John Connor, Climate Institute, and John Hewson, Asset Owners Disclosure Project at the launch on 11 December of “Climate Smart Super: Understanding Superannuation and Climate Risk.”

12 December 2013 — Green MashUP: Will your super fund leave you burning? Will your returns wipe out your investment like a home washed away in a super storm? How vulnerable are your retirement plans to climate change?

According to The Climate Institute, who have just launched their Climate Smart Super: Understanding Superannuation & Climate Risk report, many super funds are now exposed to a giant “carbon bubble” of investment ignoring the risks posed by climate change. Less than two per cent of the $30 trillion currently held by retirement savings funds around the world is invested in low carbon technologies and other climate change solutions.

And that leaves them vulnerable. As John Connor, chief executive of the Climate Institute says, climate change is costing $1.6 trillion annually, with those costs expected to rise to over $4 trillion by 2030. For Australia, conservative estimates for annual costs of unmitigated climate change on infrastructure alone are about $9 billion by 2020 and $40 billion by 2050.

“Numerous reports from banks, investment groups and others now highlight that serious climate action means many high carbon investments may turn out to be worthless, with a large majority of fossil fuels needing to be left in the ground. This could have a huge impact on superannuation funds,” Connor said.

The second Global Climate Investment Index put out by the Asset Owners Disclosure Project surveyed 1000 of the world’s largest retirement funds, insurance companies and sovereign wealth funds. It found that most were not prepared at all; they had their heads in the sand.

The survey included asset owners from 63 countries, in all regions of the world. Only South Africa’s Government Employees Pension Fund had calculated its exposure to overstated fossil fuel reserve valuations via the balance sheets of its investee companies. Asia-Pacific was the worst performing region save for Australia.

The report itself concurs with the findings of The Climate Institute’s findings that less than two per cent of a typical asset owner’s portfolio is invested in low carbon assets such as renewable energy equipment and energy efficiency companies. This is compared to an average of 55 per cent of portfolios pouring money into high carbon asset or sectors exposed to climate change (for example, mining companies, utilities etc).

This puts them at great risk, the report says.

“The recent sub-prime crisis, which the world’s financial markets are still reeling from, was a great illustration of systemic risk unravelling,’’ the report stated. “Ask any asset owner if in hindsight it would have liked a hedging strategy against the US housing market given their exposure. Any asset owners would respond positively. The same bubble is currently being created in our investment portfolios in terms of unmanaged climate change-related risks and the inevitable convergence of climate science and carbon regulation.

“There is growing recognition that climate change risks pose a similar threat to our investments as did the sub-prime collapse. This will impact carbon intensive investments and other investments exposed to the physical impacts. Just as in the sub-prime crisis. What is unclear is the speed and scale of the changes. This creates an urgent need for asset owners to manage the uncertainty. This urgency is further compounded by the possibility of significant legal risks in the event of financial losses caused by climate change impacts, both physical and regulatory, for those asset owners that fail to act.”

Former US vice-president Al Gore had also compared the carbon bubble to subprime.

“There are at present approximately $7 trillion worth of carbon-based assets on the books of public multinational carbon companies – oil coal, gas and the rest – and their valuation is based on the assumption that all of those carbon assets are going to be sold and burned. And yet it’s clear that no more than one third at most can ever be burned,’’ Gore says.

“Just as the markets suddenly realised a few years ago that the subprime mortgages were worth only a fraction of what they had been led to believe, these sub-prime carbon assets pose a real threat to the global economy.”

The property sector is particularly vulnerable. The Investor Group on Climate Change says climate change could pose material risks and opportunities to property and construction companies.

It says investors and their fund managers have a fiduciary duty to understand the risks. Social, environmental and economic considerations of climate change and sustainability should be integrated into standard investment appraisal processes and these issues are incorporated in management, monitoring and reporting procedures.

It says investment managers should also have a clear sustainability monitoring and reporting framework as part of their annual and quarterly communications and reporting procedures. That should include descriptions of how they incorporate environmental and social governance in their investment management practices, a track record of data collection, a presentation of sustainability performance achieved, some sort of contribution towards sector wide sustainability benchmarks, transparent disclosure of the industry guidelines being followed and the ability to show whether performance is externally verified and publicly reported.

Actuaries say there is still some way to go with in the way of contractual requirements. Only a minority of asset owners (18 per cent) have developed a formal process to assess prospective fund managers’ climate efforts.

Former Opposition leader John Hewson, a former economics professor and  currently Executive Chairman of Australian investment and advisory firm Shartu Capital, who is now working with The Climate Institute on the Asset Owners Disclosure Project, says many of our pension and sovereign funds are dangerously exposed to climate change risk. He wants fund managers to fess up to their exposure to carbon intensive industries, and give their investors the transparency they need to protect their money long term.

“They don’t have any easy way of managing that risk,’’ says Hewson. “They can’t lay it off in a derivative market, in the financial markets. They can’t insure that risk.

“In terms of financial consequences, it dwarfs the global financial crisis. It could have a phenomenal impact on the value of those companies. Those top 1000 [companies] control more than 50 per cent of all the listed companies on all the stock exchanges in the world. You think of the consequences of getting that wrong.

“In terms of those superannuation funds, they’re managing the financial future of people around the world and they have a responsibility to maximise the return to those superannuants over their lifetime.”

Still, there are signs that the super funds are starting to realise the enormity of the problem. The Wall Street Journal reports that some of the largest pension funds in the US and the world are worried that major fossil fuel companies may not be that profitable in the future and want details on how the firms will manage a long-term shift to cleaner energy sources.

Leaders of 70 funds said they’re asking 45 of the world’s top oil, gas, coal and electric power companies to do detailed assessments of how efforts to control climate change could impact their businesses.

The Stranded Assets program out of Oxford, which focuses on environmentally unsustainable assets that could suffer from unanticipated or premature write-offs, downward revaluations or be converted to liabilities, says the risks, whether they’re environmental challenges, regulatory change or litigation, to super funds are massive. Its solution for investors: divest.

“Divestment is a socially motivated activity of private wealth owners, either individuals or groups such as university endowments, public pension funds, or their appointed asset managers,’’ it says. “Owners can decide to withhold their capital – for example, by selling stock market listed shares, private equities, or debt – from firms engaged in a reprehensible activity.”

It says this is similar to the boycotting of tobacco and munitions stocks or of trade with apartheid-era South Africa.

Tools are now emerging making it easier for fund managers to evaluate carbon risk. Bloomberg New Energy Finance, for example, has unveiled the Carbon Risk Valuation Tool which lets investors look at a stock and see the impact of declining oil prices or a decrease in earnings as a result of decarbonisation.

The flip side is there are emerging investment opportunities in renewable electricity generation particularly in wind and large-scale solar. There is an enormous potential upside there as the world takes to these technologies to reduce emissions and make the planet a safer place.

The challenge for everyone is to ensure that super funds and managers uphold their fiduciary duty and minimise the climate risk of a climate subprime meltdown.