Investing 2.0: Assessing True Sustainability
Would you invest in companies that habitually operate beyond their financial budgets? Prudence suggests not. What about companies operating outside the thresholds of the ecological budget? Prudence speaks with the same tongue, but most investors aren't listening.
Socially responsible investors have long applied ad hoc environmental screens that vary widely, but we are unaware of investment screens or strategies explicitly tied to objective, science-based planetary boundaries or ecological thresholds. Developing and implementing such an investment approach is a positive transformation.
We welcome this shift, which builds on the existing definition and practice of sustainable investing to more explicitly respect real-world budgets of natural capital—a necessary step if we wish to retain a world that can nurture ongoing growth of financial capital. Call it sustainable investing 2.0, or perhaps threshold investing. What it's called matters less than that capital markets embrace it, so we can collectively turn our attention from the question of survival toward the creation of a thriving, sustainable economy.
The Carbon Budget
To illustrate budgets that respect the carrying capacity of natural capital, take carbon, for example. In research documented in the scientific journal Nature, the Potsdam Climate Institute pegs the world's carbon dioxide emissions budget at 886 gigatons (Gt) in the first half of this century—the amount of this greenhouse gas the global economy can emit and still have an 80 percent chance of avoiding dangerous climate change.
Unfortunately, most investment nowadays fuels a business-as-usual, beyond-budget economy that has already emitted 321 Gt of carbon dioxide in this century's first dozen years. This leaves a 37-year carbon budget of only about 565 Gt if we are to respect the 2 degrees Celsius warming threshold needed for a decent chance of retaining "a planet similar to that on which civilization developed." At its current burn-rate, carbon will almost certainly surpass that threshold and hurtle beyond, into the realm of potentially catastrophic climate change.
Investment Questions: Sustainable Risk and Return
Investors must ask themselves a couple of vital questions. What kind of world do I want to invest in: the warmer world we're currently creating, or a more stable climate, as much like our current one as possible? And which world carries less investment risk and healthier returns?
From the risk perspective, investing outside our carbon budget would leave some (or even lots of) assets "stranded." In other words, investments that must emit carbon to generate economic value may be unable to yield returns because of real-world constraints. The Carbon Tracker Initiative calls this effect a "carbon bubble" waiting to burst, just as the subprime lending bubble burst when reality intervened.
Investing within our carbon budget offers significant upside, with opportunities in established and emerging low- and no-carbon solutions, a dynamic comprehensively examined in the 2006 Stern Review. Investors who take this view can assess all companies in their portfolios in these terms, and reallocate capital from carbon-intense companies to those most likely to profitably navigate the transition to a carbon-constrained world.
Carbon Budget Yardsticks
How can investors make this assessment? One way is by looking through the lens of what the Global Reporting Initiative (GRI) calls sustainability context, one of the first-order principles enshrined in its sustainability reporting framework in the late 1990s.
"This will involve discussing the performance of the organization in the context of the limits and demands placed on environmental or social resources at the sectoral, local, regional, or global level," GRI explains. "For example, this could mean that in addition to reporting on trends in eco-efficiency, an organization might also present its absolute pollution loading in relation to the capacity of the regional ecosystem to absorb the pollutant."
In its Technical Protocol, GRI further explains that "performance [should be expressed] in relation to information about economic, environmental, and social conditions in relevant locations." For example, discussing water consumption in relation to available supply in a particular location.
In the case of carbon, this calls for comparing a company's absolute emissions to the ability of the global climate system to assimilate them. So the first step is to research the science to choose the most appropriate threshold. In the case of carbon, 350 to 450 parts per million (ppm) are the prevailing numbers (the 350 ppm target buys us the above-mentioned 80 percent odds of avoiding dangerous climate change, while the 450 ppm target weakens the odds to 50 ppm). The key is for the choice to be defensible, a best effort at aligning with how the real world works.
Allocating a Fair Share Slice of the Accountability Pie
Of course, individual companies are only accountable for their fair-share slice of the emissions reduction pie. Determining this proportionate responsibility calls for allocation. In 2006, article coauthor Mark McElroy of the Center for Sustainable Organizations (CSO) worked with Ben & Jerry's to pioneer its Global Warming Social Footprint, which allocated allowable annual carbon emissions on a per capita (or workforce size) basis. The resulting measure that year found the company operating at a level slightly beyond the threshold.
McElroy then worked with Cabot Creamery Co-operative CEO Rich Stammer and sustainability director Jed Davis to develop an economic allocation method to apply to its water use. Referred to as the "destamminator" (named after Stammer), it showed that the company's plants and member-owned farms were operating (and still are) well within the limits of locally available, renewable supplies.
At about the same time, BT's then-chief sustainability officer Chris Tuppen worked with Jørgen Randers, professor of climate climate strategy at BI Norwegian Business School, to develop a very similar economic allocation. Called climate stabilization intensity (CSI), the methodology calculates a company's contribution to GDP in terms of economic value added (EBITDA + employee costs). More recently, Randers published a journal paper on the methodology.
Autodesk used CSI as the launching pad for developing its own C-FACT (corporate finance approach to climate-stabilizing targets) methodology, an framework that the company now makes freely available. Similarly, CSO also makes the spreadsheets underlying its thresholds-based carbon metrics freely available to the public, and EMC has modified the CSI methodology for use in its own target-setting.Investors now have two free tools at their disposal to determine whether or not their portfolio companies are operating sustainably.
So, investors now have two free tools at their disposal to determine whether or not their portfolio companies are operating sustainably when it comes to carbon thresholds. With the rise of sustainability reporting, companies increasingly disclose their absolute emissions. Nothing is stopping investors from using them and investing within the carbon budget.
Threshold Investing: Decoupling Finance from Fantasy
Of course, the carbon-climate nexus is only one of the planetary boundaries. Luckily, a thresholds-based approach to investing applies to all ecological impacts. So investors can assess companies for compliance with all ecological thresholds, and allocate capital to those that respect the operating budget of natural capital.
Furthermore, sustainability applies across the triple bottom line of environmental, social, and economic impacts. Here again, a thresholds-based investing approach applies. Whereas ecological thresholds typically set ceilings based on finite natural capital resources, social thresholds typically upend this logic, setting floors or foundations of human, social, and constructed capitals that produce thriving communities and societies. Think of a living wage, or the minimum amount of income needed to survive, as such a floor.
Adopting a thresholds-based approach represents a transformation for sustainable investing. While such a shift may seem disruptive and uncomfortable, we see it as inevitable. Indeed, we don't see how professionals in the field can possibly assess the true sustainability performance of organizations, without taking contextually relevant social and environmental thresholds explicitly into account.
So we welcome this evolution, which brings the investment community into closer alignment with real-world limits and demands, finally decoupling finance from fantasy. Herein lies opportunity, as investors that work within a safe and just operating space to nurture a sustainable and thriving world, which is really our only option going forward.
Cross-posted from the Guardian with the authors' kind permission.blog comments powered by Disqus