A group of blue paper planes in flight

Beyond PRI: How (and Why) to Become a Climate Leader

September 17, 2020

Asset managers have flocked to become members of the Principles for Responsible Investment (PRI). With climate change rising up the agenda, how will you stand out?

Over the last decade, responsible investment has moved from fringe to mainstream. Asset managers have responded to new market dynamics and reassessed their investment processes to understand how ESG factors can be integrated to identify risks and opportunities. But in recent years, climate change has emerged as a portfolio-wide, systemic risk which requires another, similar reassessment. Asset owners are developing climate strategies and asset managers are responding with climate-integrated investment products using best available (and rapidly evolving) methodologies. This is the new landscape of institutional investment. But with the emergence of climate change into the mainstream investment world, how can PRI signatories stand out?

PRI membership doesn’t mean climate capable.

The PRI’s membership numbers have grown substantially over the last decade, quickly surpassing 3,500 members globally, with 2,413 being asset managers as of September 2020. In fact, 48 of the world’s top 50 asset managers are currently members. While membership means you have committed to integrate ESG considerations into your investment processes and exercise responsible stewardship of your clients’ capital, in 2020, this may simply be table stakes.

Being a PRI signatory does not mean asset managers are effectively integrating climate change risk into investment processes and strategies. In February 2018, the PRI announced that their reporting would be aligned with climate-specific indicators from the Task Force on Climate-related Financial Disclosures (TCFD) recommended governance and strategy indicators. Starting in 2020, reporting to the PRI would be mandatory but public disclosure would be voluntary. A recent PRI analysis of their 2020 reporting cycle found that only 2% of investor signatories are strategically implementing all the recommendations of the TCFD, while 74% of signatories remain in the early stages of TCFD implementation. The analysis also states that only 18% of investment manager signatories chose to make their PRI climate disclosures publicly available.

The PRI’s analysis shows that the majority of their signatories are not yet strategically managing climate-related risks and opportunities. While asset manager PRI signatories stand out with their commitment to responsible investment, more work is needed to stand out on the critical issue of climate change.

Key drivers for asset managers to build climate capabilities.

Asset owners’ are advancing their climate strategies.

Leading asset owners are recognizing the profound financial risks that climate change poses to their investment portfolios. Highlighted by asset owner-led groups such as the Net Zero Asset Owner Alliance, they have shown an understanding that, as long-term investors, a net-zero emissions future is economically and socially essential. These asset owners are using their resources and ambitions to develop climate investing frameworks and other best practices, blazing the trail for others to follow.

Asset managers need to ensure they are keeping pace with their clients’ growing expectations. Climate change is due to play an increasing and significant role in asset owners’ manager due diligence, selection, and monitoring processes, meaning asset managers need to be proactive with their responses and show how climate change has been considered.

Regulation is on its way.

Financial regulators across the world have woken up to their role of addressing climate risk in financial markets. Earlier this week, New Zealand became the first country in the world to introduce mandatory TCFD-aligned reporting for asset managers, as well as banks, insurers, and listed companies. The UK Department for Work & Pensions (DWP) is currently seeking consultation on a proposal to introduce mandatory TCFD reporting for large occupational pensions schemes (>£5bn) with smaller schemes (>£1bn) expected to follow closely behind. In March, the DWP published a non-statutory guidance document for pension trustees with a dedicated section on “Enquiries to make of asset managers” which states: “In line with their fiduciary duty, trustees should rigorously assess the capabilities and approach to climate management of new and existing managers on the factors below, structured in line with the TCFD recommendations.”

New Zealand and the UK are not alone on their journey. Canada’s Expert Panel on Sustainable Finance recommended the federal government, “define and pursue a Canadian approach to implementing the recommendations of the TCFD”, while France, Japan and the EU are all actively seeking climate disclosures from financial market participants.

Reputational risk is rising.

As institutional investors become more knowledgeable on climate change, developing authentic climate-related investment approaches is crucial for asset managers to maintain a positive market reputation. Initiatives are emerging to prevent “greenwashing” and enable greater transparency and integrity in investment products. These product labelling or disclosure schemes are designed to prevent asset managers from misinforming investors on the sustainability or “green” credentials of their investment products.

For example, the EU’s Sustainable Taxonomy, which identifies economic activities that qualify as “green”, is complemented by regulation asking asset managers to disclose their sustainable investment products’ alignment with the Sustainable Taxonomy. France’s financial markets regulator, The Autorité des Marchés Financiers’, has outlined requirements limiting asset managers’ ability to label investment products as sustainable, green, low-carbon, etc. without demonstrating a “significantly engaging methodology” (i.e. evidence that climate-related criteria has a significant impact on the investment decision-making process). And more is on the way. The EU Commission is developing standards for green bonds and green retail investment products using the Sustainable Taxonomy, while Canada could see similar initiatives take place with the creation of its Transition Taxonomy.

These new developments mean asset managers’ sustainable investment products need to be supported with an authentic and transparent approach. Asset owners will require greater levels of stringency and transparency, while asset managers will need to keep pace with their peers to attract capital from increasingly climate-aware investors.

How do asset managers stand out on climate change?

Company leadership needs to buy-in.

Organizations need to signal senior-level leadership and support on climate change to show corporate-wide prioritization. There are many ways to signal that taking climate change seriously is not an ad hoc initiative but is rather embedded in the corporate DNA: statements from the C-suite or board members, active membership of key industry collaborations on climate change, public support for the TCFD, evidence of board and management-level oversight, and public dialogue on climate-related issues, to name a few. Just as the PRI stamp has become an integral part of asset owners’ manager due diligence, these additional steps can highlight an asset manager’s commitment for addressing climate change both as an investment risk and a global imperative.

It’s not that you do it, it’s how you do it.

One common observation we at Mantle314 often find in climate-related disclosures is that the information provided is too boilerplate and lacks sufficient detail. Asset managers often disclose climate-related information without being transparent about how the integration of climate change factors has altered their investment and organizational processes. For example, an asset manager may disclose the climate-related risks and opportunities they’ve identified but provide little information on the processes behind how they have identified those risks. Can you support high-level disclosure statements with further substance and specifics?

Another example is for asset managers to disclose that engagement with investee companies plays an important role within their climate strategy. This may be true, but investors need to understand how it has played a role. Can you provide case studies of successful engagements and their outcomes? Do you have an escalation process in place if engagements are unsuccessful?

Investors need to understand that asset managers have the processes in place to manage climate-related risks and opportunities as they emerge. More focus should be on telling your story.

Don’t forget about the opportunities!

Climate change presents significant risks for investors, but the opportunities from the transition to a low-carbon economy, and the need to adapt to increasing physical climate impacts, should not be overlooked. As asset owners continue to develop long-term climate strategies for their investment portfolios such as net-zero portfolio emissions, investment allocations to climate opportunities will play a critical role. Asset managers who provide authentic and transparent investment products that seize these opportunities will stand out in this increasingly crowded space.

For asset managers, climate change shouldn’t only be cited as a reason you don’t choose some investment opportunities, it should increasingly cited for why you do chose others.