We are now in Month 14 of the coronavirus pandemic. For institutional investors like pension plans, this pandemic and its consequences highlight the reality of systemic risk: events like the ongoing pandemic can and do happen and pension plans need to get ready.
Because another systemic risk is at our doorstep: climate change. 2020 was one of the three warmest years on record, despite a cooling La Niña event, according to the World Meteorological Organization. The global average temperature was about 1.2° Celsius above the pre-industrial (1850-1900) level and the six years since 2015 have been the warmest on record, with 2011-2020 being the warmest decade on record, according to the WMO.
Read: Earth Day: Strong support for sustainable investing coming from plan members
The transition to a low-carbon economy is already underway — not only has the United States rejoined the Paris Agreement on Climate Change, but the energy transition is advancing — and it’s a multi-trillion dollar investment opportunity. Bloomberg New Energy Finance estimates that over US$10 trillion combined will need to be invested in wind, solar and battery systems to meet climate commitments.
Climate change is not just an environmental challenge — the risks and opportunities that come with it also affect health and equity. A recent analysis in The Lancet found that climate change has a disproportionate impact on the health of disadvantaged populations. This means that climate change doesn’t just impact pension plan assets, it also affects plan members’ health.
The shift from traditional energy sources to new ones presents opportunities, but also equity issues. For example, climate change could potentially displace many employees and require many more to invest in new skills. Governments and investors alike are working to lessen the impact.
Read: Biden presidency accelerating shift toward sustainable investing
In short: change is coming. And any institutional investor with a long-term view — pension plan professionals especially — must be prepared.
Place your bets
What does climate risk look like? It depends on what you think the future looks like. The goal of the Paris climate accord is to cap global temperature increases to 1.5 degree Celsius above pre-industrial levels.
What does this mean? For Canadian firms, and Canadian institutional investors alike, it means being prepared and finding the opportunities that climate transition presents. Pension funds and firms with deep expertise in infrastructure, for example, can help develop the infrastructure that will be needed to transition Canada and the globe to a low-carbon future. Clean energy will benefit, but so will other sectors, including transit, building design, food production and natural-resource management.
Make a plan
A plan for climate change requires a holistic approach — a whole-portfolio assessment of assets and the exposure to climate risk. Investors can place assets on a spectrum between so-called “grey” assets — those assets that generate high-carbon emissions and have limited capacity to transition — and “green” assets, which have low emissions and provide solutions to the net-zero transition. The assets in between become a priority focus area, to shift them through time to become more climate-ready.
By taking a holistic approach, investors can understand the totality of their exposure to climate risk and plan for a transition. This involves: setting current emissions baselines, mapping the transition capacity of current holdings, assessing portfolio opportunities for emission reductions, setting targets for reduction milestones and developing implementation plans that can be integrated within strategy, active engagement and portfolio construction decisions.
Read: Climate change a growing focus for institutional investors in 2021
This requires an adaptive approach. Strategic transition planning should also recognize that short-term flexibility may be needed, and keep in mind that some asset classes might take longer to transition than others.
A time to act
The direction the world is going is clear. In Europe and the U.K. regulators are moving ahead on climate reporting requirements, and Canada isn’t far behind, with the federal government requiring large businesses applying for coronavirus relief to conduct climate scenario analyses. The Bank of Canada and the Office of the Superintendent of Financial Institutions are also studying the implications of climate change on Canadian financial institutions and investors.
Internationally, beyond the Paris climate accords, the United Nations campaign to aggregate commitments to achieve net-zero carbon reductions is gaining momentum. Organizations of all sizes, and governments across the world, are working to reduce emissions and making a low-carbon future a reality.
The time for waiting is over. The time to act is now.
— with files from Monika Freyman, responsible investment leader in Mercer’s wealth business in Canada
Jaqui Parchment is the chief executive officer of Mercer Canada. These are the views of the author and not necessarily those of Benefits Canada.