• Finance Investing
  • Climate Change
  • Climate Action

Investors Use Sustainability Tools to Manage Financial Risk: Here’s How

Sebastian Foot
Nov 19, 2018
Smart Building 5

London’s Environmental Finance Green Equities conference held in October brought together a wide range of major pension funds, asset managers, private equity firms, and advisers. Discussion focused on how they apply climate risk tools, including the Task Force on Climate-Related Financial Disclosure (TCFD) project, and how this effects each of their approaches to investment screening, capital allocation, risk management, and divestment.

“Asset owners can change the weather.”
Archbishop of Canterbury

Mark Carney’s launch of the TCFD in 2017 has helped pension funds, private equity investors, and asset managers consider how climate risks might be incorporated into their decision-making processes. From the screening of potential investment opportunities to managing emerging risks within their existing portfolios, investors are reacting to climate risk in many ways. Each organization is applying the latest climate risk tools with a different focus and timeframe in mind.

Below are highlights of some of the lessons learned about each investor type. 

The Conversation Has Changed
“What’s the barrier to doing this?
There is only upside.”
Environmental Finance, Green Equities Conference,
October 2018

Each investor group took a different approach to what TCFD meant for the investment thesis. Understanding the differences provides a visceral sense of how mature sustainability is within the finance sector: 

  • Pension Funds: With the long view in mind and an eye on future pension liabilities, pension funds are focused on making decisions today that will have a positive impact decades into the future. Proactive funds have applied tools such as the TCFD as a top-down risk management exercise, based on their current portfolio. This can then help inform what portfolio changes may be needed to manage long-term risk and potential opportunities. Short-term spikes in energy or carbon prices are less relevant in how a fund values an asset as they intend to hold their positions over a 20-year plus timeframe. Currently, larger pension funds are applying such screening tools, while smaller funds are banding together to share views and disseminate findings.
  • General Investment Partners: General partners are those who decide which institutions should manage their capital (for example Fund of Fund Managers). While 5 years ago it was unusual to have a general partner ask about climate change assessment, it is now a common part of the conversation. Their knowledge has grown in the area and they want to know how funds incorporate screening into their decision-making process, how they see it adding value, and what it means for portfolio companies. This has led more fund managers to consider how such criteria will be applied in future fundraising rounds. 
“Talent wants to work for businesses
that care.”
North Edge Capital
  • Private Equity: Fund managers aim to acquire companies with the view to exiting them within a 3-5 year timeframe. Each company faces short-term risk (e.g., what fuel price should we assume a NetJet competitor will have to pay). Other risks being considered include how likely the fund can exit the company within a sensible timeframe. 

Climate risk tools are being applied to shape the operation of a portfolio company. For example: a travel company might be asked to weather volatility in the locations they are operating and establish plans accordingly. 

Finally, private equity firms want their portfolio companies to retain talent and reduce absenteeism to ensure that the company can grow and offer better financial returns. Increasingly, embedding sustainability into the mission and processes of the company has been used as a tool to retain employees. 

As long as asset valuations are based on estimated future cash flow, TCFD, and other climate risk management tools will continue to inform the investment decision-making.