Cop26 Perspectives

The ESG Interview: Why Size Matters in the Race to Net Zero

Roger Urwin, Co-founder of the Thinking Ahead Institute, says large asset owners must begin to pull their weight, collectively and individually.

Last month, the Glasgow Financial Alliance for Net Zero (GFANZ) declared that over US$130 trillion of private capital is committed to “transforming the economy for net zero”.

Mark Carney, GFANZ Co-chair and UN Special Envoy for Climate Action and Finance, told delegates at COP26: “The architecture of the global financial system has been transformed to deliver net zero. We now have the essential plumbing in place to move climate change from the fringes to the forefront of finance so that every financial decision takes climate change into account.”

However, analysis of the commitment made by the world’s largest asset owners to achieving net zero by 2050 suggests that much more ‘essential plumbing’ is needed if the really serious asset flows are going to drive this initiative effectively.

Roger Urwin, Co-founder of the Thinking Ahead Institute (TAI)a not-for-profit sustainable investment research group which is part of global investment consultant Willis Towers Watson – has co-authored a report revealing that of the top 100 asset owners worth US$23 trillion, just 14 have signed up to the GFANZ net zero target.

“When I did the calculations, I thought it might be a bigger figure. When you look at the 60+ organisations in the UN-convened Net Zero Asset Owner Alliance, most of them have less AUM than those in the top 100 asset owners,” Urwin says.

This matters, Urwin says, because it is the top 100 asset owners that have the ‘clout’ to not only influence investee companies to get to net zero, but to encourage other investors to adopt ESG investment strategies.

“It is obvious that everyone can make a small contribution but what we need is a big contribution.”

Prisoner’s dilemma

To clear up any confusion about the trillions of dollars pledged to net zero by GFANZ members despite the absence of the world’s biggest asset owners, Urwin explains that Carney has included commitments from asset managers, and indeed other financial services providers, in the figures.

Urwin says that a distinction must be made between asset owners and their fund managers since it is really the investors themselves that have the influence rather than those who manage the money on their behalf.

“Asset owners have to make the commitments for asset managers to be able to pursue net zero in their portfolios. It is important to see asset owners through the lens of their size, since they are the ones able to move the needle with respect to real world impact.”

Yet size alone is not enough to make a difference. Urwin points to several factors that impede asset owners from taking action.

First is a lack of ‘systems leadership’ which the TAI describes as “understanding that everything connects and behaviours matter”, which manifests itself largely in greater efforts to collaborate and find joint solutions to common problem.

At the same time, Urwin says, many asset owners also fail to practice universal ownership, explained as “the committed interest in improving the investment system built around building better beta for the benefit of all stakeholders”.

Urwin says that in adopting systems leadership and universal ownership, asset owners can “avoid the prisoners’ dilemma, of acting singly and in a self-contained mandate, and instead act collectively and with solidarity as a better path for all”.

To be able to move collectively, however, asset owners need to rethink their fiduciary duty which Urwin says is pegged to outdated interpretations of archaic legislation such as the 1984 case in which Arthur Scargill, a trustee of the UK Mineworkers’ Pension Scheme, refused to invest in assets that competed with coal even if they produced a superior financial outcome.

Urwin says asset owners need to let go of narrow interpretations of fiduciary duty and embrace the recent framework published this summer by law firm Freshfields, commissioned by the Principles for Responsible Investment, which states: “If it was once possible to approach the goal of earning a financial return in isolation from other valued goals, that time is not now. The interdependence between financial and economic activity and the systems on which it relies – and on which achieving broader goals depend – is ever clearer.”

Urwin says: “Investing for a positive impact on the environment should mean an improvement in your portfolio. But this is a broader interpretation of fiduciary duty than the one most asset owners employ which says financial benefit comes before any social or environmental impact.”

He adds: “More sophistication is needed, and asset owners will need to adopt universal ownership theory which has, so far, not come easily.”

If asset owners are to modernise their approach to fiduciary duty, they will need robust data to support them.

Urwin describes the ESG information currently available to asset owners as “messy”, adding: “People are struggling with uneven data which is difficult to apply across multiple investment cases.”

However, he says: “Most people are saying [poor data] is unsatisfactory and while I agree it is a challenge, it is one that must be worked though.”

Some leading asset owners, he says, are already building processes to turn overabundant data into value-adding intellectual capital, thus diminishing reliance on external provider networks over time.

Political bias

Urwin expects the ongoing trend to insourcing asset management by the largest asset owners to drive the move to net zero. He points to Canadian pension funds, two of which are in the top ten global schemes by assets under management, where three-quarters of investment management is undertaken in-house.

“By and large we are seeing [asset owners’] internal teams grow steadily and as result they have specialist expertise in the sustainability area.”

However only the Canada’s largest pension fund (Caisse de dépôt et placement du Québec, which has US$ 390.5 billion AUM) is signed by to GFANZ.

Urwin notes that political bias plays a major part in holding asset owners back from pledging a net zero commitment. For example, none of the ten largest sovereign wealth funds are members of GFANZ, half of which are based in the Middle East with a heavy reliance on oil production. A further two are located in China, responsible for 50% of the world’s coal consumption.

The TAI report states: “Many asset owners must answer to political bodies and can face heavy, unmerited criticism for decisions that are challengeable when results are not immediately positive.”

The way round this, according to Urwin, is more regulatory support which would not only circumvent allegiances that contradict the path to net zero but reinforce the need to include sustainability risk as part of fiduciary duty.

“If anything, we need more net zero regulations being adopted at nation state level that are properly configured for non-state actors. In the UK, fiduciary duty is going to hold people back from doing net zero and you could set regulations to make it a safe harbour,” Urwin says.

Irrespective of more regulation, however, Urwin says it is up to asset owners to push the net zero agenda.

“This is a defining moment for asset owners and it’s decision time. They can stay in their narrow mandates or step up with a systems-leadership mindset to play a galvanising industry role that unleashes a torrent of net zero aligned capital.”

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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