Are large asset owners overstepping the mark by using their claimed status as ‘universal owners’ to justify strong activist agendas on climate change?

Limiting global warming to 1.5°C or very close to it is the headline climate goal of investor initiatives such as Climate Action 100+ (CA100+) and the Net Zero Asset Owners’ Alliance (NZAOA).

Involving over 700 investors, Climate Action 100+ asks the world’s largest corporate greenhouse gas (GHG) emitters to take real action on climate change by reducing emissions across their value chain.

The initiative is coordinated by five investor networks: Asia Investor Group on Climate Change (AIGCC), Ceres, Investor Group on Climate Change (IGCC), Institutional Investors Group on Climate Change (IIGCC) and Principles for Responsible Investment (PRI).

The NZAOA’s institutional investors are committed to transitioning their investment portfolios to net zero emissions, focusing on real-economy outcomes.  This involves “advocating for, and engaging on, corporate and industry action” to deliver “a low-carbon transition of economic sectors in line with science”.

But with increasing doubts about whether there is a credible pathway to limiting the rise in global temperature to no more than 1.5°C above pre-industrial levels are asset owners and managers biting off more than they can chew?

Perhaps reflecting this concern asset managers State Street Global Advisors,  JP Morgan Assessment and PIMCO all recently withdrew from CA100+ and BlackRock transferred its participation to its international arm.

State Street said it believed the updated CA100+ ask of companies (e.g. to implement transition plans) compromised its independent approach to investee engagement. CA100+ responded by saying all members are free to engage with companies as they wish.

Universal ownership theory

Universal ownership theory argues that investors’ financial interests at the portfolio level are optimised by taking an economy-wide view of the impact of investment decisions, managing systemic risks and internalising intra-portfolio externalities.

An asset owner should, for example, seek to convince/pressure high-emitters in its portfolio to reduce their emissions – even if doing so would be financially detrimental to those companies – if this would produce a net benefit across its entire portfolio by reducing the negative impacts of climate change.

In a recently published paper titled Universal owners and climate change, Tom Gosling from the  London Business School says “in an era of scrutiny about fiduciary legitimacy of investor action, universal ownership is an attractive horse to which an environmentally or socially (ES) conscious investor can hitch their ES wagon.

“Action on any ES issue that can be presented as a systemic risk can be justified as consistent with an asset manager or asset owner’s fiduciary duty to maximise portfolio risk-adjusted returns to investors, indeed even required by it”.

In other words, it may be in line with an investor’s fiduciary duty to take an action that is inconsistent with the financial interests of a given portfolio company.

However, Gosling says the suspicion on the right of politics is that “universal ownership theory is being used as a trojan horse to shoehorn all manner of progressive causes into the investment process”.

Nice on paper

Gosling says asset owners with climate goals need to show there is a “plausibly reliable connection” between a given climate goal and enhanced risk-adjusted portfolio returns, and believe they have credible means – or tools – to achieve the goal without exposing beneficiaries to excessive costs and risks.

These ‘tools’ included increasing the cost of capital through divestment and engaging directly with companies to encourage changes to strategy, operations, and capital investment decisions.

What Gosling concluded from his research was that universal ownership as a mechanism to solve climate change “is nice on paper but seems doomed to fail in practice. It t is far from clear that pursuing 1.5°C with limited or no overshoot would be value-maximising for clients even if universal owners could achieve it.

“And the evidence strongly suggests that the tools at universal owners’ disposal are too weak to bring the targeted change about. Therefore, the idea of forcing change to reduce externalities from one set of companies to gain offsetting benefits elsewhere in the portfolio is simply not credible”.

Gosling suggests the value-maximising level of global warming for financial markets, even on a risk-adjusted basis, “will almost certainly be higher than the level set by a political process that takes a much broader view of economic welfare and intergenerational issues”.

He says it would be “remarkable if we were so fortunate that the optimal action on climate from a financial markets perspective was also the optimal action from a social welfare perspective”.

Lose-win scenario

Universal ownership logic requiring shareholders to force changes on companies that may be costly for them individually but beneficial for the wider portfolio is a “lose-win scenario”.

Gosling says there is evidence that investee engagement can change corporate action but he says the results are modest “and are most effective when the desired actions are aligned with value creation at the level of the engaged company rather than, as may be the case with universal ownership theory, acting against it”.

In their recent working paper Will Systematic Stewardship Save the Planet? Zohar Goshen and Assaf Hamdani note that “pushing companies to take meaningful steps to cut emissions requires investors to devise firm-specific strategies.

“Without an actor that could drive firm-specific changes, universal owners’ stewardship will have, at best, a limited effect on emissions, according to their European Corporate Governance Institute (ECGI) paper.

They believe investor stewardship is “a very poor substitute for environmental regulation. Universal owners might as well direct their efforts to lobbying governments – who do have the resources for policymaking as well as the scale for economy-wide coordination – for comprehensive climate regulation”.

They also see some problems in an approach where universal owners “are willing to inflict losses on – or “sacrifice the value” of – individual firms. Such an approach involves “openly prioritizing the benefit of diversified shareholders at the expense of” an individual firm’s other shareholders.

“Both the directors and the universal owners would face significant legal risks. The directors could be liable for violating their fiduciary duties, while universal owners themselves might be sued for aiding and abetting the directors’ breach of fiduciary duties,” the authors suggest.

Not really universal

Perhaps the biggest problem with universal owner theory is that even the biggest asset owners are not really universal owners – they do not in fact ‘own the economy’.

Asset owner portfolios are very heavily weighted towards public equity markets (and typically large companies in developed economies) whereas much of the negative impacts of climate change are generated by private and state-owned companies.

For example, national oil companies, including those with operations outside their home country, produce more than half of the world’s oil and gas, according to the International Energy Agency.

The so-called majors like Exxon, Chevron, ConocoPhilips and Woodside produce only 13 per cent of the total.  Even if asset owners were able to make any progress with the recalcitrant listed majors any curtailment of petroleum production could be quickly covered by the non-listed players.

And in public equities generally there are limits on what shareholder engagement can achieve.

In half of the world’s stock markets, at least one-third of all listed companies have a single owner holding more than 50 per cent of the equity capital. In almost 10 per cent of the world’s largest listed companies, the public sector holds more than 50 per cent of the shares.  And in half of the world’s listed companies, the three largest shareholders hold more than 50 per cent of the capital.

The boards of these companies are much more likely to be attentive to the views of their majority and/or controlling shareholders than to an activist minority investor preaching to them on climate change.

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