What role can markets play in preventing climate change?
It’s the key to the change we need. Governments, of course, must establish the rules of the road and enact new policies. But the market allocates more money in a single day than all of the governments of the world put together allocate in a year.
I believe that markets will find more efficiency and superior performance by fully integrating sustainability values. That leads you to the conclusion that, even in the absence of new government policies, a movement towards rationality and a full, holistic integration of sustainability by the markets, by firms in the markets, will bring about significant change in the environment.
Is it happening already?
There’s so many examples I could use. Here’s one. I was in Toronto recently and I met with leading figures in the real estate industry there as well as the mayor. They told me how every sizeable new office building constructed in the last two years has been a green building, with low CO2 emissions, and the reason has little or nothing to do with politics or policy, but all to do with changes in the market.
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Now, the extent to which these sustainability features are reflected in the resale value of green buildings accelerates the adoption of these new practices. But you could use this example across all sectors. In almost every case, an intelligent integration of these sustainability values leads to more efficient, more productive, more profitable business practices. And as more and more business leaders, and more and more investors, recognize that it’s not just ideological, but it’s actually the truth, then this is going to be a growing wave. We’ve just barely seen the beginning of it.
So you believe this will become engrained in the daily fabric of business and finance?
Here’s another quick example. Western democratic society reached a point not too many decades ago where the commitment to diversity and the integration of minority ethnic groups became of much higher value. Those companies that demonstrated a commitment to that new appreciation for inclusiveness and diversity were often richly rewarded in the marketplace, and found new market opportunities.
I think that corporate CEOs are ahead of most of the investment community. They have long since begun to understand these new opportunities. Some of them have openly said that they would appreciate it if their large shareholders, including institutional shareholders, were themselves more understanding of corporate strategies that might require sensible investments that would bring returns over a slightly longer time horizon, which is often necessary to integrate these sustainability values into corporate strategy.
"There's a rush to find good ways to incorporate indicators of sustainable value, which means the end of the short-termist bubble is near. And good riddance, because a lot of damage was done to the environment, and continues to be done, because of it"
You’re now seeing it among some of the larger banking institutions. In some cases the commitment of larger banking institutions has run ahead of the expertise and knowledge that currently exists. And that’s OK. It’s right to try to understand the best ways to maximize the opportunities. It’s a massive shift, and it’s going to pick up speed and be one of the largest movements in the history of business.
Finance is a people business. If you don’t get the best and the brightest then you’re going to fall behind. So when the brightest say: "We won’t come unless you have a serious commitment and a sensible strategy on climate", then they’re going to go back to the executive suite and say: "Hey, we need a serious commitment and a sensible strategy".
Does it encourage you when you see major companies like TXU change strategy under pressure from both financial markets and environmental lobbyists?
It definitely does, and there’s more of that to come.
Where does your preference lie on carbon abatement – cap and trade or taxation?
Well my position is an unusual one. I am strongly in favour of both and I have never accepted the easy assumption that they are somehow mutually exclusive. They are not. They can and should work together.
I do understand, having spent almost 30 years in the political world, that there may be only political gumption enough to adopt one, if that. I do, however, think that the boundaries of political possibility are being expanded even as we speak, and what seems impossible and impracticable today may well be imperative tomorrow.
Cap and trade has one advantage in that it can be adopted as a global regimen, while it is truly difficult to imagine the maturation of the world’s political systems to the point where a global CO2 tax would be within the realm of the remotest possibility. It’s not. However, nation by nation I do think you are going to see a growing recognition that CO2 taxes have a role to play, and the advantage of CO2 taxes over cap and trade is that they are far more efficient economically – they put a price of carbon directly into every calculation and they drive efficiency.
Bankers of course would argue that markets are the most efficient mechanism of all.
CO2, of course, is odourless, invisible and tasteless, and as government policies, consumer preferences, branding strategies and environmental imperatives all move us toward a reduction in CO2, those who adopt efficient strategies for internalizing CO2 by pricing it will harvest increasing advantages over time. Look at nations that have been the most intelligent in pushing the boundaries of free trade and opening their markets. It seems painful in the short-term political context, but those nations have benefited the most over time, because they’ve given themselves the opportunity to face the full reality of competition and make appropriate, efficient decisions. CO2 taxes are in the same category.
So is taxation likely to play a more prominent role than cap and trade?
