Institutional Investors and Coal – Beyond Reputational Damage?
In light of recent divestment announcements by insurers from coal, Lisa Benjamin examines emerging legal obligations for institutional investors in high-emitting industries such as coal.
A few days ago the Italian insurer Generali announced its plans to divest from coal-related businesses by no longer making new investments in the industry, slowly withdrawing its existing investments in coal, and increasing investment in green businesses. This announcement follows on from similar announcements from Lloyds of London last month that it will start excluding coal from its investment strategies from 1 April 2018, following Axa - one of the initial industry players to announce partial divestment in 2015. The insurance industry has been badly affected by a string of extreme events in the past few years, including hurricanes, floods, and wildfires. A recent report in December 2016 by ClimateWise (a coalition of some of the world’s largest insurers) concluded that the insurance industry’s ability to manage societal risks was being jeopardised by climate change, with more frequent extreme events making some assets uninsurable. The group also reported that due to the increase in extreme events worldwide, 2017 is likely to be the most expensive year for the industry on record.
The investor industry approach has by no means been uniform. In February 2018 it was reported that Aviva was increasing its investment, through its Polish pension fund OFE Aviva BZ WBK, in the Polish coal industry. The news was particularly surprising in light of Aviva’s Strategic Response to Climate Change, which includes strategies such as active engagement as well as divestment from ‘highly carbon-intensive fossil fuel companies’ where progress towards engagement goals is deemed to not be making sufficient progress. There is ongoing debate regarding divestment, with some investors choosing to remain and engage with management in carbon-intensive companies on enhancing low carbon emissions trajectories (although it should be noted in this instance that Polish pensions funds are restricted from engagement on investment strategies).
These recent events have highlighted the increasing importance of the issue of climate change in investment portfolios. Where investors have made commitments towards long-term temperature goals, the importance of interrogating their entire portfolios has been illustrated by Aviva. In addition, in light of these partial or complete divestments, it is important to note that legal principles for investors are beginning to emerge, and therefore investments in coal may, in the future, attract more than just reputational damage.
There have been a number of reports and guidelines issued in the past few months targeted at institutional investors and climate change. However two sets of principles are noteworthy.
In January 2018, the Oxford-Martin Principles to Guide Investment towards a Stable Climate (the Oxford-Martin Principles) were published in Nature by four academics at Oxford University. They are designed to provide physically-based engagement principles that are clear and fact-based. They set out three main principles to guide investors: ensure your investment target company has a clear commitment to net-zero emissions by a certain date, provides a profitable net-zero business model, and articulates clear, quantitative mid-term targets for emission reductions.
On 18 January 2018, a group of eminent legal experts published the Principles on Climate Obligations of Enterprises (the Enterprise Principles), which aim to outline the current state of international legal obligations of both enterprises and investors on climate change. The Principles are noteworthy as they articulate what the authors believe to be the current state of the law, providing obligations for both enterprises, but also for investors. The Principles are specifically positioned by a group of eminent legal experts as outlining the current state of international law, or, more likely, where they believe the law will develop. Although they recognize the Principles may be ‘aspirational’, they specifically mention the Principles may also constitute opinio juris, thereby over time providing a potentially binding legal character to them under customary international law.
The Enterprise Principles establish five main categories of legal obligations for enterprises and investors. Enterprises have obligations to reduce emissions from their own activities (Principles 2-8 and 12-16); to reduce emissions from their products and services (Principles 9-11); to reduce emissions in their supply chains (Principle 17); and procedural obligations on disclosure and environmental impact assessments (Principles 18-24). Investors and financiers have direct obligations as well, which include carrying out an assessment of the GHG emissions of any project (Principles 25-30).
It is important to note that investors, excluding pension funds, are considered to be enterprises under the Principles and therefore are bound by obligations to reduce emissions (Principles 2-24). Pensions funds are excluded from the obligations of emissions reductions as their profits are to be paid out to beneficiaries, and therefore would not be considered a private ‘enterprise’ under the Principles. Other investment actors, specifically asset management companies, however, would be covered by principles targeted at enterprises.
Pension funds such as OFE Aviva BZ WBK would be caught by Principles 25-30, which are targeted directly at investors and financiers. Under these principles, investors should ascertain the GHG emissions of any project throughout its lifetime (Principle 25), and consider whether the entity they are investing in complies with the Principles as a whole as part of its long-term strategy (Principle 26).
Critically for investors, Principle 28 states that no investment should be made in coal-fired power plants or enterprises engaged in excessively emitting activities (with a caveat that this definition will change over time) without ‘a compelling justification.’ If investors decide to remain with high-emitting investments, they should promote compliance by these companies with the Enterprise Principles by making use of their powers as investors (Principle 29). The Principles also advise investing in the best performing non-compliers. Non-active investment is high emitting-companies, and investment in worst-in-class companies, is therefore discouraged.
The extensive commentary which accompanies the Principles discusses the issue of coal and high-emitting industries. Principle 23 contains disclosure obligations for fossil fuel producing enterprises, and the commentary notes that it is ‘self-explanatory that limitations on the future extraction or use of fossil fuels will have an adverse impacts on the financial situation of this branch of industry’, rendering new reserves of oil and gas as stranded (p. 188). The Principles acknowledge that investors are bound to make a return on their investments in order to manage risk and inflation, but note that in their view investors are not only allowed, but in fact are obliged, to invest in less-profitable funds in the near future if this investment strategy is the only way to avoid a temperature increase of above 2°C (p. 226), providing an important gloss on the interpretation of fiduciary duties.
Fiduciary duties and duties of due consideration by directors can and are interpreted against industry norms and standards. While the Enterprise Principles may not create new legal obligations for institutional investors today, together with previous guidelines and principles as well as recent industry divestment activities, they signal a sea-change in industry standards. They will also provide fertile ground for litigation against high-emitting companies which will have consequential negative impacts for investors in those companies. The Principles also highlight the potential for retroactive action against high-emitting enterprises, as well as their investors both present and past, for climate damage. The Principles’ approaches to legal obligations for investors in coal and high-emitting industries should be noted, and should inform investment strategies going forward.
Lisa Benjamin is a 2018 Global Leaders Fellow at the Blavatnik School of Government, University of Oxford, and an Assistant Professor at The University of The Bahamas.
Image credit: Paul Downey via Flickr (CC BY 2.0)
