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Californian Pension Funds Face Forced Divestment of Fossil Fuel Holdings

Transaction and opportunity costs from California State Bill misrepresented by CalPERS and CalSTRS, says campaign group.

Two of the largest public pension schemes in the US face a critical legislative hearing this week which could shape the pace and nature of their net zero pathways.

The California State Teachers’ Retirement System (CalSTRS) and the California Public Employees’ Retirement System (CalPERS) have “wildly exaggerated” the costs of divesting fossil fuel holdings, according to climate activist group Fossil Free California (FFC).

Two of the state’s three largest asset owners, representing a combined US$800 billion, have been overstating the negative impact of divestment both in terms of transaction costs and wider potential losses incurred from selling out of investments based on prior experience, an FFC report has found.

The report stated that both funds had “repeatedly given incorrect and inflated figures of the costs of divestment, including in the numbers reported to the Appropriations Committee last month for the Fossil Fuel Divestment Bill (SB 1173)”.

The bill, which is in committee stage and earmarked for a hearing on 19 May, would ban CalSTRS and CalPERS from making further investment in fossil fuel companies or renewing similar existing investments. It requires divestment by 1 July 2027, and annual reports to be submitted to the legislature and Governor from February 2024.

As well as the potential costs, the pension schemes have both opposed the legislation on grounds that it would prevent them from engaging with fossil fuel firms to bring down their emissions levels.

“Divesting from fossil fuels ignores the larger climate-change risks to the portfolio,” said CalSTRS in a written response to ESG Investor. “CalSTRS’ approach is more holistic and includes measuring emissions, engaging directly with companies, working to expand government policies, and investing in solutions.”

Counting the costs

According to FFC, Joycelyn Martinez-Wade, CalSTRS’ governmental affairs director, stated at two recent hearings that previous divestment exercises had cost the fund US$9 billion, while CalPERS CEO Marcie Frost said it had cost CalPERS US$8 billion.

FCC pointed out that Wilshire and Associates, a consulting firm hired by CalPERS, had revealed that for the period to 30 June 2020, CalPERS’ divestment programmes had “delivered positive performance”.

In the case of thermal coal, Wilshire found that consistently divesting had resulted in net gains for CalPERS. The report said that while CalSTRS had not yet published a similar statement, “one would expect similar results”.

The funds have estimated combined holdings of US$11.5 billion in fossil fuel investments that would need to be divested under SB 1173. The bill must pass through a fiscal impact examination, known as ‘suspense’, and carried out by officials, away from public scrutiny, before it can be enacted.

Elsewhere, the report highlighted that CalPERS’ US$75-100 million estimate of transaction costs is contradicted by Wilshire and Associates, surmising that previous costs associated with selling assets had been “negligible in all cases except for tobacco”.

CalSTRS stated it would incur transaction costs of US$11.6 million.

According to the report, a fiscal note accompanying the state of Maine’s fossil fuel divestment legislation described the associated costs of selling shares as “minor”. Additional costs to the Maine Public Employees Retirement System and the Office of the Treasurer of State to implement the legislation could be “absorbed within existing budget resources”, it continued.

FCC added that buying and selling shares is an occurrence transacted regularly by fund managers and that costs were “already covered in the ordinary course of business”.

Turning to potential losses, the report highlighted that while CalSTRS’ deputy chief investment officer, Scott Chan, had publicly anticipated losses of up to US$20 billion as a result of the legislation, separate reports from BlackRock and Meketa Investment Group had concluded that investment funds had suffered no negative financial impacts from divesting from fossil fuels so far, pointing instead to modestly improved returns.

The report also quoted former New York state vice comptroller Tom Sanzillo as saying that those within the investment community arguing losses will be incurred as a result of divestment were “absolutely wrong”.

“Oil and gas stocks have collapsed over time, despite the current high oil and rising stock prices,” he said.

Reasons for opposition

Last month, the CalPERS board voted to oppose SB 1173 as well as another bill requiring divestment from companies with operations in Russia or Belarus.

CalSTRS’ board opposed the proposed law partly on grounds that it has an existing policy to oppose any legislation restricting its authority to administer retirement plans, but also cited negative impacts on pay-outs to beneficiaries, as well as conflicts with its existing policies to reduce portfolio emissions.

According to its analysis, the bill would require CalSTRS to divest from 174 firms with a combined market capitalisation of US$4.1 billion, resulting in a tracking error of approximately 1% from its benchmark.

“Potential costs resulting from a tracking error would put at risk the CalSTRS Funding Plan to reach full funding for California’s public educators. Any resulting costs would increase the unfunded liability and may also result in an increase in the state’s contribution to the Defined Benefit Program,” it said.

Further, the fund said divestment would reduce its ability to accelerate the global transition to a low carbon economy and limit future opportunities for investor engagement. CalSTRS also noted that it would not have been in a position to support Engine No 1’s campaign in 2021 to elect new directors at ExxonMobil had the proposed legislation been in place.

Despite their opposition to legislation forcing divestment by 2030, both schemes have made commitments to reduce portfolio emissions.

In September last year, CalSTRS’ board committed to net-zero greenhouse gas (GHG) emissions by 2050 or sooner, aligning with science-based Paris targets and establishing its own policy which outlined it would take the above measures.

This followed plans to oppose directors failing to achieve equal representation at board level, in a revamp of its diversity strategy.

Last month the fund revealed in its 2022 voting strategy that it would oppose both lack of board diversity at companies and failure to progress on climate change.

CalPERS’ five-year decarbonisation targets, required under its membership of UN Net Zero Asset Owner Alliance, were not included in a progress report published last October,

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