Investing in climate transition and stewardship is critical to achieve net-zero

Last month, Engine No. 1, an activist investor, sent shockwaves through the financial and energy sectors when it succeeded (with the support of powerhouses BlackRock, State Street and Vanguard) in its mission of installing three climate-friendly directors on Exxon’s board with the ultimate objective of pushing the defiant energy company to reduce its carbon footprint.

Engine No. 1’s actions were driven not by ideology, but by its belief that Exxon’s long-term strategy puts shareholder value at risk by failing to adequately address climate risk. This kind of successful investor activism is undoubtedly a harbinger of what is to come. 

Engine No. 1’s strategy is indicative of a larger shift amongst asset owners, asset managers and others to more actively engage with companies on the transition path to a low-carbon economy. At Chevron, a majority of shareholders recently voted for a resolution calling for a substantial reduction in its Scope 3 emissions (emissions associated with its value chain). Investors have also submitted proposals for mandatory climate-related disclosures at major transportation companies such as General Motors, United Airlines and Delta. There is growing pressure from investors to reduce carbon emissions because the effects of not doing so pose material risks to these companies.

In some cases, companies like Exxon simply refuse to plan seriously for how their business model fits in a low carbon economy; in others, commitments to net-zero are not backed up by science-based targets or reasonably available technology. In either case, greenwashing and the failure to set realistic transition pathways are a major threat to shareholder value as well as global net-zero achievement.

An important lesson from Engine No. 1’s Exxon triumph and the successful shareholder vote at Chevron is that achieving net-zero by 2050, cannot be achieved solely by over-investment in companies that are net-zero today (although investment in net-zero companies is itself critical) and divestment from today’s high-emitting companies or sectors.

Rather, getting to net-zero will require active stewardship across all economic sectors to guide today’s laggards through the tough decisions that they will need to take on their 10, 20 or 30-year transition. A portfolio with zero fossil fuel assets will have made less of an impact on global carbon emissions this quarter than Engine No. 1 putting its money — and climate activism — squarely behind one of America’s most intransigent fossil fuel companies.  

Not only does active stewardship with respect to companies’ transition pathways make good climate sense — it makes good investment sense. Fostering longer-term stewardship and engagement with a company in transition is not only more effective in mitigating climate change, but also in ensuring higher returns on investments. Successful and active engagement is significantly correlated with profitability of the corresponding company. This relationship makes sense: around 60 percent of companies in the S&P 500 (with a market capitalization of $18 trillion) hold assets at high risk of physical climate change impacts, including wildfires, water stress, heatwaves and hurricanes. While it is easier to show that one’s portfolio only involves today’s green companies, stewardship and engagement with high-emitting companies and sectors can materially reduce carbon emissions through net-zero carbon strategic advisory, knowledge sharing and coordination to operationalize sustainability. 

While there has been popular activism toward divestment from fossil fuel and other high-emitting sectors, divestment should be selective; divestment may make most sense as part of a broader strategy toward climate-aligned investing following escalations in engagement and persistent failures of a company to incorporate climate-aligned strategies, rather than as a first step. When a company does not meaningfully respond to the risks it faces, it makes financial sense to divest.

Critically, the push for active stewardship and engagement will require a regulatory framework — including both a taxonomy and disclosure requirements — that take transition into account. Regulators in Europe, the U.S., China and elsewhere are considering or already implementing climate-related disclosure and other requirements. In each case, the ultimate success or failure of these regulations will hinge on how they account for transitions.

For example, the EU Sustainable Finance Taxonomy, in addition to establishing a unified classification system for green and sustainable economic activities, must help investors, companies and issuers to navigate, and value, the transition to a low-carbon economy. The taxonomy classifies transitional activities that are not yet fully sustainable but have best industry-level emissions practices and does not lock in polluting assets or crowd out greener approaches. The EU’s approach is dynamic, allowing for further transitional and enabling activities to be added over time. But more needs to be done in the taxonomy space to account for transition: for example, indicators that monitor incremental progress toward a net-zero target will help to incentivize various actors to make a step-by-step transition.

Other economies, including the U.S. and China, are trailing the EU but are quickly playing catch-up. As the U.S. Securities and Exchange Commission proceeds to develop disclosure rules related to climate change, disclosure focused on alignment with transitional activities and not merely a static picture of where a company is at today will be critical to the creation of products that can adequately and accurately capture these activities. 

Forthcoming climate stress tests conducted by central banks, which will undoubtedly provide a wake-up call with respect to climate-related risks to financial systems, should be a call to action today, and must also highlight the data and reporting gaps that must be developed and implemented to allow regulators and investors to track, measure and value a company’s transition.

Engine No.1’s success is a pioneering example of shareholder activism and climate action. In the near future, we can expect such shareholder stewardship to become a common and effective strategy for engaging companies, and this value should be supported and recognized by reporting standards and taxonomies. With time, engagement and coordination, stewardship has the potential for real carbon reductions consistent with the goals of the Paris Agreement.

Jia Jun Lee is a research assistant at the Columbia Center on Sustainable Investment, Columbia University. He previously worked for the World Bank. 

Brooke Güven is senior legal researcher at the Columbia Center on Sustainable Investment, an applied research focused on aligning investment with the Sustainable Development Goals. Follow us at @Ccsi_Columbia. 

 Lisa Sachs is director at the Columbia Center on Sustainable Investment.