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Business Commentary Institutional investors must lead our transition to long-term sustainability

Dr. Janis Sarra is Presidential Distinguished Professor and professor of law at the Allard School of Law, University of British Columbia.

University of Toronto President Meric Gertler's announcement this week that his school will direct its $6.5-billion in assets under long-term management toward the fight against climate change is a welcome development.

At the recent COP21 conference in Paris, 195 countries adopted the first-ever "universal, legally binding global climate deal," committing to limit global warming "to below 2 degrees Celsius above pre-industrial levels," with a further goal of working toward a 1.5-degree limit. The science is now clear: Under our current approach to emissions, we will face severe water and food scarcity and irreversible loss in biodiversity within 40 years. The International Energy Agency estimates that the world must invest at least an additional $1-trillion (U.S.) a year into clean energy by 2050 if there is any hope of limiting global warming.

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Carbon dioxide is the greenhouse gas to be most concerned about, as its life in the atmosphere is up to hundreds of millennia, far longer than other human-released greenhouse gas. There is need to drastically reduce our use of fossil fuels, the most serious generator of such emissions. And yet in 2015, the top 200 fossil-fuel companies allocated $674-billion (U.S.) for developing more reserves, and governments continue with fossil-fuel subsidies of $548-billion a year, revealing a disconnect between global aspirational discussions and economic reality.

Institutional investors have an important role to play in charting a new course in corporate approaches to climate change, aimed at long-term sustainability. Institutional investors, such as pension funds, are by their nature "patient capital" because of their size in the market and illiquidity of their shares. Collectively, they can have a significant influence on corporate decision makers in tackling climate change.

Aside from our collective public interest in a sustainable world, there is a business case to be made. At risk is a significant portion of the value of diversified investment portfolios. Howard Covington of Cambridge and Raj Thamotheram of Oxford have suggested that value at risk due to climate change in just 15 years could result in a permanent reduction of up to 20 per cent in portfolio value. Hence, there are compelling reasons for capital-markets participants to aggressively press for immediate and comprehensive action. Indeed, it can be argued that institutional investors have a fiduciary duty to act to prevent risk to their portfolios from anthropogenic climate change. The strategies need to be multifold: decarbonization of electricity, a massive move to clean energy or lower carbon fuels, less waste in all sectors, improvement of forests and other natural carbon sinks.

There is a nascent but growing type of institutional shareholder activism called "forceful stewardship," in which investors are demanding a recasting of fiduciary obligation away from short-term shareholder returns toward ethical obligations and reduction of long-term environmental risks. Forceful stewardship involves helping directors and officers of all types of businesses understand that it is a breach of their fiduciary duties to ignore long-term environmental risks such as climate change. This activism by our most powerful advocates in the market is an important development in the potential to change the current course of climate change.

The University of Toronto commitment is to direct its investments actively and in a targeted way, integrating environmental, social and governance (ESG) factors, including climate-related risk and a move toward a low-carbon economy, recognizing that such a move aligns with the long-term financial best interests of its beneficiaries.

The university did not adopt a strategy of wholesale divesting from fossil-fuel companies, but rather, it will vote proactively on shareholder resolutions aimed at reducing climate-related risk for firms it's directly invested in, evaluate these firms for reduction of emissions and lowering of carbon footprint, and use its shareholder weight to exert pressure on firm management to adopt ESG practices.

Dr. Gertler observed that fossil-fuel producers account for just 25 per cent of Canada's greenhouse-gas emissions, so that its investment decisions will also target other sectors, such as transportation, which currently accounts for 43 per cent of Ontario's emissions. Over the longer term, the university will seriously consider extending its new investment approach to its indirect investments through pooled and indexed funds. The university will also join the United Nations-supported Principles for Responsible Investment Initiative, an international network of investors with $59-trillion (U.S.) under management, working together to put responsible investment into practice, including environmental sustainability.

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Another recent example is the Swedish pension fund AP4, which is committed to decarbonizing its entire $20-billion listed-equities portfolio in less than five years. It has a multifaceted strategy that includes opting out of companies with the greatest and most negative impact on the environment in terms of carbon dioxide emissions; providing funding for more green projects by being active in the primary market of the new issue of green bonds; and participating in the trading of green bonds on the secondary market to help the asset class become more liquid and more attractive. AP4 is a member of the Portfolio Decarbonization Coalition, a coalition of 25 investors committed to the decarbonization of $600-billion in assets under management.

Forceful stewardship has potential impact across the financial system. For example, Lloyds Banking Group announced last month that it will offer £1-billion in cut-rate loans for green buildings, citing investor pressure.

Preventable Surprises, a "think-do" tank that seeks to assist institutional investors align their activities with the long-term needs of their members, has suggested how investors might play a bigger role in the solution to climate risk. Investors can declare their intentions to vote in favour of shareholder resolutions to help reduce systemic climate risk while growing shareholder value in the long term. They can vote in favour of resolutions that call for listed companies to publish robust analyses of their assessments of the physical and economic impacts to their businesses of carbon budgets. And they can press for a halt to the hundreds of millions of dollars spent on lobbying campaigns by the fossil-fuel industry to mislead the public about climate science and delay adoption of cost-effective policies.

Institutional investors need to be innovative in how they encourage a shift away from short-termism. One approach is to seek amendment of corporate charters to specify that the company is to be managed in keeping with the objectives of the Paris Agreement, specifically, to hold the increase in the global average temperature to well below 1.5 degrees C above preindustrial levels. Enshrining such objectives in the constating documents would give directors and officers an express mandate to make business judgments with that corporate purpose in mind. The time for investor leadership is now.

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