FTSE chief: Green investors can’t just divest from everything

In setting out a pathway for the low-carbon transition in a fossil fuel-based emerging economy such as South Africa, the declaration highlighted the tension between the urgency of transitioning to net zero by 2050 and ensuring people have continued access to energy.

A country like South Africa poses important challenges for investors. It is heavily dependent on coal-fired power generation and on the mining and industrial sectors. It also faces development challenges, including poverty, inequality and unemployment.

Turning off fossil fuel-based power generation is simply not an option, as there isn’t any existing alternative renewable energy capacity. The reality is that changing energy infrastructure of a country such as South Africa is the work of decades, not a few years.

That is where investors can play a vital role.

Firstly, they have a role as shareholders in companies drawing energy from the existing fossil fuel-based system. Secondly, they have a role as owners of sovereign bonds.

But most important is the role to be played as providers of transition finance for those same companies and the government to meet net zero objectives. A very large part of this capital will need to be provided by private investors who will need to earn solid returns.

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We should be under no illusion that this will be easy, as investors face strong pressure to dramatically reduce greenhouse gas-emissions in their portfolios. This is in turn creating pressure to reduce investments in higher emitting companies and, as a consequence, risks reducing investments in major industrial sectors in emerging economies.

While the logic is obvious from the perspective of climate change, decisions to disinvest or decarbonise your portfolio rather than to engage and own a company through a complex transition could have significant undesirable consequences. These may lead to long-term investors effectively washing their hands of investments in emerging markets. This ultimately would deny economies such as South Africa’s the very capital they need to transition to the net-zero future to which they are committed.

We are not arguing that investors should simply ignore climate change or see it as an issue to be addressed in the decades to come. Rather, we are arguing that investors now need to take a more engaged and long-term approach to investing in high-impact sectors. This means providing capital needed to transition over time and working with companies to ensure that they take effective action to manage and mitigate any negative social consequences associated with this transition.

It requires us to enter into new partnerships with governments, companies and civil society, based on transparency of country and company transition plans and targets. That can enable financial commitments to be made from investors alongside public commitments such as the $8.5bn outlined in the South Africa declaration.

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To do this will require us to be transparent and accountable. This is where investor interventions such as the Transition Pathway Initiative, backed by more than 120 investors with more than $40tn in combined assets under management, will play a key role.

Over the past five years, investors with FTSE Russell have worked together with the London School of Economics and Political Science’s Grantham Research Institute on Climate Change and the Environment to develop a framework that enables us to assess the credibility of companies’ decarbonisation strategies and to address questions such as whether they are committed to net zero, have implemented management strategies and processes to deliver on that, and are performing against those commitments.

While initial focus has been on greenhouse gas emissions, we will be integrating social issues — the ‘just’ transition — into these assessments. This will enable us to assess how well companies are navigating the low-carbon transition.

TPI will be a key tool for investors to demonstrate the effectiveness of their engagement activities, and to demonstrate that they are supporting a transition that is both low carbon and socially just. TPI is increasingly being integrated into more sophisticated indices and passive investments that take into account these assessments and facilitate transparent redirection of capital.

Be under no illusion, this is a harder path to pursue than disinvestment. It requires the courage to own high-carbon companies through the transition. It requires us to stand with emerging economies to understand what the transition means at the national level and how we can work practically in new partnerships to provide the necessary transition finance.

More asset owners and fund managers need to join in to provide the confidence for governments to go further and faster.