Should large shareholders divest from high-emitting industries? Experts in Environmental, Social, and Governance (ESG) investments believe this approach is not the most effective means of addressing the climate crisis. Instead of fossil fuel divestment, they posit that investors can make a significant impact through engagement, as their financial power can influence boardrooms to adopt more socially responsible business practices.
Within the first months of 2022, the world has already been hit by a range of environmental disasters resulting in financial losses, injuries, and even casualties. These are not isolated events, however. The percentage of the global population susceptible to natural hazards has steadily increased over the years and will continue to grow unless adequate climate preventive action is taken. Covid-19 and climate change have created an unprecedented humanitarian crisis that has disproportionately affected the most vulnerable groups of society. This has exposed and exacerbated socio-economic disparities within and between countries, highlighting the need for greater integration of environmental and sustainability strategies globally. Since 2015, the United Nations Sustainable Development Goals (SDGs) represent the universal blueprint for achieving sustainable economic and social development for the period running up until 2030. Their implementation is the responsibility of both governments and the private sector.
As the major players in production and industry, businesses are morally obliged to actively participate in the fight against climate change. Tackling the world’s social and environmental challenges requires undertaking initiatives of a scale that only the business community can achieve. In the past few years, the private sector has shown more willingness to take accountability for its impact on the environment, recognising that a more sustainable world could also benefit its business operations. A large majority of the world’s business executives are concerned about climate change, and a significant percentage are already facing such challenges in their organisations; nearly 30% of executives are experiencing the operational impact of climate-related disasters, and more than a quarter report encountering resource scarcity. Despite corporate setbacks from the pandemic and the subsequent economic downturn, the significance of this newfound commitment to sustainability is expected to grow exponentially in the following years.
Moreover, younger generations are dramatically transforming the workplace. The fight against climate change is characterised by a clear generational divide: young Millennials and the Generation Z are at the forefront of the sustainability movement, and their voices are expected to become more prominent as they enter the workforce. Furthermore, the disruptive force of the pandemic is acting as a pivot point for societal transformation. Covid-19 resulted in an economy-wide shock not seen in many generations. The business community has begun to fear that the environmental crisis will have a similarly wide-ranging macroeconomic effect, but of greater proportions.
Today, companies must demonstrate their commitment to climate action under mounting pressure from numerous stakeholders. Among these, investors hold a great deal of influence over organisations’ business conduct. Once a secondary concern, sustainability is now deeply integrated into investing criteria. The growing investor interest in ESG factors places intense focus and scrutiny on ESG metrics and methodologies which can provide insight into a company’s emissions, as well as its climate risk mitigation abilities and renewable energy strategies. Concurrently, ESG ratings present various shortcomings, such as high levels of inconsistency across rating providers. This is partially a consequence of a lack of clarity and transparency concerning the methodologies used, highlighting the need for data standardisation. Despite obvious barriers to objectivity, studies have shown that there is a positive relationship between receiving a good rating on material sustainability issues and achieving high financial performance.
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With that being said, should investors redirect their trillions away from hard-to-abate sectors? Among responsible investors, there is an ongoing ethical dilemma regarding how to address their financial interests in high-emitting corporations: remaining engaged and engendering change “behind closed doors”; or divesting their financial holdings to exert pressure on company reputation and balance sheets.
BlackRock, the world’s largest asset manager, pledged in 2020 to eliminate companies that generate more than 25% of their revenues from thermal coal production from its active investment portfolio. The financial firm’s decision, initially praised by climate activists, was later vehemently criticised as it only pertained to a fraction of the coal industry.
In the eyes of Kaitlyn Allen, fossil fuel divestment is not the right answer for achieving zero-emission. Allen serves as the Vice President of ESG at ClimeCo, a global sustainability company advancing the low-carbon future with market-based solutions, and has extensive expertise in ESG investing and corporate sustainability communications strategy. According to her ,divesting out of hard-to-abate companies is not the most effective means of addressing the climate crisis. Instead, she strongly believes that it is necessary to engage with high-emitting industries, as they represent the biggest obstacle to net-zero. These industries are in fact responsible for a significant proportion of global emissions; their successful decarbonisation would represent an enormous step toward bending the emissions curve downward.
Allen says that high emitting and fossil fuel divestment leads to environmentally conscious investors losing their voice within corporate policy-crafting, whereas through active engagement, they have the critical opportunity to shift company behaviour. By selling off their share, she explains, they will not shift the needle towards net-zero emissions. The perspectives of academics researching business and management seem to accord with Allen’s view. A study conducted by two business professors from the University of Pennsylvania’s Wharton School and Stanford Graduate School of Business demonstrates that ESG divestitures from what they refer to as “dirty” companies do not have enough impact on the cost of capital to affect any meaningful business decisions. In order to drive real change, investors should retain their stake and exercise their control rights, demanding companies take necessary action on social and environmental issues. Likewise, research published by professors at the universities of Trento, Harvard, and Chicago argues that in terms of pressuring companies to act in a socially responsible manner, engagement is more effective than divesting. Kaitlyn asserts that in addition to being proven inefficient, fossil fuel divestment may result in shares being acquired by investors that do not care about the environment.
The business community has finally realised their exposure to climate risks, recognising their responsibility in ensuring the most carbon-intensive industries make the transition needed to cap global warming. Investors have the power and the resources to drive this change and actively contribute to climate action. Finally, greater transparency in the ESG regulatory environment will positively influence the perceived legitimacy and adoption of climate finance initiatives. Investing in environmentally conscious companies aimed at supporting mitigation and adaptation actions, as well as ensuring the world’s largest corporate greenhouse gas emitters take the necessary step towards emission reduction, are essential in reaching a net-zero outcome.