Are We at the Inflection Point of Climate Change Investing?
The rise of environmental, social and governance (ESG) investing is nothing short of extraordinary, according to Yu Meng, Chair of Asia Pacific at Franklin Templeton. As we are constantly reminded by extreme climate change events, he says urgent actions are required from all of parts of society and the economy, including the financial markets. In this excerpt from his recent article, “Are we at the inflection point of climate investing?” in the Journal of Investment Management, Meng explores whether climate change investing is at an inflection point.
Received wisdom in financial markets is being challenged by rising concerns with sustainability, as human economic activity stresses planetary boundaries and societal expectations for shared prosperity rise globally. The adoption of the UN Sustainable Development Goals by close to 200 nations in 2015 is one sign of the shared global ambition to tackle climate change, eradicate poverty, end hunger, foster productive work and education, ensure gender equality and protect the natural environment.1 Finance will play a vital role in achieving these goals. However, there is a gap between the demand for capital to respond to the risks and opportunities of sustainability, and the enablers of supply, which would allow the financial markets to allocate capital efficiently. The result is more noise than signal.
The breadth and depth of climate change issues test conventional appraisal of risk and return. The question for investors is whether capital markets are at an inflection point that could bring rapid, transformative and potentially disruptive changes. If so, how can investors ride the waves of change, which are driving both risk and opportunity in finance? In navigating the potential turbulence ahead, we need to close the gap between the demand for finance to address climate change, and the current constraints on supply capacity for markets to efficiently price those risks and opportunities.
We identify two broad sets of constraints: (1) lack of investment-grade climate-disclosure data and analytics (usually as part of the broader ESG data disclosure and analytics), and (2) misaligned incentive (e.g., presence of fossil fuel subsidies and absence of carbon pricing).