If and when the US and China, the two largest emitters, come into membership in the carbon-trading regime, it will become a much more efficient system. In the European trading system, there were flaws in the base-year calculation and overly generous, politically driven initial allocations. But a lot of those problems have been fixed, and it is now much more efficient.
And yet on a global basis the carbon-trading regime is like a bucket with a large hole in it. It will become more universal. I think it will become the principal way that the international political community addresses carbon emissions. But there will be a growing recognition that CO2 taxes alongside cap and trade represent the most efficient way of reaching the desired outcome.
Absolutely, I am encouraged. I am also constantly impressed by the need for urgency. A recent study shows the North Polar ice cap lost an amount of ice that equates to an area almost twice as large as Britain in just one week. Based on the current rate of decline, the scientists who conducted the study now estimate that if nothing is done it could be completely gone in less than 23 years. And if it goes, it won’t come back on any time scale relevant to the human species.
So the urgency is still nowhere close to what it needs to be.
David Blood and I founded Generation a few years ago after we were introduced by a close mutual friend who knew that each of us was conducting a search for the same specific opportunity – how to integrate sustainability into mainstream investing. We started from different points but we were headed towards the same destination. So we met, found that we shared much in common and we began a wonderful friendship, as well as partnership.
We founded Generation after looking carefully at all of the existing firms that had attempted to integrate sustainability in the investment marketplace.
There have been three waves of efforts to do this. The first was the so-called ethical investment wave, or negative screen. This was perceived by the fiduciary community to be unsatisfactory as it failed to get the best returns on investment. The conclusion was that leaving whole sectors out of consideration for reasons not directly related to the markets was at odds with the reality that risks and opportunities naturally fall in a pattern that covers the entire board of play.
"The carbon trading regime is like a bucket with a large hole in it. It will become more universal. I think it will become the principal way that the international political community addresses carbon emissions. But there will be a growing recognition that CO2 taxes alongside cap and trade represent the most efficient way of reaching the desired outcome"
The second wave was designed to address that perceived problem by keeping all sectors in consideration, but doing extra diligence in areas that needed it. This became known as positive screening, or best in class, and even though some firms are still building their track records, the fiduciary community perceives it as a less than satisfying model.
So we tried to come up with a new third way that would fully integrate the environment and all of the other sustainability factors, including treatment of employees, the executives’ ethics and values, treatment of community and stakeholder interests, and to fully integrate the sustainability values into every aspect of the investment process. We do deep research, using a team that is well trained and deeply versed in these matters.
Then we made two other commitments: one to full client alignment in the fee structure and in the full participation by all of our partners and employees; and secondly, importantly, by adopting a truly long-term approach that is reinforced in every one of the incentive structures in our partnerships.
The initial results are extremely good, but we are committed to continuing every single day to push the cutting edge of research and understanding to try to get the best return for our clients, full stop, and to do so in a way that fully utilizes the integration of sustainability.
There’s significant shift in thinking now evident throughout the investment marketplace, which is a very healthy and positive development. And it will continue to reward the early movers, because it brings the entire marketplace into alignment with reality.
What do you mean?
We have been living in a kind of bubble. I know the word is provocative. But the extreme short-termism that has been identified and criticized as a villain in the marketplace for so long has done particular damage to the commonsense approach to taking these factors into account in a normal and healthy way. Now, there’s a rush to find good ways to incorporate indicators of sustainable value, which means the end of the short-termist bubble is near. And good riddance, because a lot of damage was done to the environment, and continues to be done, because of it.
I don’t know that I would call it added pressure, because I think every investment firm has pressure enough. It’s a very competitive marketplace. I find it exhilarating, I enjoy it immensely, even more than I thought I would – it has been a fun intellectual challenge, and the team at Generation are a joy to work with.
Well one person’s labour-intensive initiative is another person’s entry barrier. We’re not sitting on some easily transportable crown jewel that someone could carry off in his pocket and then we would no longer have it.
But we do share a lot of our research, but there’s no dilemma. The more people who adopt our approach, the better, not only for the market and for the sustainability of our society, but for us specifically, because it is such a huge market, so filled with opportunities.
Part of our mission at Generation from the first day was to provide thought leadership and to help nudge the market towards transformative change. It’s not naïve altruism, as you would suspect – we know how hard it is to do what we do. And it’s particularly hard if you have a legacy process that conflicts with this new approach. We’re genuinely eager to encourage change throughout the marketplace but we know it’s going to take time, and we’re just doing our best and having fun in the process.