sudden, unpredictable and high-impact changes in ecosystems as “tipping points” are reached at which will accelerate and environmentally, socially and economically harmful effects<br />
    12. 12. P5<br />Environmental Externalities<br />Environmental externalities result in significant costs to the global economy:<br />The Stern Review estimates that if the growth in greenhouse gas emissions continues unabated the estimates of the costs of damage could rise to 20% of annual global GDP or more by 2050<br />In China, economic losses from natural disasters account for 3.5% of GDP in recent years, with climate-related disasters accounting for almost two-thirds of these losses. <br />The World Health Organization estimates that air pollution causes approximately two million premature deaths worldwide each year and that reducing particulate matter emissions could save the European Union up to €161bn per annum– or over 1.7% of EU GDP in 2005<br />
    13. 13. P6<br />Capital markets are intrinsically linked to the global economy<br />The growth in global GDP on an annual basis is highly correlated with the growth in capital markets<br />As a consequence, externalities that affect the growth of the global economy will affect the growth of the capital markets and, therefore, the returns to universal investors<br />
    14. 14. P7<br />Universal Owners<br />A Universal Owner is an institutional owner whose holdings are highly diversified and, typically, held long-term. <br />The holdings of many institutions are a small but significant cross-section of publicly traded stock and debt in the economy and, therefore, represent a share of the entire economy. <br />A truly Universal Owner would own a weighted selection of financial assets in proportion to global capital markets<br />U.S. institutional investors’ ownership of 1,000 largest U.S. Companies was 76% as at 20072<br />The value of the top 3,000 public companies globally equates to ~90% of global equity market3<br />Trucost research<br />Pensions & Investments online, “The 2008 Institutional Investment Report: Trends in Institutional Investor Assets and Equity Ownership of U.S. Corporations”<br />Trucost research, Bloomberg, World Federation of Exchanges<br />Universal Owners are exposed to the effects of externalities on the global economy<br />
    15. 15. P8<br />Findings: Global Environmental Externalities<br />External costs vary by type and region<br />
    16. 16. P9<br />Findings: Major Global Environmental Externalities<br />65% of global environmental externalities arise from greenhouse gas emissions <br />Water abstraction and air pollution are also major externalities causing 25% of global external cost<br />
    17. 17. Ecological crunch – Carbon Crunch<br />Credit crunch<br /><ul><li> There are important parallels between the financial crisis and global warming
    18. 18. We’re living through the credit crunch – are we about to see a carbon crunch?
    19. 19. “We cannot be certain (until it is too late) that continuing to emit carbon at our current pace will lead to disaster; but we do know that the chance of a catastrophic outcome is high enough to make insuring against worst-case scenarios the rational response. Surely the financial crisis has taught us that a low-probability tail risk is still a risk.” FT, Tuesday 3rd November</li></ul>10<br />
    20. 20. Post Copenhagen<br /><ul><li> Many commented on the excess leverage in the global economy, but risk models failed to take this into account
    21. 21. Is there another inconvenient truth out there?
    22. 22. Most scientists believe that human induced climate change is happening
    23. 23. Whatever your personal views, the political establishment has come to believe the scientists
    24. 24. Regulations that place a price on the carbon emissions of companies exist and will increase post Copenhagen</li></ul>11<br />
    25. 25. Post Copenhagen<br /><ul><li> Cap and trade schemes and other carbon pricing methods create winners and losers among companies
    26. 26. Whether a company is a winner or a loser depends on how carbon efficient it is compared to its peers
    27. 27. Goldman Sachs research predicts: “At a carbon cost of US$60, 10% of total cash flow of listed companies will be transferred from companies with below average carbon efficiency to those with above average efficiency.”
    28. 28. Data on the carbon efficiency of companies will increasingly give investment advantage
    29. 29. But it is difficult to get comprehensive, comparable, consistent data</li></ul>12<br />
    30. 30. Environmental reporting: dilemma 1<br />Poor disclosure by companies: some geographies are worse than others<br />
    31. 31. Environmental reporting: dilemma 2<br />Lack of standardisation or inaccurate data when companies do report <br />Example: International Power<br />Reported to CDP4<br /><ul><li> 84,430,200 tonnes CO2</li></ul>Reported to Trucost<br /><ul><li> 68,530,000 tonnes CO2</li></ul>International Power website<br /><ul><li> 52,000,000 tonnes CO2</li></li></ul><li>Environmental reporting: dilemma 2<br />Lack of standardisation or inaccurate data when companies do report <br /><ul><li> “It appears we have not applied the revised GHG protocol definitions”
    32. 32. Resulted in 70 million tonnes of carbon being ‘misplaced’
    33. 33. 10% of the UK’s entire carbon emissions
    34. 34. No revision to the CDP database – no analysts, no model to compare disclosures with</li></li></ul><li>Portfolio carbon footprints<br /><ul><li> Trucost has comprehensive, standardised, normalised data on over 4,500 companies allowing comparison between investment portfolios and benchmark indices
    35. 35. Trucost has 5 years’ back data for most investment indices
    36. 36. Trucost has been commissioned by over 1,000 equity funds with more than 1 trillion in AUM to measure their relative exposure to carbon pricing
    37. 37. It is not uncommon to find funds that are running 5x as much carbon risk relative to their benchmark and peers</li></li></ul><li>Environment Agency Pension Fund reduces its footprint year on year<br />
    38. 38. How can carbon price risk be reduced?<br /><ul><li>Divest of companies in high emitting sectors (negative screening)
    39. 39. Boycott certain sectors entirely
    40. 40. This is what many SRI strategies do in reality
    41. 41. But this has important consequences
    42. 42. It introduces huge non-market risk</li></li></ul><li>How should carbon price risk be reduced?<br /><ul><li> “What is needed are investment strategies that relatively reward companies that are more carbon efficient and which penalise less efficient companies while keeping a neutral exposure to sectors as a whole.”
    43. 43. Trucost has worked with a number of investment companies and index providers to do precisely that – including S&P and Deutsche Bank
    44. 44. Because these strategies do not necessarily exclude any companies and are sector neutral, they track their underlying indices very closely
    45. 45. The tracking error of the S&P US Carbon Efficient Index is around 0.5% yet the re-weighted companies emit 48% less carbon per annum than the S&P500</li></li></ul><li>What happens if carbon prices go up?<br /><ul><li>These funds and indices track their parent indices so they are essentially passive, except in one particular circumstance, i.e. when/if carbon prices increase
    46. 46. They reduce exposure to the systemic risk of regulations designed to control climate change – and they do so at no cost to financial performance
    47. 47. Trucost has proved beyond a shadow of a doubt that it doesn’t cost anything to invest greener
    48. 48. “We cannot be certain (until it is too late) that continuing to emit carbon at our current pace will lead to disaster; but we do know that the chance of a catastrophic outcome is high enough to make insuring against worst-case scenarios the rational response. Surely the financial crisis has taught us that a low-probability tail risk is still a risk.” FT, Tuesday 3rd November</li></li></ul><li>Carbon Optimised Investment Products<br />
    49. 49. Carbon Optimised Investment Products<br />
    50. 50. About Trucost<br />Same financial returns – half the carbon<br />