Superannuation fund responses to the challenges and opportunities presented by climate change have been patchy to date, with funds facing lack of compulsion and limited incentives and experiencing meaningful constraints on how they invest, a new paper published by The Conexus Institute* has found.
The paper, Climate-related investment activity by superannuation funds, says climate change is highly relevant to funds for both its potential relevance to investment outcomes – including associated risks such as lowering economic growth, boosting costs and inflation, creating stranded assets and causing physical damage – and for the possibility it may give rise to “winners”.
“Climate change could throw up opportunities for generating returns,” the paper says.
“Most notable is the need to invest large amounts of capital in the energy transition as the world shifts towards a lower-carbon economy.”
But funds also must consider their legal and regulatory obligations, possible impacts on their own business operations, meeting community expectations and associated reputational effects.
The paper says that the member best financial interests duty (BFID) is open to interpretation, and considerable uncertainty exists over how climate actually affects investment outcomes, giving funds room to “exercise judgement” in how they address climate change and potentially holding them back from responding more effectively.
The paper, authored by the institute’s executive director David Bell and research fellow Geoff Warren, says an analysis of what Australia’s largest super funds are doing in response to climate change shows progress remains both uneven and relatively modest.
“We observe a range of climate-related investment activities being undertaken by super funds,” it says, but there is “considerable dispersion in climate-related investment activities”.
The paper says direct investment is modest in aggregate across funds, but consideration of climate risk is a more common occurrence.
“The upshot is considerable dispersion in climate-related investment activities, but the actual impact on portfolios remains constrained and relatively small,” the paper says.
“Significantly expanding the scope of climate-related investment activity by super funds probably requires a coordinated set of developments, including policy measures and changes in incentives for funds, such as a significant shift in community expectations, redirection of assets by members and adjustment of fund remuneration structures to take climate considerations into account explicitly.”
Limited scope
The paper says the “somewhat limited scope” of climate-related investment by the super industry, and the dispersion of action across funds “seem explainable by the circumstances in which funds operate”.
“Super funds face some significant constraints in the extent to which they are incentivised and able to undertake targeted climate-related investments,” it says.
Funds place a priority on investment performance under the BFID, the Your Future Your Super (YFYS) performance test and peer comparisons, and there is “an absence of any clear business incentives to pursue climate-related investment activities at scale”.
At the same time, funds have scope to interpret investment mandates, and returns from climate-related investing remain uncertain.
In combination, these factors mean that funds enjoy “considerable latitude to decide the extent to which they pursue climate-related investments”.
Even so, funds are not ignorant of the issue of climate change, and most have at least integrated climate considerations into their investment processes.
“We also see funds undertaking stewardship and related activities, such as membership of climate-related investor groups,” the paper says. However, these activities are “undertaken to varying degrees”, and while they are “constructive towards addressing corporate activities that may contribute to climate change [the] degree of the impact is nearly impossible to estimate… but we suspect it is modest.”
Such action as funds are undertaking “does not seem to have any significant influence on the shape of super fund portfolios including investment in the energy transition”.
Changing this situation requires either significant policy change, which would be difficult to secure and highly contested; and/or a major shift in community expectations “ideally coupled with members showing much greater willingness to direct where their savings are invested”.
“We suspect that a combination of developments is required to have significant impact, including multiple policy changes in concert,” the paper says.
“Isolated policy changes such as tinkering with the YFYS test benchmarks seem likely to have only marginal effects.”
Mandatory VER
One mechanism for lifting funds’ climate-related investment activities could be to require APRA-regulated funds to adopt a value-of-emissions reduction (VER) framework.
A companion paper, A mandatory value of emissions reduction framework for super, authored by the chair of the institute’s advisory board, Jeremy Cooper, says a mandatory VER framework could accelerate climate change-related investing.
Cooper’s paper says that mandating a VER framework – a globally accepted mechanism – would have two key advantages: it would bring all APRA-regulated super funds up to a uniform standard to the benefit of the system as a whole; and it would ensure that all members of APRA-regulated funds uniformly get the benefit of a VER framework in driving decarbonisation in super.
Cooper’s paper notes that a VER framework “directly aligns with, and is contemplated by” the Australian Sustainability Reporting Standard for Climate-related disclosures
AASB S2 (ASRS), issued by the Australian Accounting Standards Board and applied to RSE licensees under the Corporations Act.
The Bell and Warren paper says that perhaps the best chance for a major shift would be a galvanising climate event and precipitates a financial market climate-related “Minsky moment”, providing governments with the political capital to take aggressive policy action, and placing strong pressure on asset owners including super funds to respond.
“It is anybody’s guess as to if and when such a development might occur,” it says.
“Unless something significant changes, we expect more of the same from the super industry, perhaps with some modest expansion in targeted climate-related investment activities.”
*The Conexus Institute is a not-for-profit think-tank philanthropically funded by Conexus Financial, publisher of Professional Planner.
