November brought us some interesting regulatory announcements and research insights as we begin to wrap up the year. The U.N. climate summit concluded with big climate finance commitments; investor skepticism of greenwashing is rising; the Fed began pressuring big banks to ensure preparedness for climate shocks; Alphabet shareholders filed a proposal for a racial equity audit; and the “divestment vs. engagement” debate rages on. Let’s break it down:
COP is the annual United Nations summit where governments and private actors work toward climate change mitigation pathways. This year, the Glasgow Financial Alliance for Net Zero (Gfanz), which is made up of 450 banks, insurers and asset managers in 45 countries, committed to invest over $130 trillion of private capital to transform the economy for net zero by 2050, accompanied by rigorous reporting and tracking. Some critics expressed doubt in Gfanz’s effectiveness because it does not require financial institutions to make commitments to stop financing fossil fuel companies.
What does this mean for advisors?
The global economy needs to transform at a massive scale to avoid the worst effects of climate change, requiring investment from governments and private investors. Financial advisors should be aware of the potential risks and opportunities that will come with the transition to a low-carbon economy. Many economists warn of “stranded asset” risk, where assets tied to fossil fuels will no longer be able to generate economic return because of the decarbonizing economy. This Gfanz commitment represents the other side of the coin—the investment opportunity to fuel rapid global infrastructure change over the next 30 years.
Both EY and Edelmen released research reports last month showing a continued uptick in investor demand for ESG investment solutions, with 90% of investors caring more about ESG than they did a year ago. Along with the increased attention comes a rise in skepticism. According to EY, 89% of investors said that it would be helpful to have regulators mandate reporting of ESG performance against a set of globally consistent standards. In the Edelmen report, investors agree that companies that excel in ESG merit a premium, but 86% of U.S. investors believe that companies frequently overstate or exaggerate their ESG progress.
What does this mean for advisors?
These studies underscore an important trend: along with the demand for more ESG solutions comes client awareness of greenwashing and desire to avoid it. These latest surveys demonstrate similar conclusions to surveys conducted throughout the second half of 2021, with growing confidence. The best advisors will differentiate themselves on being able to understand their clients’ values and analyze the data behind the investment portfolios, beyond what the fund managers say about themselves, and beyond any one-size-fits-all ESG score.
The Fed is putting pressure on big banks to run climate change risk analyses and release broad findings to the public by 2023. Building off of the stress test framework developed during the 2007–09 financial crisis, banks will have to demonstrate their preparedness for the potential effects of climate change, including physical shocks like extreme weather and sea level rise, as well as potential regulatory action. This announcement follows the lead of European regulators, some of which have already started testing running these scenario analyses for their banks.
What does this mean for advisors?
The anticipated reporting requirements underscore the interconnected implications of climate change, and the different categories of risks to different sectors of the economy. While avoiding investments in fossil fuel companies may seem like a simple solution, advisors will have to pay attention to each industry’s specific risks and opportunities to give good financial advice as the world feels the effects of climate change and goes through rapid decarbonization. In the case of banks, the climate-preparedness of the loan portfolio is vastly more important than, for example, the greenhouse gas emissions from their direct operations. Advisors might look to resources like the Sustainability Accounting Standards Board to understand which issues are most material to companies in each sector.
The Nathan Cummings Foundation filed a shareholder proposal asking Alphabet, the parent company of Google and YouTube, to commission an independent racial equity audit “analyzing Alphabet Inc.’s adverse impacts on Black, Indigenous and People of Color (BIPOC) communities.” Employee members of the Alphabet Workers Union, shareholders and civil rights groups have endorsed the proposal with concern that Alphabet faces legal, financial and reputational risk due to practices that perpetuate racism and employee discrimination. Ultimately, the audit could uncover certain practices that impact Alphabet’s standing in ESG-approved funds.
What does this mean for advisors?
As social and environmental shareholder proposals receive record support from investors, and record levels of implementation by companies, activists and labor organizers are turning to shareholder engagement as a mechanism to change companies. Racial equity is a particularly hot topic in shareholder engagement, as corporate disclosure lags the shareholder demand for action that has skyrocketed since the start of the COVID pandemic. Your clients may be interested in learning more about how they can participate not only in investing in companies that align with their values, but supporting proposals like this one to improve the companies that are already in their portfolios.
A Stanford/Wharton research paper examining the impact of impact investing found investors could achieve more impact by pushing company management to adopt better ESG practices, instead of selling shares in unsavory companies. At the same time, some large asset managers that have engaged with fossil fuel companies are considering taking a new approach, ramping up pressure through divestment and public shareholder activism. Others argue that shareholder activism, investing in solutions, and divestment jointly act as a “carrot and stick” to reward companies for good behavior while bringing negative public pressure to the worst companies on ESG issues.
What does this mean for advisors?
There are many approaches to impact within ESG investing, and many strongly held opinions. Some clients will believe it immoral to do anything short of divesting from industries they consider evil. Others will be swayed by the likes of Engine No. 1, and see the impact potential of activism. The different impact theses must also be considered in the context of financial performance, but again, there is no clear answer. Many investors want to steer clear of fossil fuel assets they think will lose value, while others are attracted to the historical positive impact of shareholder engagement on share price and corporate behavior.
Gabe Rissman is the president and co-founder of YourStake, a platform to help wealth and asset managers to build custom ESG portfolios and provide personalized ESG reporting.