Fear, greed, and finance

There is a growing gap between investor awareness about climate change and actual patterns of invest

Clean energy is all the rage on the world's stock markets. Rising oil prices have resulted in investors' eyes focusing on the potential of alternative sources of supply. The stock-market valuation of the world's solar companies has risen seven-fold since the beginning of 2003. Even once-dull sugar producers have been reinvented as biofuel firms producing ethanol to serve the rising agenda of energy independence. And, as in so many things, everyone's eyes are on Asia, where China leads the United States on fuel efficiency and India is home to the largest wind-power company by market capitalisation.

But there is more to this than raw economic need. Fear and greed - the ancient gods of finance - and long-held investor assumptions about risk and opportunity are currently being recast by global warming. On the regulatory front, the EU's Emissions Trading Scheme (ETS) has finally given a cost to carbon. This has not only created a fast-growing carbon-trading market with London as its home, but also means that investment analysts are incorporating carbon prospects into their share-price projections for the energy sector. And, in the wake of Hurricane Katrina, investors have realised with a shock that climate change is not some future threat, but a clear and present danger, with a huge economic price tag attached for infrastructure, industry and insurance. Traditionally sceptical about environmental issues, increasing numbers of mainstream investors accept that addressing the long-term risks of climate change is part of their "fiduciary duty". One symbol of this new awareness is the Carbon Disclosure Project, an alliance of more than 200 institutional investors with assets greater than $31trn under management, which annually presses the world's listed companies to report publicly on the business-critical aspects of climate change.

Yet, behind these positive trends lurks a far more disturbing reality. For all the buzz about renewables and climate change, more money than ever before is going into carbon-intensive investments. The market capitalisation of the world's oil-and-gas sector, for example, has more than doubled to almost $2trn in recent years, as investors bet on demand for oil going ever higher, unconstrained by the needs of the climate. The International Energy Agency (IEA) estimates that more than $17trn is required worldwide over the next quarter-century to meet energy-demand growth that will top 50 per cent. And, says the IEA, the bulk of this will be invested in fossil fuels.

London's financial markets play a central role in providing capital for these carbon-intensive projects. The UK only emits 2 per cent of global greenhouse gases as a country, but about 15 per cent of the world's total emissions are generated from the products and processes of companies listed on the London stock exchange, such as BP, Rio Tinto and Shell. In addition, London has been an attractive place for new fossil-fuel companies to raise finance - from coal mines in Bangladesh to the oil fields of Sudan.

This gulf between rising investor awareness about climate change and actual patterns of investment urgently needs to be closed if the world is to achieve energy security and environmental sustainability. To date, the focus of attention has rightly been directed at the responsibilities of corporations to reduce carbon emissions. The task ahead is to identify matching duties for investors - essentially curbing the oxygen of capital for carbon-intensive activities. Here, inspiration can be taken from reforms introduced in the US in the wake of the corporate governance scandals symbolised by Enron and Worldcom.

With business malpractice threatening the integrity of the financial system, regulators decided that corporate accounts were failing to give sufficient assurance to investors. Special measures were introduced to hold executives to account and provide investors with additional transparency.

For investors faced with climate change, the problem is that corporate accounts still fail to tell the ecological truth, despite the positive impact of the EU ETS. Economics teaches us that climate change is simply a matter of externalities, whereby polluters fail to pay for the damage done by carbon emissions. One way of resolving this would be to require corporate accounts to include "shadow-pricing" scenarios that would show the impact of internalising carbon costs into a company's business. Using the Treasury's estimate of the cost of carbon at around £20 a tonne, research has shown that, on average, more than 12 per cent of the annual earnings of the UK's top 100 largest listed companies could be at risk. Providing investors with these scenarios would help to bring forward the future impacts of climate change, and demonstrate why additional action is required. Alongside this, investors themselves need to become more transparent about their own carbon performance. Investors have started to press companies to disclose their greenhouse-gas emissions, but are notably reticent about their own. Just as mutual funds in the US have to publish their voting records at company meetings to encourage better corporate governance, so funds could also report on the carbon emissions associated with their investments. In 2005, Henderson Global Investors was the first fund manager to produce a carbon audit of one of its Sustainable and Responsible Investment (SRI) funds, a development that will be extended this year.

With luck, we could look back five years from now and see this as the time when capital markets were mobilised for a low-carbon future. At stake are not just trillions of dollars of investment capital, but the future of the world itself.

Nick Robins is head of SRI Funds at Henderson Global Investors www.henderson.com/sri

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