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Climate paradoxes

Why engagement with companies is the answer to public policy

Home / Hermes EOS Blog / Climate paradoxes – Why engagement with companies is the answer to public policy

Over the last couple of years, we have seen real progress in our engagement with companies on climate change. The shareholder resolutions put together by the Aiming for A investor coalition, which now cover seven companies in the extractives industry, are helping to define a new industry standard for reporting on climate change. Meanwhile, with the 2015 Paris Agreement, global leaders have finally got their act together on climate change policy.  The agreement sets out the ambition to limit the increase in global temperature as a result of climate change to at least 2°C and a framework for ratcheting up national policy over the coming years.

Market failure
This progress is great but is it enough? Unfortunately, we must acknowledge that the global economy, and therefore most company activities, remain misaligned with the desired 2°C goal. Despite the claims of some, this is not really the result of corporate irresponsibility. Rather, Lord Stern’s analysis for the UK Government nearly a decade ago remains valid: “Climate change is a result of the greatest market failure that the world has seen”. Market failures are primarily a reflection of policy failure and therefore, in our view, the greatest blame lies with policy-makers. Neither companies, nor their shareholders, can invest at the scale required without the right economic framework.

Policy barrier
The key barrier to better policy is not actually the economic cost of tackling climate change, which is small – an estimated 1-5% of GDP according to Stern – in comparison to the roughly 300% growth in GDP anticipated globally by 2050. The real barrier is political nervousness over the pace of change and the creation of new winners and losers, particularly if this involves significant job or financial losses. This is the main reason behind the current de facto policy approach, which is to proceed at a sufficiently slow pace to avoid political pain, but which misses the 2°C goal.

Company support
To proceed more rapidly, governments need the support of the business community that their policies will primarily affect. They also need fresh ideas. There is no one better to deliver this than the companies themselves, which have deep insights into the pitfalls of regulatory change. However, to date, companies appear to have seen it as their duty to preserve shareholder value by ferociously defending the ground on which their current business models operate. The paradox is that long-term focused, universal investors actually want the opposite, namely companies taking a constructive approach to the development of ambitious policy frameworks, even if this leads to the inevitable shrinkage of some of their existing business activities, such as fossil fuels.

This sounds good in theory, but can it work in practice? There are glimmers of hope. In 2015, six of the world’s largest oil and gas majors called on the UN to help set a framework to introduce carbon-pricing systems. The Oil & Gas Climate Initiative, a coalition of 10 oil and gas majors formed in 2015 to tackle climate change, now has the opportunity to further consolidate this work. Our task as investors, through good stewardship, is to encourage companies to work together with policy-makers. We will also need to encourage and empower companies to support outcomes and be flexible to scenarios which may not be aligned to their existing business models. This is our engagement challenge.

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Bruce Duguid Bruce Duguid is a director at Hermes EOS and leads engagements with environmentally-exposed companies across the mining, oil and gas and utilities sectors, as well as corporate governance engagements in the UK. He is the lead author of the Institutional Investors Group on Climate Change’s 'Investor Expectations of Mining Companies – Drilling Deeper into Carbon Asset Risk’. Prior to joining Hermes EOS, he was head of sustainability at the UK Green Investment Bank, where he spent four years working on the project to establish the bank and then building its sustainability function. Before working in sustainability, Bruce worked in corporate strategy as a management consultant at the Boston Consulting Group and as head of strategy at Visa Europe. He is also a qualified lawyer in England and Wales and holds a degree in Natural Sciences from Cambridge University.
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