On Jan. 1, 2017, the action of numerous institutional investors in favour of the transition from the use of petroleum hydrocarbons to green energy, which up until now has been voluntary, will become obligatory. Article 173 of the Aug. 17, 2015, French law deals with the transition to a low carbon economy and creates a transition between the environmental concern(s) of institutional investors and their actions against climate change. Institutional investors will have to integrate criteria relating to social, environmental and quality of governance objectives (SEG) into their investment policies (French Financial and Monetary Code, Article L533-22-1).
From the fear of "peak oil" through the depletion of reserves to an overcapacity crisis provoking the devaluation of carbon assets
The economic impact of climate change has been known since the Stern report estimated in 2006 that the cost of inaction against climate change would represent between 5% and 20% of global GDP. Measures aiming to limit the rise of temperatures to 2 degrees Celsius, in accordance with international agreements, will have to be universally applied. However, a 2015 study published in the magazine Nature established that in order to meet the goal of 2 degrees Celsius, the CO2 emissions accumulated between 2011 and 2050 must be 3 times lower than the current greenhouse gas emissions stemming from the fossil fuel reserves (petroleum, coal, gas).
In addition, non-governmental organizations have highlighted the overcapacity of the gas and coal industries within the context of a reduction in the global consumption of coal over the past two years, according to a 2015 IEEFA report. The economists J. Boissonnot and F. Meunier recently emphasised that it is the attrition of demand that will push the economy into the post fossil fuel era and not a drying up of the supply.
The economic impact of climate change will affect the financial sector which is well aware that this transition profoundly modifies the economic models of fossil fuels, rendering the current fossil fuel assets obsolete prior to their amortisation and invalidating the dominant mechanism for valuation based upon the state of the reserves of exploitable fossil fuels held by organisations.
In response to this trend, institutional investors are contributing to the growth in the number of members in the financial sector required to engage in environmental reporting.
A double obligation for institutional investors and most likely for asset management companies: taking into account the actions taken by companies within which they invest in order to define their investment strategy and to exercise voting rights.
The social and environmental obligations imposed upon large organizations to measure the environmental footprint of their activities have grown increasingly since 2002. The Aug. 17, 2015 law increases their obligations starting Jan. 1, 2017 so that decision-makers, administrators, and shareholders are required to consider the impact of their company’s activities on climate change.
The report of the President of the board of a publicly listed company in France will have to present the long-term financial risks to the company associated with climate change and the low carbon strategy adopted to reduce it. This report which is required to be approved by the Board of Directors of the company and the shareholders is therefore significant. Large organizations will also be required to inform their shareholders in a more detailed manner regarding the consequences of the organization's activities and the use of goods and services on climate change.
The Aug. 17, 2015 law also makes the previous voluntary decision to take into account climate change by certain institutional investors, mandatory. This obligation which remains in the domain of "soft law" requires them to indicate within the company’s Annual Report the level to which their assets are exposed to climate-related risks, the portion of their assets which favour a low carbon economy and resource efficiency, the influence of the SEG criteria in their investment strategy, their actions which contribute to energy transition, the eventual changes in their investment policies and potentially in the engagement policies with the issuers and management companies. In summary, the institutional investors are encouraged to reorient their investments towards "carbon free" assets at the expense of fossil fuels which have become "stranded assets" or "blocked assets".
The law lists the concerned institutional investors are subject to these obligations. These include insurance and reinsurance providers regulated by the insurance code, health insurance providers or unions regulated by the health insurance providers code, pension institutions and their unions regulated by the social security code, venture capital organisations, the Caisse des dépôts et consignations (Deposits and Consignments Fund), supplementary pension funds regulated by the social security code, the complementary pension fund for non-statutory employees of the State and public bodies, the public establishment which manages the compulsory supplemental public-service pension scheme and the state insurance fund for local government workers. There remains is some doubt regarding the applicability to management companies which are not specifically listed under the law but merely by the decree implementing it (French Monetary and Financial Code, Article D533-16-1).
A methodological vagueness assumed by the legislator
Whether voluntary or imposed by the shareholders, certain companies had previously communicated the carbon footprint attributable to their activities and investments. However, these evaluations are sometimes limited and founded upon uncertain methodologies which do not allow for an adequate analysis of performance to be established or for comparisons between investors.
The application of this vague methodology is expected to continue until 2019 as the French Government preferred the empirical method based upon a variety of approaches which take into account the nature of the activities and investments of each of the regulated entities instead of prescribing a method which defines the calculation methods to be used and prescribing how the data is to be presented, thereby not allowing for a comparison of the data between financial organisations and products. An overview of the application of these approaches to encourage the identification of best practices will be completed before the end of 2018, in order to identify a protocol to establish the definitive baseline targets developed for the entities mentioned under the new law and its implementing decrees.
The protocol may end up reflecting the initiatives which emerged in the beginning of 2016, such as the those to be developed by the task force which was created by the Governor of the Bank of England and the Energy Transition Risk which created by the think tank, 2 Degrees Investing Initiative. Those initiatives aim to list the information that is to be provided by companies in the financial sector to enable investors to better appreciate the exposure of companies to climate related risks and to develop a financial risk evaluation methodology linked to energy transition, in order to better integrate those policies into the management of their portfolios.
The success of the transition to a low carbon economy rests largely on its financing. More than raising supplemental capital, this depends upon a significant reorientation of capital which is already available towards new technologies, services and carbon free infrastructure. The transparency obligations relating to the SEG criteria, by supporting this movement, appear to be key success factors for this energy transition.
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