In a report released January 6, shareholder coalition Ceres found that many asset managers don’t account for risks associated with climate change. Ceres surveyed 84 managers who are collectively responsible for $8.6 trillion in assets. 44% don’t believe that climate risk is financially material; more tellingly, as Barry B. Burr notes in Pension & Investments, 71% only consider climate risk when they’re marketing a “green” fund.

Spotting Material Risks beyond this Quarter

One need not be a “believer” in climate change to prepare for a carbon-constrained future, or expect corporations to prepare as well – as even carbon-heavy ExxonMobil is doing. And yet, Ceres found that most asset managers don’t look at even the most vulnerable sectors:

“Less than one-third of asset managers incorporate climate risk into their corporate governance analysis. Even in sectors where asset managers believe that climate risk may be important, three-quarters have not changed their analysis of governance to include that risk.”

Ceres believes that managers’ short-term pay/performance metrics encourage myopia about long-term secular risks:

“Incentive structures and benchmarks that asset owners use for evaluating asset managers are heavily weighted towards short-term performance focusing primarily on quarterly returns where climate risks are far less likely to show up.”

Pension Funds Plan for Long Haul

Of the managers who didn’t account for climate risk, 49% said that their clients didn’t ask them to. Those clients who take a longer-term perspective on risk and return, such as pension funds, are more likely to expect their managers to do the same. Barry Burr of P&I spoke to Ricardo Duran of the California State Teachers’ Retirement System, who described CalSTRS’ efforts:

“’At this point, it’s an engagement process,’ Mr. Duran said. CalSTRS wants to impress on its managers the importance of including climate risk as part of their due diligence in their investment decision-making, he added.

“’Climate risk is a factor in long-term value, that’s what [CalSTRS CEO Jack Ehnes] has said,’ Mr. Duran said. ‘So climate risk ought to be looked at, not as the sole factor but as a contributing factor’ in investment value.”

Mr. Burr does note that CalSTRS will continue to use some managers who don’t incorporate climate risk into their analyses.

The Climate Change Governance Framework

How could clients help asset managers better account for climate risk? One solution could be the Climate Change Governance Framework, which was developed by RiskMetrics in 2008 and endorsed by the Investor Network on Climate Risk (INCR), a coalition of Ceres member organizations. INCR’s endorsement came as part of a Call for Action adopted at the 2008 Investor Summit on Climate Risk held at the United Nations. (The next UN Investor Summit on Climate Risk is scheduled to take place on January 14.)

Altogether, more than 80 institutional investors with nearly $10 trillion in assets under management have endorsed this plan, including more than a dozen state treasurers.

Florida Puts the Framework to Work

The Climate Change Governance Framework has five main elements addressing board oversight, management execution, public disclosure, emissions accounting and target-setting and product development to address climate change. Major pension funds, including CalSTRS, have formally adopted the framework in their Global Governance Principles to help guide their corporate proxy voting and management engagement efforts.

The Florida Treasury is the first in the nation to use the framework to evaluate its corporate bond managers’ climate risk accounting. Holdings of each manager are evaluated under the framework’s scoring system, and aggregate portfolio scores allow the Treasury to compare each fund manager against a benchmark.

The governance practices of higher-scoring portfolios indicate that they’re better positioned to meet the challenges and opportunities posed by climate change. The Florida Department of Financial Services queries its bond fund managers on a semi-annual basis, and expects ongoing improvement in their scores.

Managers Need Not Become Experts or Activists

Ceres’ recent report called for “each manager to have expertise in climate change,” but that may not be a realistic goal. It also may not be necessary. Application of the Climate Change Governance Framework, along with appropriate ESG research tools, could enable them to account for climate risk, whether they’re “green” or not.

Thanks to RiskMetrics analyst Doug Cogan, who contributed background on the Climate Change Governance Framework for this article.