From the halls of the Capitol to the steps of statehouses across the U.S., policymakers are locked in a fierce debate about ESG.
Even titans of the financial world, such as BlackRock CEO Larry Fink, have begun to stop using this term, partly to avoid accusations of being part of a “woke” establishment. Meanwhile, Republican legislators across the country have accused many major institutions that have embraced the practice of putting a divisive ideology ahead of investor returns and “boycotting” vital oil and gas industries.
While some applications of ESG, which stands for environmental, social and corporate governance, are valid for healthy debate, a theme is seemingly emerging in which all such investment considerations are seen as ideological. Similarly, there has been an increase in political “anti-ESG” commentary, which threatens to undermine investors’ ability to tackle some of the most widely recognized and science-based ESG risks, including those posed by unmitigated climate change.
At this point, the science is unequivocal: Climate change is affecting the global economy and promises to do more harm if we continue with a business-as-usual approach. Damages from natural disasters, which are exacerbated by climate change, totaled $165 billion in 2022 alone. According to a study by Swiss Re, a multinational reinsurer, climate change could reduce economic output worldwide by $23 trillion by 2050, equivalent to the entire U.S. GDP in 2021.
These numbers speak for themselves. The effects of rising temperatures are reverberating across the economy, depressing productivity, increasing scarcity and imperiling the continued health of the global economic system. For long-term institutional investors, adverse climate impacts pose an existential threat.
Responding to realities
Beyond the emerging political debates, investors must consider how their investments impact — and are impacted by — the ongoing climate crisis.
The first step is recognizing that the global economy must rapidly shift away from its dependency on carbon-intensive energy sources. The idea that fossil fuels and anthropogenic carbon emissions are the primary contributor to climate change is not politically driven. Rather, scientific evidence supports this, as acknowledged by the American Petroleum Institute, the International Energy Agency, countless oil and gas companies and the world’s scientific community. Investors and corporate leaders must integrate this fact into their business steering and decision-making.
To avoid potential massive losses for companies and investors, the response to this reality must meet the challenge at its scale. The costs and risks of climate change and of other environmental damages are borne by all of civilization, the global economy and nature at large. It follows, then, that solutions to the climate crisis must also occur at the systemic level.
Systemic solutions require action by all stakeholders across all facets of the economy. The specifics of the transition away from fossil fuel dependency will look different for these various stakeholders, but the common thread is one of cost and risk distribution, proportional to the risks posed when considering the alternative of unmitigated climate change.
This does, of course, have implications for the fossil fuel industry. Historically, the social benefits created by the fossil fuel industry included job creation and the growth of communities who came to depend upon the industry for economic sustenance. Fossil fuels remain economically critical today and will certainly play a pivotal role in the climate transition. But the truth is that continued fossil fuel investment, even in the short term, creates risk for the entire economy. This is not driven by ideology, nor a desire to “boycott” thriving businesses, but by overwhelming evidence that continued investment in fossil fuels will exacerbate climate change, create uncertainties for companies and threaten future returns for investors.
Fulfilling fiduciary responsibilities
Clearly, global warming is a societal and economic concern that will have direct and significant effects on investors. The implication is that investors have a fiduciary responsibility to act on it.
A key focus of the debate around ESG and climate-aware investing is the extent to which investors are working together to address the realities described above. Naturally, investors’ fiduciary duty requires them to consider, evaluate and make decisions based on what supports the best interests of their beneficiaries. The need to respond to this is fundamentally an individual responsibility. Nevertheless, in the face of the existential threats posed by climate change, it is widely recognized that there are efficiencies gained from working independently in a joint effort.
Voluntary, private-sector alliances can help inform, shape and drive action when they are seen as credible and involve a critical mass of private-sector actors. Such alliances can also help to significantly catalyze and accelerate government policy and regulatory reform by politically elevating relevant topics and by providing policymakers with the proof of concept and of viability for actions that are needed.
The U.N.-convened Net Zero Asset Owner Alliance (NZAOA) was created to bridge this gap. Members represent funds from across the world, each with their own stances on ESG as a whole, and the specifics of addressing climate risk.
Members benefit from positive association, a sign to their clients and other investors that they are committed to solving pressing issues with a direct impact on their returns. All members set individual targets and are committed to decarbonizing their investment portfolios and achieving net-zero emissions by 2050. While the NZAOA sets baseline recommended minimum science-based standards, members decide individually how to reach their own targets.
This represents a bottom-up business-led initiative to create value for investors. Once set, these “soft science-based standards” can create a ready-made template for policymakers to shape into smart, business-friendly regulation that is informed by real market experience. This is precisely the level of action needed to support systemic climate solutions, ultimately helping individual members fulfill their fiduciary responsibilities to manage risks.
Collaboration with policymakers
While we may disagree on a whole number of cultural and political issues concerning the financial world, the reality is that climate change cannot be one of them.
Rather than painting this effort as ideological, policymakers have a golden opportunity to engage with financial institutions to create regulation that is both climate-friendly and business-friendly. We have a narrow window, that is steadily shrinking, to deliver these benefits and avert climate disaster.
Günther Thallinger is chair of the UN-convened Net-Zero Asset Owner Alliance, and a member of the Board of Management of Allianz SE.