Planetary Pulse | Chapter 2

Beating the barriers

Why are asset owners not more invested in transition finance?

17 Oct 2022

4minutes

Why are asset owners not more invested in transition finance?

Why are asset owners not more invested in transition finance?

There are several reasons. One of the most important is that it requires them to make a shift in their approach or culture. In our survey, for example, more than half of asset owners (55%) say their fund is not focused on any goal beyond the risk and return performance of their assets.

Portfolio managers at these asset owners are not driven by top-down sustainability principles. They could, of course, invest in transition finance, if they believe it would improve the risk-return profile of the fund, but they are less likely to be seeking such investments.

There is also the idea that climate-related investing leads to lower returns, which 40% of asset owners in our survey believe.

“Most investment professionals have grown up in an era where the framing of sustainability has typically been concessionary,” says Alison Loat, managing director, sustainable investing and innovation at OPTrust, a CA$25 billion Canadian pension plan. “There has been a huge mindset shift, because it is no longer always true, yet the framing still exists for many.”

Loat says that shifting towards transition finance involves asking different questions, gathering new data, challenging our assumptions and instilling new approaches into diligence, assessment and stewardship.

Committed for the long term

For funds that have positive climate outcomes as an explicit objective, there is another challenge: short-termism.

In 2022, the soaring cost of energy reminded the world of the risks of a disorderly transition. Some of the highest-emitting companies in the world made enormous profits, and their investors shared in the returns.

Climate-focused funds are unlikely to have owned many of these companies, and would have missed out on the ensuing dividends windfall.

“Having a bias towards positive climate outcomes means you have to tolerate some periods of shorter-term underperformance,” says Daniel Spencer, portfolio manager at Brunel Pension Partnership, a £35 billion UK local government pension scheme. “There’s no corrective action we take, because our climate outcomes are a permanent feature of our funds. But we expect that in the longer term we are positioned to benefit from the transition towards a lower-carbon environment, and that we are doing the right thing from a fiduciary standpoint.”

Nurturing institution-grade opportunities

For transition finance to grow faster, asset owners and investors need a greater pool of viable opportunities. In our survey, the most commonly cited barrier to transition finance is simply a lack of companies with credible and feasible transition plans — this was cited by 60% of respondents.

Established institutional investors are not used to micro-managing a fund or a company to improve their investment potential. “We can’t be investing in moon shots — as a pension plan, that’s not our purpose,” says Loat. “Everybody is trying to work through how to get more climate opportunities to an institutional level. There is an aspiration to invest more in transition finance, and we have to ensure funds and companies that we invest in have the governance procedures in place to adhere to what we require as an institutional investor.”

Another top barrier, which is cited by 55%, is the difficulty asset owners face in measuring and quantifying an organisation’s progress in its climate strategy or related projects. This is something that should steadily improve as disclosure and data regulations change and transition finance matures, but it is complex and challenging for today’s asset owners.

“We track various KPIs, such as emissions intensity, science-based targets, ESG ratings, and so on,” says one sustainability leader at a European asset owner, “But we can only manage those KPIs that are reliable and can be tracked reliably. We don’t like estimation models when it comes to emissions, for instance. We need more progress in this area — we need good quality data, especially data directly from high-emitting companies.”

How do we increase transition finance?

“I think I would probably start with the policy framework. So what do I actually need in the real economy? What are the specific outcomes we want? Then we need some certainty. One of the common questions is, ‘What is the plan for this sector?’ One of the examples we keep going back to — and which we want more of — is the announcements that have been made around the internal combustion engine and the shift to electric vehicles. That has set some clear timelines that policymakers, regulators, car manufacturers and investors can all get behind, because we know there are set deadlines within different markets for different parts of this, and a very clear transition plan for the shift to electric vehicles. We need similar types of long-term, well-thought-through strategies for each of our sectors.”

Faith Ward, Chief Responsible Investment Officer, Brunel Pension Partnership

The barrier outlook

  Rated a
'major barrier' today
Expected
to worsen
Expected
to improve
Insufficient companies with credible, realistic and feasible transition plans 27% 24% 17%
Difficulty measuring or quantifying company progress in climate strategy/projects 26% 24% 24%
Internal resistance to changing traditional strategies 25% 29% 20%
Expected returns are too low 25% 26% 18%
Beneficiaries demanding low-carbon only, not transition finance 24% 29% 15%
Lack of beneficiary demand for climate-related investments 21% 17% 14%
Transition finance does not easily integrate with our allocation approach 20% 9% 8%
Lack of transparency into investee activities 18% 19% 21%
Lack of clarity on the definitions or criteria for transition finance assets 16% 18% 18%
Insufficient track record for transition finance assets 15% 22% 19%
Lack of consultant advice on how to invest in transition finance assets 15% 11% 21%
Reputational risk 15% 18% 20%
Lack of suitable asset-management products 15% 19% 26%

 

Next chapter:

The emerging net-zero world

Emerging market transition finance will be critical to successful climate action.

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